February 27, 2020 - Equity markets have suffered sharp selloffs in recent sessions in reaction to escalating fears about the ability to contain the coronavirus (aka COVID-19). During the first few weeks of reports about the illness, equity markets showed resilience, while yields on US and global sovereign debt plunged dramatically, reflecting both a flight to safety and expectations for meaningful economic slowing across the globe. (See Chart A.) This expectation was not shared by equity markets, as evidenced by their resilience. As new illness clusters surfaced in South Korea, Iran and Italy, equity markets began a selloff which, as of this writing, is continuing.
Despite all that has been reported in recent weeks, the most important thing we can relay about the virus and its potential impact on global economies and markets is that we still have far more questions than answers. As is often true of panic-driven news events, speculation has outstripped logic at this point. Still, we don’t know how bad things may get and, in light of the already weak global economy, we should expect, at a minimum, that the coronavirus will have a negative impact on China’s near-term GDP and a resulting negative effect on the global supply chain.
We do know that the epidemic seems to be spreading more aggressively than experts initially predicted and that some conventional methods of containment have failed. On the positive side, when compared to other disease outbreaks, the severity of coronavirus looks more like the flu, as shown in Chart B.
Currently, the fatality rate outside of China seems measurably lower than inside China. Furthermore, the most recent data for the total number of infections does not seem to justify the panic now driving the news cycle. (See Chart C.)
At this point, we simply don’t know how serious the outcome will be and it would be imprudent of us to sound the “all clear” based on the above data until more information is known.
The US equity market correction has been dramatic, but not at all unprecedented given how strongly equities advanced in the fourth quarter of 2019. Though we must take into account that news events such as this often spark price corrections that are temporary in nature, we believe investors should be prepared for continued weakness until there is more definitive data regarding the outbreak.
As we are in the later stages of a long-term economic and market cycle, it is natural to wonder if this event could set into motion events that lead directly to a recession or a secular downturn in the equity markets. As of now, we see no evidence of that. Although it is true that epidemics can be the kind of “black swan” event that changes a market environment, history tells us that global growth slowdowns have rarely led to US recessions. More often the reverse is true, with slowing in the US economy and US consumption driving the world into a recession. US consumers remain quite strong and we are watching data closely as any marked weakening in consumption or consumer confidence might change our outlook.
Over the past years, we have made a lot of money for our clients (and saved them from significant losses) by counseling under-reaction to panic-driven news events such as this. However, we are well aware that this particular event could manifest itself in many different ways. We believe that until more is known, investors should be ready for either continued equity market weakness or a rapid reversal and snapback if reports show the virus abating.
It is quite possible that global central banks, including the Federal Reserve, will be even more accommodative in their monetary policies in reaction to a coronavirus-related economic slowdown. This could set the stage for a cyclical rebound if the outbreak subsides over the coming weeks.
As always, the team at Pitcairn will closely monitor events as they relate to our portfolio positioning and risk allocations. We believe our long-term view allows us to put news events such as this in the proper perspective. As actionable information unfolds, we will keep you updated. Please do not hesitate to contact us or your relationship manager if you have any questions.