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Coronavirus: Important But Not Knowable [Yet]

by Catherine Trinder Miller, February 28, 2020


Over dinner with famed investor Howard Marks, Warren Buffett shared the following invaluable piece of advice. “For a piece of information to be worth pursuing, it should be important, and knowable.” His lesson highlighted the foolishness of predictions and the importance of evidence-based analysis and investing. Our investment style embodies Buffett’s important lesson. It is through this lens that implications of the coronavirus are increasingly challenging to measure.

The market loathes uncertainty, which the coronavirus powerfully and disturbingly embodies. This uncertainty has fueled the sharp swings in asset prices we’ve seen in the past week. With negative supply and demand implications for the global economy, coupled with transmission uncertainty, investors’ ability to assess the potential impacts to growth, and therefore asset prices, is limited at best in the short-term.

The following details about coronavirus are important: 1

  • Approximately 95% of cases remain inside China with the vast majority in the Wuhan province.
  • Reported new cases in China appear to have slowed dramatically; President Xi is actively balancing reopening Chinese businesses with containing the spread. Some green shoots this week:
    • Starbucks reopened 85% of its stores in China.
    • Apple reopened 29 of 42 China-based stores.
  • Transmission in the U.S. to-date has been low.
  • According to Raymond James healthcare policy analyst, Chris Meekins, we should know in the next three weeks if a wide-spread outbreak in the U.S. is likely.
  • While transmission rates appear high relative to other viruses, virulence is low with over 80% having mild illness and recovery.2
  • Efforts to contain the spread of the virus are vigilant and global.

Economic Implications & Responses
The base case scenario until recently assumed restoration of Chinese business activity by early April. If reported data is sound, China appears to have turned the corner with the number of new cases falling dramatically. Interestingly, while the U.S. stock market decline accelerated on Thursday, the Chinese financial market posted a gain.

China is already stimulating to restart their economy including interest rate cuts, liquidity for small and mid-sized businesses, and postponement of debt collection. This is only the beginning; Chinese leadership appears to be preparing significant stimulus, which could restore employment and output in the second half of 2020.3

Other governments and central banks are following suit with Hong Kong providing relief measures of HK$10,000 per individual and full loan backing for small firms up to HK$2.0 million.3 Germany is considering suspending the country’s curb on taking on new debts.4 Malaysia announced a $4.8 billion stimulus package to support tourism.5

Expect more fiscal and monetary policy expansion to follow building a bridge to recovery. And what about the U.S. Federal Reserve? In the words of former Federal Reserve Board member, Kevin Warsh, in Thursday’s Wall Street Journal op-ed, “A central bank’s primary job is to offset major disturbances to the economy. Today, the novel coronavirus is a material risk to the economy. It represents an unexpected shock, and the Federal Reserve should lead the world’s central banks in taking immediate action.”

In our opinion, it is increasingly likely that global central banks, possibly in a coordinated move, loosen monetary policy to bolster confidence and ignite demand. In the regions most affected, and as seen in past exogenous shocks, pent up consumer demand will release once markets reopen, potentially fueling a powerful rebound.

One of the most challenging questions investors are grappling with is the potential impact on global supply chains. What will this mean for de-globalization? Price inflation? These will take longer to play out.

Until we have better visibility on virus containment, it is difficult to estimate the potential economic impacts domestically or globally.

Risk Management Is Essential
Risk-taking behavior has been elevated for months. Throughout 2019 and early 2020, an increasing number of investors abandoned low-yielding bonds for the hope of higher returns in stocks; yet, as is often the case, these investors have little tolerance to stay the course in periods of market volatility.

As volatility has spiked, we’ve seen investor sentiment shift from flawless to hopeless with nearly unprecedented speed. Opportunities are unfolding. Given high, near-term uncertainty with virus transmission, and businesses and governments increasingly ring-fencing their people, we are vigilantly managing investment risks. With a 1.31% yield on the U.S. 10-year Treasury as of yesterday, safe-haven interest rates have reached levels that almost surely will generate negative returns relative to inflation; it is hard to imagine a scenario in which credit and stocks don’t outperform government bonds over the medium to long term.

While the human impact of events such as coronavirus can be devastating, history shows market volatility doesn’t necessarily imply negative investment returns by the end of the year. See Exhibit 1.


According to Bespoke Invest, there have been seven prior periods during which all three asset classes – US Treasuries, Gold, and the VIX (i.e., volatility index) – were simultaneously at least two standard deviations above their 50-day moving average. Measuring from the first day in each period, equity market performance over the following 1-3 months was mixed; one year later, the S&P 500 was higher all seven times, by an average of +16.1%. In short, the longer your horizon, the more likely equity prices stabilize and rebound. We expect volatility to persist in the near term. As asset prices decline, expected future returns increase. We are patient, yet diligent in seeking opportunities to capitalize on great entry points for highquality assets.

Invest in You. Trust in Us.

Footnotes:
1 – Worldometer; www.worldometers.info/coronavirus
2 – Whitworth, Jimmy, London School of Hygiene and Tropical Medicine
3 – Wall Street Journal; Hong Kong, Hit by Coronavirus and Protests, to Hand Out Billions of Dollars in Cash; 2/27/2020
4 – New York Times; Germany Eyes Tax Breaks to Counter Coronavirus Impact; 2/27/2020
5 – Bloomberg; Malaysia Announces Stimulus Package to Blunt Coronavirus Hit; 2/27/2020

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Catherine Miller and Theresa N. Benson, CDFA and not necessarily those of Raymond James.

All opinions are as of this date and are subject to change without notice.

Past performance may not be indicative of future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Dividends are not guaranteed and must be authorized by the company’s board of directors. Diversification and asset allocation do not ensure a profit or protect against a loss. Holding investments for the long term does not ensure a profitable outcome. Investing involves risk and you may incur a profit or loss regardless of strategy selected. No investment strategy can guarantee success.

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