When the coronavirus (Covid-19) first hit the news, the markets shrugged off the outbreak, assuming that China’s aggressive efforts to quarantine Wuhan would limit the spread. This assumption fell apart rapidly over the past weekend as cases appeared in South Korea, Italy and Iran. In keeping with other periods of stress, stocks have fallen sharply (7-8% in the last few sessions as of this writing) and quality bonds have rallied as investors seek safe alternatives for their assets.
None of us are contagious disease experts, but our reading suggests that this virus has spread to all 5 continents and that reports of new cases are likely to continue to escalate in the near term. Western scientists determined that over 3,000 individuals were flying out of Wuhan (a city with a population of over 10 million) every day during the early stages of the epidemic. Some of these individuals must have been carriers of this virus and it has been documented that person to person transmission is reasonably frequent. China’s official statistics are most likely under-reporting the number of cases of the disease. On the positive side, Covid-19 does not appear anywhere near as deadly as SARS since the vast majority of those infected by the coronavirus only experience mild symptoms not requiring hospitalization. Early estimates of mortality rates from contracting the virus are less than 2%.
The spread of the disease has caused two types of economic damage. The first is a reduction in supply as many supply chains in Asia have been disrupted. Workers returning home from the Chinese Lunar New Year were often locked out of factories causing production to plummet. Apple warned of these issues last week. The other economic issue involves a decrease in demand. Sick individuals are not buying goods and services causing a contraction in the Chinese economy. The combination of these negative consequences will spread with the virus.
Our working assumption is that these impacts will be temporary and economic growth will return once the disease has run its course. There is also the potential for antivirals or vaccines to be developed to combat the illness like those developed for SARS or the common flu respectively. It is possible to imagine an alternative scenario where the disease pushes the global economy into recession and a slowdown becomes self-reinforcing. We are not able to predict the future but do not recommend selling stocks and waiting in cash or bonds until conditions improve. Market timing does not work since it’s impossible to pick market tops or bottoms and especially hard to re-establish positions after exiting the market.
Bond yields are now at all-time lows as investors have flocked to US Treasuries. The 10-year bond yields 1.28% and the 30-year Treasury yields only 1.8%. These rates are below both the dividend yield of the S&P as well as below inflation so that investors buying these bonds will lose purchasing power over time. Low yields are another compelling reason not to sell stocks.
The above recommendation to remain invested assumes that the investor’s asset allocation is appropriate for his or her circumstances and risk tolerance. We continue to advise that clients keep a few years-worth of cash flows in cash and high quality fixed-income investments to withstand potential investment losses in stock portfolios. It is also helpful to place this volatility in a historical context. While markets dipped during the 4th quarter of 2018, we have not experienced a sustained bear market for over a decade. Last year, US stocks increased by about 30% in value while international common stocks appreciated over 20%. We have been due for a pull back for years and the triggering event could have been any shock. US stocks are only down about 3% year-to-date and the market is trading at the same levels it did in early December of 2019. It is impossible to predict how this epidemic spreads and the associated economic developments; however, we recommend patience and expect stock prices to rebound when there is less uncertainty.