The impact of the coronavirus has made for some heart-racing moments in financial markets over the last couple of weeks. But let’s take a quick step back for perspective. Investors greeted the new year with a surge in optimism due to the “Phase One” U.S.-China trade deal, falling Mideast tensions, a strong jobs report, and positive corporate earnings. Stocks abruptly reversed course and exited January in risk-off mode due to growing concerns over the potential economic damage from the fast-spreading coronavirus. In our view, the market had simply become overly complacent, having gone since October 2019 without more than a 1% correction. Stocks then briefly rallied into February as President Trump was acquitted and it looked like the coronavirus might be contained, before a surge in the number of new cases outside China unsettled investors. Since then, rising fears and uncertainty over the human and economic toll that awaits us have sent stocks sharply lower with equities falling at their fastest pace ever from a 52-week high to a 10% correction.
This pessimistic outlook on global growth has spread into the fixed income market, where bond yields have plunged to record lows, and is being confirmed by the relative weakness in small cap stocks, commodities, and value stocks – three areas most sensitive to economic activity. We believe investors are likely to remain jittery as long as the global economic ramifications of the viral outbreak remain unknown. Despite the potential for large cuts to global growth in 2020, we would expect to see economic activity and stocks rebound strongly once it is clear the epidemic is under control and normal business activity resumes itself, particularly as investors realize that the vast majority of stocks have dividend yields exceeding the 0.88% of 10-year U.S. government bonds. Importantly, central banks of the world are united in pumping liquidity into the global financial system, which ought to provide support for stocks. Not to be outdone by the Fed’s $60B monthly purchases of bonds, China has pumped hundreds of billions into its economy to cushion the shock to financial markets from the outbreak and our Fed just instituted its first emergency rate cut in more than 12 years.
So, what lies ahead? According to Cornerstone Macro, history shows that equity markets see a V-shaped recovery after a viral fear recedes, based on the four previous global viral outbreaks (Avian Flu, SARS, H1N1 and Ebola). While this outbreak is likely to have a wider reach and be more extended in terms of its impact, the Fed is likely to remain accommodative to help offset the short-term decline to global growth, and we wouldn’t be entirely surprised to see more precautionary interest rate cuts by global central banks.
In summary, if the above unfolds, history would point to an acceleration in economic growth next year with equities rallying in advance on both cheaper valuations and anticipated stronger earnings, and we are adjusting client portfolios accordingly. In the long run, we know superior managers focus on preserving investment capital to ensure they have the dry powder to go on the offensive when stocks become more cheaply priced. Over the past few months, we have simultaneously balanced an increasing preference for equities with de-risking measures such as improving the quality of our bond holdings and favoring lower-volatility stocks such as dividend payers and multi-asset income funds. This should serve investors well in the months ahead as we continue to monitor the situation and selectively respond to new developments.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.
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