The old saying “what goes up, must come down” seems like an appropriate saying for the recent performance of the market. The markets had a surprisingly strong year in 2019, which was not fully justified given the economic realities and some of the risks that were known. Markets were priced almost to perfection; with stretched equity multiples and new all-time highs, it does not take much to reverse the momentum and move back to reality. In this case it only took 6 days from new all-time highs for the market to reach correction territory, the fastest drop from all-time highs to correction territory ever. During this period, the VIX, also referred to as the fear index, spiked from around 15 to an intra-day high of 49 on February 28.

We want to provide a brief summary of some of the major index performances both for the month of February and year-to-date:

At the start of the year, sentiment was high and not many people had heard of the coronavirus, let alone were they worried about it. The fears started to spread in mid- to late-January, but the markets did not appear to begin to care until around February 20.

Nobody seems to be able to put any certainty around the impact that the coronavirus can have, nor is there complete confidence of the real global penetration rate. Data coming out of China is regularly questioned for accuracy and these data releases are not different. We are not doctors, and any doctors or government regulators we hear speak about the virus do not seem to know much about the magnitude or impact that it will have. We do know that the virus is very contagious and could be fatal to some humans. While we are concerned with human life, our commentary is going to be focused on the potential impact this new virus may have on the markets.

We do know that the majority of cases are found in China, which is the world’s second largest economy and the linchpin of many supply chains. Many goods are made in China, but even the goods that are not made in China still have inputs that start in China. With some parts of Chinese cities under quarantine, many businesses in China have closed which means goods cannot flow easily to other less impacted parts of the world. This will impact many multi-national companies and small companies that count on goods coming from China. Many travel-related companies like airlines and cruise ships have been impacted, and retail companies who count on the wealthy Chinese consumer for purchasing have been hurt.

The risks of the coronavirus have driven interest rates lower, pushing the 10-year treasury yield to all-time lows. With lower interest rates and an inverted yield curve, banks and other financials have been hurt. With the expectation of lower global growth and lower oil demand, oil prices have fallen, hurting the energy sector. The energy sector fell over 14% during the month of February alone.

In addition to the risks of coronavirus, the odds that Bernie Sanders will win the Democratic nomination have increased. Wall Street does not want Bernie Sanders to win the nomination and quite frankly, we don’t think the Democratic National Committee does either, but he is gaining momentum and currently looks to be the favorite to win the nomination. The rise of Bernie and the coronavirus are compounding negatives for the markets. If the coronavirus were to cause economic troubles or the unlikely, a recession, between now and the election, that hurts President Trump’s reelection campaign. It is unlikely that the rise of the coronavirus will cause a recession. If it did, it would be very difficult to get re-elected President in the same year, and if Bernie is on the other side of the ticket, investors will be concerned.

Another troubling effect of the coronavirus is that monetary or fiscal stimulus cannot help stop the spread of the virus and boost the economy. Lower interest rates will not drive consumers to take cruises or travel, nor will it put Chinese workers back to work. Lower rates may be able to help in the recovery. However, if goods can’t be sold because they will not make it from China or businesses can’t build goods because the inputs are still in China, it does not matter how low taxes are or how low the cost to borrow money. 

In previous commentaries, we had been skeptical of the markets seamless march to new highs on less than supportive economic news. We now find ourselves warning about getting to negative over the current landscape. We think things could get worse before getting better, but markets fell so significantly and so quickly that markets may be short-term oversold. The last week proved to be another reason why investors should be invested based on their objectives and not on the sentiment of the market. If you are a long-term investor with significant equity exposure, you should not be concerned with the recent correction. The same is true if you have a short-term need for your money or are drawing on your portfolio periodically, for example in retirement, because you should be invested in an allocation that is not fully exposed to these large and quick drawdowns. The coronavirus is causing short-term disruptions in the economy and market, but over longer periods we continue to believe equities will provide an adequate return for investors.

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