The saga of the coronavirus disease or COVID-19 has evolved into a global concern in the last couple of weeks. The virus, while now apparently on the decline in China, has spread to more than 60 countries, with the US experiencing its first virus fatality over the weekend. The global nature of COVID-19 is causing consumers and companies to change behaviors, as reflected in China’s record low in recent manufacturing surveys. These changes are causing investors to start worrying about a recession in 2020. As a result, the S&P 500 dropped 15% from its all-time high just 8 trading days ago, experiencing its worst single week since 2008. A global ‘flight to safety’ has driven the 10-Year Treasury yield to nearly 1% and oil prices under $50.
Riverfront’s Playbook For The Unexpected: Trust The Process
The fear of the unknown can be gripping. This fear often leads to panicked selling as investors start to discount a worst-case scenario. While we have no unique insight on how or when this particular panic will end, we think the ‘worst case scenario’ often proves to be too punitive. For this reason, we think it’s important to take a deep breath and trust a well-constructed process to remove emotionality from decision making.
• Strategic Process: We build portfolios targeting investment horizons that range from 3 years to 10+ years, stress-testing them through past recessions and similar historical shocks. As a result, our shorter-horizon portfolios incorporate a conservative strategic asset allocation.
• Tactical Process: Historical review suggests that the recent sell-off may eventually present a buying opportunity, as we believe COVID-19 is unlikely to be a sustained economic issue. Thus for longer horizon investors, we suggest not selling into the current decline, and so far we have chosen to remain at current risk levels in our longer-horizon portfolios.
• Risk Process: To further protect principal from market volatility, our tactical risk management process is most acutely focused on the shorter-horizon portfolios, where we recently reduced risk and raised cash. For our longer-horizon portfolios, although we have not taken action, we are monitoring events closely. Additionally, since equities often quickly recover, reinvestment plans need to be decided at the time of sale and implemented when appropriate.
Maintaining Perspective: History Suggests Shocks Are Transitory
At RiverFront, our overall view remains that a non-financial ‘black swan’ event – such as a terrorist attack or a global epidemic like COVID-19 – is likely to have a negative near-term impact on the affected region’s economy, but that effect usually rights itself within a quarter or two. Similar double-digit stock sell-offs occurred after the SARS outbreak in 2003 and the 9/11 attacks in 2001. Global stocks ultimately recovered their losses in both cases. This is because risks cannot be viewed in isolation and tend to be met with countermeasures by policymakers.
Can Policymakers Mitigate A Global Recession?
While there remains skepticism about the limits of central bank accommodation, we believe that lower interest rates do have a positive effect on economic output through the transmission mechanism of housing, lending, and consumer and business confidence. As an example, the yield on 10-Year Treasuries has dropped roughly 80 basis points (bps = 1/100th of 1%) and West Texas Intermediate (WTI) Crude Oil has dropped nearly $14 since the beginning of the year. The combined effect has the potential to lower mortgage payments for those choosing to refinance and give consumers a needed income boost through lower gasoline prices.
Fed funds futures markets are already pricing in a high likelihood that the Federal Reserve lowers interest rates in March and again later in the year, and international central banks like the European Central Bank, Bank of Japan and People’s Bank of China are following suit with stimulus of their own. To this end, Fed Chair Jerome Powell helped spark a mini-rally after he mentioned the Fed will “use its tools and act as appropriate to support the economy.” We anticipate a coordinated response by the world’s central banks, which we think could help restore fragile investor confidence. Investors shouldn’t forget that policymakers also have a toolkit beyond just interest rates, and that definitive communication around a commitment to reflation can have significant impact on business confidence and financial conditions.
Risk Management: Next Technical Levels Of Support
As our chart below shows, the speed of the sell-off over the past week is of a different, more pernicious nature than anything we’ve experienced recently. Our first set of trailing risk management stops, a discipline we consistently monitor in good times or bad, were violated last week. In swift fashion, the S&P 500 violated what we would view as important support level at 3045 (200-day moving average) and is seeking to find support at 3000, an important psychological level. This may mean the market may not be quick to right itself in the near-term. We believe the next meaningful support exists around the 2845 level and, below that, at 2750. These may be viewed as important risk management alerts, in our opinion.
Appendix: What We Know About Covid-19 So Far
COVID-19 is a unique challenge for investors, with so much still unknown both about the disease and its ultimate effects on the global economy. However, as the epidemic enters its 2nd month and the worldwide infection rate nears 100,000, some characteristics are becoming clearer. Ironically, the more we learn about the virus, the less ‘existential’ its risks appear.
It does not appear nearly as dangerous as many past global epidemic concerns, such as SARS or Ebola. A quote from the Wall Street Journal last Thursday: “SARS killed about 10% of the people it infected, while about 2.9% of the people confirmed to be infected with this new coronavirus have died, according to World Health Organization data.” It’s also reasonable to believe that the ultimate mortality rate of COVID-19 will be lower than the current rate, simply because its asymptomatic nature (many carriers will never show symptoms) means that scientists are probably understating the total infection rate currently.
It does not appear to be mutating. COVID-19 has remained genetically stable so far, according to the US CDC.
There are no known vaccines or treatments approved yet, but several are in development. Technological progress in the last few years means that the genetic code of COVID-19 has been sequenced and decoded much faster than prior epidemics, leading to accelerated vaccine development (source Wall Street Journal, 2/25/20). In addition, existing anti-viral drugs that were effective on Ebola are also being tested.