The 12% drop in US stock prices (and somewhat less overseas) from the peak last week to yesterday’s close has probably grabbed your attention. So, we’re writing to give you a summary of our perspective amid the heightened pitch of news.
Steep declines from shocking developments are a known feature of investing as markets seek to estimate corporate earnings drops caused by changed economic circumstances. As recently as late 2018, we experienced a 20% decline in US stock prices while market participants feared the Federal Reserve would continue hiking interest rates toward normalcy in the face of an aging economic cycle. In January 2019, the Fed announced a change in direction and went on to cut rates three times, fueling a 25% advance in stock prices in the 12 months to last week’s peak.
Hot markets always need to cool down and something will always act as the trigger. This time the precipitating event is a virus, which adds a personal dimension (I could get sick!) and challenges us to imagine the speed and scale of infection and the consequences for economic activity as the public, governments and companies react.
This uncertainty seemingly removed the incentive for market participants to bid for stocks and other “risk assets,” the result of which can be seen in falling prices. Still, at some point the selling will exhaust itself because it is not as if some range of probable economic dampening can’t be estimated. Eventually, markets will price below the boundary of that range, and cooler heads will start to buy assets on the cheap.
As explained by the head of epidemiology at the University of California, Berkeley in a call with investors yesterday, coronaviruses like COVID-19 are common. He expects nearly everyone will eventually be exposed and not be symptomatic. Like the flu, the elderly and others with compromised immune systems are the most at risk. When asked how he and his colleagues are personally responding, his answer was to carry on as usual with good hygiene practices. We are adopting the same approach here and note that we can conduct business remotely, if necessary.
The economic dislocation from the virus comes from changed behaviors and policies: entire cities quarantined in China, schools closed in Japan, restaurants avoided and travel plans cancelled. These have already created some supply bottlenecks as well as declines in consumer demand.
Thankfully, new cases in China seem to have peaked and the country is trying to get back to work. The rest of the world is only now going through the process of infection, and that will take time to play out. In coming days and weeks we will learn of greater infections here and elsewhere, which we expect to contribute to further market stress.
What is the likely scale of economic fallout? US economic data was reasonably strong and improving as the virus hit, so we start from a position of relative strength. Estimates we’ve seen are that corporate earnings growth for 2020 will move down from 6% or so to zero. That helps explain the fall in stock prices, but isn’t anywhere near the scale of profit decline experienced in 2008-2009 as the popping of the housing bubble led to a global credit panic.
Beyond concerns about the virus, the presidential election is likely adding to investor anxiety. Given the success of the Bernie Sanders campaign for the Democratic nomination, we may be headed for one of the more dramatic choices in policy direction reflected in two candidates than we’ve seen in a long time. The odds of a Sanders nomination or presidential win may have been underappreciated by financial markets until recently.
While the virus and the election will be with us for some weeks and months to come, it is important to keep sight of several other factors that are also driving the economy and are likely to shape returns over the near-term and mid-term. These are summarized well in the Market Perspectives piece from Vanguard, which you can click here to read.
There are moments in financial life when market stress gives rise to an impulse to act (often to sell). We know that success comes from resisting impulses and reflecting deliberately in search of productive assets at prices that promise long-term rewards. We are monitoring opportunities as events develop and may be in contact about a recommended portfolio adjustment.
In the meantime, we wish you well and welcome your call about any concern.