The selloff was mostly driven by concerns about the spread of the coronavirus outside of China. Although the World Health Organization (WHO) said that it was not yet a pandemic, it increased its risk assessment from ‘high’ to ‘very high.’
Although the bond market received less media attention, the results were equally dramatic. For reference, the yield on the 10-year US Treasury on January 31st was 1.51 percent. On Friday, February 21st, it was 1.47 percent, modestly lower, but largely unchanged. By Friday, February 28th, the yield dropped to 1.15 percent, well below the all-time record low of 1.36 percent set in 2016.
Market prices are resetting partially due to fears of the unknown, but partly because the virus will certainly impact the economy and corporate earnings, but nobody knows the degree (especially since the virus is ongoing and doesn’t appear to have peaked).
Back in January, the market’s assessment of the virus was that the economic impact would be confined to China’s first-quarter economic growth with some supply chain impact, but following the v-shaped recovery that we’ve seen over the last decade.
Those views have largely passed, and the market is now expecting something more dramatic. For example, Bank of America downgraded its estimate of global growth for 2020 from 3.1 percent to 2.8 percent, the first sub-three percent growth rate since the 2008 financial crisis.
From an earnings standpoint, most companies are saying that they can’t yet estimate the impact of the virus, but markets are estimating cuts their too. Goldman Sachs, for example, cut their 2020 S&P 500 earnings estimate from $174 per share to $165 per share, suggesting that they think earnings won’t grow at all from 2019 levels.
All of this leads to two questions that we’re hearing from clients. First, should we sell stocks, and, second, should we buy stocks? I suppose those divergent views are what makes a market.
The best answer, of course, is that we don’t know. Like everyone else, we don’t know how far the virus will go and what the economic and market impact will be when it’s all said and done.
It’s easy to imagine that the virus fades from the media’s focused attention as it stops spreading, and there are fewer cases. If at the same time, central banks announce coordinated action and earnings come in better than their lowered expectations, markets will recover quickly and ‘buy the dip’ will have worked out fabulously again. We’ll forget about this episode, just like we did for SARs, bird flu, swine flu, and all of the other things that spooked us in the past.
Unfortunately, it’s also easy to imagine that the impact is worse than market expectations, and has a long-lasting impact, which could cause sentiment to change in the stock market, and lower overall valuations.
The trouble is that we just don’t know what will happen – nobody does!
But, that’s exactly why we take a balanced approach and set our asset allocation for each client based on their own financial circumstances and risk tolerance. Although we would never have predicted this specific event, we’ve planned for this by stress testing client’s financial plans, and so far, we aren’t seeing anything out of the ordinary from markets. Unpleasant? Yes. Outside of expectations? Not even close.
In every market selloff, I always repeat the same phrase: we planned for this.