The Coronavirus and Market Volatility

By Steven Smith | Uncategorized

Mar 06

The trickle of news out of China, beginning last December, around the novel coronavirus (now being called Covid-19) became a deluge last week, as over 100,000 cases have now been detected in 70 countries, including the US.  Colorado reported its first case yesterday. There have been around 3,000 deaths reported world-wide, including 12 as of this writing in the US.

Starting from a record high for the S&P 500, reached on February 19; the index fell 14% during five days of trading beginning on Monday February 24th. The third worst one-week decline since 1976. This week has experienced dramatic daily up and mostly down swings. Markets are hoping for a strong global government public health and financial response.

A one-half point rate cut by the Fed on Tuesday together with the flight to quality (investors buying bonds) has driven the rate on the US Treasury 10-year note below 1% for the first time.

One thing is certain, we are in for a bout of prolonged financial market volatility.

Health Implications, Prevention and Preparation

We have no idea how virulent or deadly the disease will be.  There is not nearly enough data in yet to know whether the virus is either more contagious or more deadly than seasonal influenza; especially given the dearth of testing in this country and the inability to know how many people have been infected but are asymptomatic. A 2% fatality rate is a drastically different result if the denominator is 1,000,0000 than if it is only 100,000. And, of course, there is widespread use of flu vaccine, which could account for a relative higher lethality of any novel coronavirus. There is strong evidence that the virus disproportionately affects the elderly and people who are already compromised.

Steps are being taken to isolate people who have been infected. A smattering of schools has closed in this country. But school districts and the sponsors of sporting and entertainment events are on high alert in case the virus begins to spread more quickly. Non-essential travel is being imposed by many businesses and conferences are being canceled.  Obviously, we are way ahead of the science and knowledge that existed during the 1918 pandemic, which killed 50 million people world wide..

Far be it from a financial advisor to render medical advice. But the best sources I have seen for reliable information and for what preventative measures to take are The World Health Organization and The Center for Disease Control. And I particularly liked this article in Scientific American.

As for how to to sanitize your space when you are flying, if you must.

Economic Implications

There is genuine concern for what actually may occur in the economy if the virus spreads and people are confined to their homes or hospitalized as took place in China. (Although things have appeared to get a bit better in China over the past few days.)

It is not clear to what extent normal monetary or fiscal policy could work in a situation like this in which the underlying problem may not be on the demand side; but rather a “supply shock” – caused by a health crisis – creating shortages as well as the inability of people to go to work. Plus, there remain millions of Americans who do not have access to quality health care and could certainly not afford a prolonged hospitalization.

China is the world’s second largest economy and, for better or worse, has been integral to the growth in global GDP for a generation. Like it or not our economic fate is entangled with theirs. Economists are uncertain of the medium and long-term economic fallout.  Businesses have remained closed there.

In addition, the US economy is largely a service economy. The more the virus spreads and people react with “social distancing” by staying from the gym, sporting events etc., the more the economy is likely to suffer.

Investment Implications

Epidemics, in the abstract, are just like any other exogenous jolt to the economy and the markets. Fear is a natural reaction to events like these. Where this is going is extremely uncertain. Veteran financial journalist Jonathan Clements has called the coronavirus event a nearly perfect laboratory experiment to test investors’ mettle; ticking of just about every emotional and cognitive trap in the behavioral finance lexicon.

Don’t Panic. The overwhelmingly most important consideration for how to manage this situation is the manner in which you have anticipated for it in your plan. This was part of the risk tolerance and portfolio construction exercise taken when implementing your strategy.  If you are losing sleep; it’s a good time to at least check in on your strategy and make sure it is still appropriate.

Risk vs. Volatility. Volatility, the inevitable and sometimes dramatic changes in securities prices is different from risk. Risk is the chance that you won’t be able to meet your financial goals. They are related because volatile asset classes generally have higher expected returns. The critical thing is to have at least close to the right mix of return seeking and buffering asset classes to meet your individual circumstances.

Time Horizon. It’s very important to know and be comfortable with the time horizon of your portfolio. One of the advantages of being a long-term investor is not having to know what’s going to happen tomorrow, next year – or even five years from now. Remember, what matters is not what tomorrow’s news will bring. But rather whether it is different from what today’s investors think tomorrow’s news will bring.

It is very common to have significant intra-year declines even in good years for the market. There’s no way to know whether volatility on a given day or week is a harbinger or not. For long term investors the pain is likely to be temporary. We have had significant virus related sell-offs in the past (2003 -SARS; 2016 – ZICA) and markets recovered after a few months. Of course, this one may different and take longer for the global economy to digest.

Liquidity.  Make sure you have enough in cash and bonds to meet any short term and intermediate term needs.

Only Time Will Tell

Nobody knows how or when this will end. The most important thing is to take care of yourself and your family. And to take whatever steps you can to lessen the impact on your community. Feel free to check in with us about your portfolio.

 

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