Coronavirus Sparks Volatility

Wednesday, March 4, 2020
Coronavirus Sparks Volatility

 

Stocks have been whipsawed in recent days as news of the coronavirus spread fears of economic damage around the globe. Initially, the virus and the economic impact were thought to be relatively confined in China, which was forced to attempt to contain the virus despite the negative impact on economic activity. Markets reacted swiftly and severely once it became clear that people were being infected in other countries and in the U.S. As is typical in environments of higher volatility, steep selloffs have been somewhat offset by sharp increases. The volatility is likely to continue in the weeks ahead as investors try to sort through the noise, and the medical community along with policymakers try to respond to the situation. Ongoing campaign season developments are also likely to exacerbate volatility in the weeks ahead.

The stock market entered the year with stretched valuations after an incredible run in 2019. As a result, it’s no surprise the market reacted so negatively to the coronavirus news. Aside from the obvious health-related fears, the concern is that the virus continues to spread, causing further economic damage resulting from supply chain disruptions and reduced consumer spending. Some of these outcomes are already apparent, such as sharp reductions in travel, shutting down of businesses and schools, cancellations of large public gatherings, and so on.

Interest rates and commodities have also experienced significant volatility. Interest rates have fallen to record-low levels. The ten-year U.S. Treasury note yield has fallen to all-time lows of less than 1%. As a result, high-quality, safe-haven bonds have provided positive returns so far this year. Crude oil futures plummeted as demand projections were being slashed, while gold prices have risen on the uncertainty of the overall situation.

Unsurprisingly, economic growth estimates and company earnings estimates have been drifting lower as the virus has spread. The big question for investors is whether and how much further both fall before the virus is finally under control. Since there are many unknowns about the virus itself, this is an extremely difficult question to answer with any degree of confidence. As politicians and health officials scramble to react, central banks have made a coordinated effort to calm markets with stimulative policy responses. The Fed cut its benchmark rate by a half-point, a rare and bold move that demonstrates the level of concern about economic prospects. As always, investors will be watching to see how impactful such responses will be on the real economy.

The virus-induced stock-market selloff is the latest example of the wisdom of diversification and a focus on quality. It is impossible to know when these events will occur, which is why an appropriate level of exposure to bonds is a key component of our investment strategy for most clients. In part due to expanding valuations in 2019, we were more defensively positioned entering the year. And while it is impossible to completely avoid losses in the stock market, an emphasis on quality within the stock portfolio helps cushion the blow.

This correction was also notable for being one of the fastest on record. As painful as they are, these quick, sharp moves often create dislocations in pricing and fundamentals of individual securities and even entire asset classes. We are always on the lookout for opportunities to take advantage of these dislocations to position portfolios for the future.

Finally, in times like these, it is helpful to be reminded that staying invested is the most prudent strategy to build wealth. Allowing fear and panic to drive decision making undermines the ability to succeed over the long term. There are any number of statistics that provide perspective for long-term investors, but perhaps this is one of the most persuasive: between 1926 and today, the S&P 500 Index posted a positive return 56% of the trading days, 75% of the calendar years, 88% of the 5-year periods, and 95% of each 10-year period. Importantly, large portions of these positive returns have come in the form of rebound rallies following a selloff, such as those seen in recent days. As a result, it’s critical to maintain a disciplined approach, especially during these stretches when it can be the most challenging.