The COVID-19 Virus and Investment Volatility

Global equity markets were “rocked” this past week as many investors decided to “sell first and ask questions later” regarding how the Corona Virus (COVID-19 virus) might impact the global economy, and more importantly, the impact to the general population.

Over the past six market sessions, most broad equity markets entered correction territory (defined as down more than 10%) which, in the United States, was the fastest drop into correction territory from a record high that has thus far been experienced in market history.

This certainly can be viewed as concerning and is definitely something to keep an eye on.  However, in the context of what we know currently, please consider the following observations:

1. The U.S. stock market in particular has been rising substantially since 2016 while corporate earnings overall have not followed suit.  That means that there has been a significant Price / Earnings expansion which can often deflate as quickly as it inflates when something out of “left field” (like this new virus) comes along.  We think that the U.S. market in particular has been ripe for a sell-off, given the 10 plus year business expansion that we have enjoyed and very low levels of volatility, which we view as investor complacency.  While the potential of human tragedy could be significant, given how contagious COVID-19 appears to be as well as its higher than normal mortality level, the concerns for investors stem from the second and third order effects of what is going to happen to the global economy.  Given the number of just-in-time global supply chains that are linked around the world, what happens to corporate profitability if multiple supply chains need to be created (i.e. diversifying away from China)?  What happens if the virus shuts down human “flow” for months instead of weeks?  What happens if countries start shutting down their borders?  While we do not claim to be virologists, it does appear that the pace of the virus expansion is slowing down in China, but picking up in other countries around the world.  We don’t know these answers, but we believe this is a primary reason that, AT THE MARGIN, many investors are panicking and not waiting to see what happens.

2. Various styles of investing such as Large Cap Growth, Small Cap Value, etc. have been down nearly the same amount from peak to trough.  To us, this is an indication of panic selling driving by people selling broad index and ETFs indiscriminately.  Even gold, which had been consistently rising through this time of market volatility, fell 5 percent last Friday which was blamed on a number of factors, including investors having to sell “good” investments in order to meet margin calls. 

3. While there remains a long way to go to see who the Democrats put up against the current incumbent, it appears that investors are becoming nervous about the increasing odds of a Bernie Sanders nomination – given his proclaimed socialistic economic policies and what investors believe the impact to business and market prospects will be.  We believe that this is another variable, in addition to the Virus, that has surprised investors at least to-date.

4. Until we have further information regarding the spread, severity and duration of the Virus that is different from past “events”, we believe that this pullback, which could possibly morph into further downside, is creating the opportunity for much higher equity premiums to be harvested for investors with a longer-term view.  Please see the below chart for the rationale in making this statement. As always, we believe times like now are “gut checks” to review how much investment risk one can really absorb.  We have discussed doing these checks over the past year as it is always best to do these checks “in advance”.

Sources: Robert Shiller Data Collection at Yale University and Centers for Disease Control and Prevention. S&P 500® Composite Index does not include reinvested dividends.

Seasoned investors know that markets do not just go up with minimal pullbacks on a continuous basis.  Volatility, often from unforeseen events, creates the “oxygen” to fuel healthy future returns assuming that there is not massive and permanent economic damage.  Please contact the County National Bank Wealth Management Team at 517-437-3371 if you have further questions or concerns.