Our Viewpoint on Coronavirus and the Markets
We’ve all watched markets plunge this week, largely due to concerns around slowing global growth accelerated by the spread of the coronavirus to nearly 50 countries as of this writing. We’d like to offer you our thoughts regarding the rapid descent of the markets this week. While we know the drop likely raises concerns about your investments, we want to reassure you that we are keeping a close eye on the markets and will continue to provide guidance as this health crisis continues to evolve. We even think that this market downturn has a silver lining of sorts, in that it’s a reset that could set the stage for potential advancement during the year.
1. We have expected and embrace a market pause/pullback (though we are sorry to see it inspired by a global health concern). Quite frankly it could have been ignited by any number of headline issues…campaign, geopolitical tensions, fallout from impeachment, etc., but coronavirus is the item du jour. As we noted, we believe that a pullback is healthy to reset or refresh. That said, we think the potential path to advancement may be a little different than originally anticipated—perhaps the first half may be a bit softer than expected and the second half a bit stronger—but we maintain our 3350-3500 S&P 500 target for the year and even remain biased to potentially take this target up, if the coronavirus issue stabilizes in the time frame we expect, and the likely bounce in CEO confidence stemming from improvement on the trade/tariff front is able to reveal itself.
2. We take comfort in the fact that fundamentals were improving going into this coronavirus scare…to wit, Q4 2019 earnings are being reported at better than expected levels (+2.5% overall EPS growth versus negative expectations going into reporting season and a better 5% EPS growth result, ex-energy, as declining oil prices caused energy sector earnings to plummet 20%). Payroll growth is great, and wage growth decelerated to a good spot, strong enough to spur spending, but not too robust as to crimp margins. Housing is very healthy and a key driver of U.S. growth/the continued expansion story. We saw bounces in the leading economic indicators, including retail sales and even PMI manufacturing data. The same can be said with global data. It was getting less worse or beginning to stabilize/bounce in a number of areas and metrics. The point is, we face the coronavirus headwinds with some tailwinds and momentum rather than with various economies running out of gas.
3. There is some positive trend in the coronavirus data itself that seems to be lacking attention. Specifically, new daily cases reported in China have peaked above the 2,000 level. New cases have been falling for some time and are now down to the 500 level. This is very important. The fact that this country with over a billion inhabitants and the source of where it all started is getting this under control is critical. This is being offset by news of new cases in South Korea, Italy and Iran, as well as in pockets of South America, which is grabbing attention and offsetting the positive trend in China that accounts for over 90% of all cases. We also recognize the risk of global spread, but containment in China is encouraging and there is no reason to jump to worst-case outcomes and assume it cannot also be contained in these other areas. The pandemic calamity that is implied in current market behavior would not be our base case. The CDC is saying that the risk has increased and that this could become a pandemic and wants people to respect the risks here.
4. There is a big difference between a temporary supply shock issue caused by a self-inflicted quarantine that creates supply shortfalls and a temporary inability to meet demand that is still there, versus an implosion in final demand caused by massive long-term dislocations in the economy (e.g., surging unemployment, credit market distress imploding earnings) and imminent recession. What we have here is the former rather than the latter. The former is characterized by a temporary decline in activity similar to what happens in natural disasters such as hurricanes or earthquakes. We tend to see v-shaped or u-shaped fallouts in these cases. Demand falls swiftly due to the disaster but recovers swiftly as things stabilize and pent-up demand quickly shows up. This is why we expect a softer first half than originally anticipated but a swifter second half, in the form of a v-shaped or u-shaped pattern.
5. Linked to the point above there is likely a v-shaped or u-shaped pattern to the market correction and associated recovery in our view based on the fundamentals and the nature of this supply-oriented versus demand-oriented issue. We believe it is inappropriate to take significant action in such an environment because, by the time you sell, you are into the correction and, by the time the swift recovery begins, one is generally too late to shift into buy mode to benefit. Hence, we believe it is best to hold positions or make only modest opportunistic adjustments in stock selection. This is far different from bull market tops that are followed by multi-quarter, multi-year steep market drops that require significant defensive adjustments. We do not see signals of the latter currently. In our opinion, it is key not to mistake activity for progress. We take action when we think there is true benefit and potential value added.
6. Balance is the key today, not heroics, and that is what we have employed in our investment strategy. Many say, “absolutely go for it” and “buy on the dips,” like now. Others say, “no, no, no, this coronavirus scare “is different”…run for cover and sell all your more aggressive and cyclical holdings and go to pure defense”. We think such extreme/heroic thinking is off base. We are pleased that we strive to establish a balance of growth and value and of offense and defense in our portfolios. Poise, diversification, measured action and balance are the key in our minds to success in the midst of this volatile, but still likely positive, trending market.
7. With regard to measured activity, while we lean toward wanting to view the current pullback as a buying opportunity, we want to be poised in doing so and do not plan reflexive buying immediately. We respect that the coronavirus situation is evolving, as well as the psychological reaction to it.
8. What happens if we are wrong regarding our relatively positive base case and the worst case of pandemic spread of coronavirus takes hold? We would likely adjust our thinking and raise cash/become more defensive. And we believe there is time to do so if this occurs. After all, we are only back to the 3100 level at this writing, which is where we were in December of 2019 following a 31% run in the market. It’s not as though changing positions based upon new data at this point is a defeat…it would be protecting a significant amount of gains that were generated during 2019, at a time when we were very positive and most were preaching doom and gloom about 2019. 2019 itself is a great example of why we should not jump to worst-case conclusions but maintain the poise to listen to the data.
The S&P 500 Index is a market-value weighted index provided by Standard & Poor’s and is comprised of 500 companies chosen for market size and industry group representation.
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