No one can accurately project the bottom of this correction, but the full story of coronavirus is not yet written.
The equity market underwent a 10%+ correction last week and sentiment was very negative because of coronavirus fears. What is the best course of action now?
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The coronavirus is a serious concern from both a global health and a capital markets perspective. Below we will examine the virus’s effect on the markets last week and provide comments about our current thought process.
We advise: don’t give in to the fear. In our opinion, a client’s investment strategy — a diversified portfolio, thoughtfully selected to match their goals and risk tolerance — should not be abandoned because of this correction. The market may go lower from here — no one can predict where or when the bottom will put in — but history shows us the recovery will come.
Market correction
The continued spread of the coronavirus has caused a violent correction in global equities last week. As we all know, corrections are normal — but this one was especially swift. According to Deutsche Bank Securities data, the S&P 500’s drop by 10% from its peak over the last six days is the fastest correction on record.
The swiftness and severity of this correction indicates a very high level of fear. The market appears to be reacting quickly to all negative headlines. Media outlets are hyping the “Dow’s Record Point Drop,” which is just click-bait for those who don’t understand that it is percentage gains/losses that matter, not points. CNBC’s prime-time schedule Friday included a ‘Markets in Turmoil’ special for a record fourth straight day.
History of pandemic fears
Besides the fact that corrections are a normal — but painful — part of the market cycle, it’s also relevant that this is not the first time that pandemic fears have rattled the markets. Going back just a few decades, there is a long list of infectious diseases that became a “front-page” concern, including — but not limited to — SARS, MERS, swine flu, bird flu, dengue fever, and Ebola. The human suffering that these diseases caused is not to be dismissed, but from a purely markets-based perspective, they did no lasting damage to the global economy or the markets. It’s probable — though not guaranteed — that coronavirus/COVID-19 will play out the same way.
To repeat: no one can accurately project the bottom of this correction. The fact that coronavirus effectively took the world’s second largest economy, China, offline for a month shows that it is a very serious matter. The supply disruptions stemming from the interruptions in China may reverberate for months to come. Certain industries, such as airlines and cruise operators, have been hit very hard. Companies across many industries have revised Q1 and H1 revenue lower this week. The market reacted to this new information with the correction, so it may be said a lot of bad news is “priced in,” but the full story of coronavirus is not yet written.
Outlook
Central banks have shown they are ready and willing to provide as much liquidity as needed to support asset prices. As of only one week ago, the implied probability of a Fed rate cut at their March meeting was 9%. As of February 28, a March rate cut has a 99% probability (Bloomberg). Some believe we may not even have to wait until the March 18 meeting. The bottom line: the monetary policy backdrop for the markets remain positive.
The recent move in interest rates has been dramatic. On January 2, 2020, the 10-year U.S. Treasury bond yielded 1.88%. Today, the 10-year is yielding 1.16% and got to a low on Friday of below 1.10%. Correspondingly, the dividend yield on the S&P 500 as of todays close is 1.85%.
If you look at 10-year Treasury as a stock, it is trading for over 85 times earnings, and those earnings can’t increase for 10 years.The current earnings yield on stocks — the inverse of the P/E ratio, is more than 5%. This logic certainly seems to imply that relative to bonds, stocks remain attractive.
At the time of publication, March 2, 2020, the DJIA closed up nearly 1300 points. That's over a 5% gain for the day.
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