BSW has been following the spread of the Coronavirus (COVID-19) very closely. At this point, it seems to still be spreading rapidly through much of Asia and is creating slowdowns and bottlenecks in a supply chain that was likely just starting to revive from the loosening of tariffs.
To be clear, we don’t think that this is the zombie apocalypse. Studies show that most individuals who get infected will recover. We do acknowledge and recognize that if there are any active cases anywhere in the world, that we are not out of the woods. This virus has proven to be highly contagious, especially amongst older people. One of the biggest risks that we see is that China and other countries sound the all-clear too soon and that the cycle of infection starts anew.
- The number of people infected by COVID-19 at this stage of the virus cycle is well ahead of both the 2009 Swine Flu and the 2003 SARS Infection. Note: The below chart is log scale, meaning that the growth depicted is exponential in nature.
- The virus is highly contagious. As an example, reports show that one infected person that disembarked from a cruise ship in Japan led to 600+ others infected within a short period of time. The COVID-19 death rate is also much higher in those over age 60. Those under age 15 seem to rarely contract the virus.
- China has imposed travel restrictions and quarantines that have resulted in factories running at a reported 50% of capacity. Many workers that left big cities for the lunar new year holiday in January were not allowed back in after the virus took hold.
- Information on the spread of the virus in places like India and Indonesia is unknown because these countries are not testing for it yet.
- So far, the global stock markets seem to have taken the slowdown in these large economies in stride. The prevailing sentiment is that China is pumping record amounts of liquidity into its market, cutting taxes and cutting interest rates to aggressively combat any slowdown. It is also thought that other central banks will soon follow suit. Per speculation, the probability of a Fed rate cut this coming July was hovering at 20% before the outbreak – now it’s at 75%.
- Despite the stock market largely ignoring the epidemic, the bond, gold and commodity markets have recently priced in a more significant hit to the global economy. Gold is rallying to new highs; bond yields have fallen, and oil and copper prices have plummeted.
- In our opinion, there are signs that the quarantine in China will have immediate adverse effects on corporate profits. Apple recently said that it will struggle to ramp up production of cell phones and earbuds due to its China factories running at half speed. The auto industry has raised warnings. It may take another quarter for CEOs to come to grips with what is happening on the ground. We think the virus may start to take more of a center stage as the excuse for companies not hitting revenue targets.
Handicapping the Unknown – Where Math and Theory Break Down
- Wall Street in general has not been very good at discounting or handicapping Black Swan events. Its standard answer for almost all scary, unforeseen events seems to be to ignore them. It has worked most of the time. The answer to the recent Suleimani bombing? Ignore. Trump winning the election in 2016. Brexit. Ebola in 2014. Stock market flash crash in 2010. Ignore. Ignore. Ignore. Ignore.
When faced with a high probability that an event will have no effect on the market, paired with a low probability of a serious negative effect, the resulting rational reaction has been no action.
- In our opinion, this time may be different in two important ways.
- Unlike other recent unanticipated events, COVID-19 may have longer lasting economic ramifications. The longer the negative impacts, the more stocks need to go down to account for the decrease in earnings expectations. A “V” shaped recovery is the best-case scenario. A “U” or “W” (the latter in the case of virus re-occurrence) would open the market up for more potential downside.
- COVID-19 has surfaced at a time in the market cycle where stock valuations seem to be much closer to overvalued than undervalued. In other words, stocks are more vulnerable to a pull back.
- BSW expects that volatility will increase in the coming weeks as the virus proves to be hard to contain.
- We rebalanced portfolios at the end of January, meaning we took some profits in stocks and added to bonds in most cases. This disciplined rebalancing should put portfolios in a good place to absorb and take advantage of any market dips going forward.
- We are working closely with investment partners that are on the ground in Asia to keep abreast of the fluid situation. The next few weeks should be telling. The key, in our opinion, is to see the second derivative (the rate of change) of new infections come down and level off. Building from there, we need to see the known infection numbers drop to near zero before China and other countries lift quarantine measures – due to the infectious nature of the virus.
- Lastly, we want all our valued clients to know that we do not believe now is a time to panic. We have attempted to build portfolios based upon individual long-term goals, objectives and risk tolerances that importantly attempt to take these types of bumps and events into account. We feel your angst regarding not only the financial impact of this new virus, but also the humanitarian impacts that it is having around the globe. Our thoughts go out to those impacted. It is times like these that nations need to set aside their differences and unite to help prevent a broader epidemic.
Until the next update and always, your team at BSW is here for you.
Director of Public Investments