In late February, headlines and concern that efforts to contain Coronavirus Disease 2019 (a.k.a. COVID-19) might result in slower global economic growth disrupted global markets. Share prices fell as economists and financial analysts revised growth expectations downward, and investors worried about the possibility of recession.1, 2
Efforts to contain the virus have included quarantines, factory and school closings, and trade show cancellations, reported Financial Times. These measures have slowed productivity in nations where they occur and elsewhere. For example, many American companies rely on raw materials and parts from overseas to produce goods here. When supply chains are interrupted, profitability may be hurt.1, 2
Consumer-oriented businesses like restaurants, entertainment, and travel companies have also been affected. Since consumers are the primary driver of economic growth in the United States, any event that slows spending has the potential to slow growth, reported MarketWatch. If consumer confidence is dented, growth could slow further.3
The good news is the majority of COVID-19 cases appear to be quite mild. The Director-General of the World Health Organization (WHO) reported COVID-19 appears not to be as deadly as other coronaviruses have been, such SARS and MERS. Based on information available at the time, WHO estimated eight out of 10 cases will be mild.4
Late cycle angst and a market correction
The recent downturn in U.S. markets may have as much to do with worries about the end of the United States’ extraordinary economic expansion and bull market as they do with coronavirus. At this point in the economic cycle, investors often are both hopeful and doubtful. The Economist explained:5
“[Investors] hope that the good times will last, so they are reluctant to pull their money out. They also worry that the party may suddenly end. This is the late-cycle mindset. It reacts to occasional growth scares – about trade wars or corporate debt or some other upset. But it tends not to take them seriously for long.”
COVID-19 has created another growth scare.
In January, the International Monetary Fund (IMF) projected global growth would strengthen from 2.9 percent last year to 3.3 percent this year. Then, COVID-19 began disrupting business in China and elsewhere. The IMF revised its estimate and predicted global growth would be dinged 0.1 percentage points if China’s economy returns to normal during the second quarter of the year.6
As the disease has spread more widely, estimates for global growth in 2020 become less optimistic. Former Federal Reserve Chair Janet Yellen commented on the virus at an economic conference, according to Bloomberg News. She said:7
“We could see a significant impact on Europe, which has been weak to start with, and it’s just conceivable that it could throw the United States into a recession…If it doesn’t hit in a substantial way in the United States, that’s less likely. We had a pretty solid outlook before this happened – and there is some risk, but basically I think the U.S. outlook looks pretty good.”
Whether the coronavirus will prove to be a tipping point for U.S. economic growth and how the Fed will react remains to be seen. Right now, there is tremendous uncertainty about the spread of the virus and its economic impact. As we all know, markets hate uncertainty.
Uncertainty may have had something to do with the market’s late February decline. Share prices declined around the globe as investors fled to safe-haven investments. On Thursday, February 27, major U.S. indices dipped into correction territory. (Corrections occur when a stock market, or an investment, declines by 10 percent or more.)8, 9
There have been quite a few corrections and sell-offs during the current bull market. Yardeni Research calls them ‘panic attacks,’ and reports the S&P 500 has suffered 62 of them since 2009. That number includes the recent decline that appears to have been triggered by COVID-19.10
It is possible investors will settle and the bull market will continue when COVID-19 is contained. It is also possible investors will remain nervous and the market will drop lower, possibly into bear market territory. (A bear market is defined as a decline of 20 percent or more from recent highs.)11
The situation remains fluid, but COVID-19 will run its course. Already the number of cases in China is declining.12
What should investors do?
First and foremost, investors should remain calm. It’s never comfortable to watch the value of your savings and investments decline by a significant amount. That said, investors who panic and sell when markets are falling lock in their losses. Those who remain invested may have opportunities to regain lost value if the market recovers, as it has many times before. We call this the "Behavior Gap". The difference in an investor's return vs the investment's return.
In addition, it’s important to remember, when stock markets fall, there may be opportunities to invest in shares of profitable companies at attractive prices. Those opportunities have been less abundant in recent years when share price valuations have been high.13
For example, the price-to-earnings (P/E) ratio for the S&P 500 Index has been well above its long-term average (15.78) for decades, suggesting companies in the index have been trading at relatively high valuations.13, 14
It’s possible the U.S. Federal Reserve will implement additional measures to support economic growth. There have also been suggestions central banks around the world offer a coordinated global response. That could soothe investors’ worries, too.15
Until the full effect of COVID-19 is known, markets may remain volatile. If you’re feeling unnerved, please give us a call. We’re happy to talk with you and help you decide on a course of action that is best for you.
1https://www.ft.com/content/e0a8cf67-896e-3b0c-89ce-03e43581008d (or go to https://peakcontent.s3-us-west-2.amazonaws.com/Peak+Documents/Apr_2020_FinancialTimes-Coronavirus-WHO_Escalates_Risk_Assessment_of_COVID-19_to_Very_High-Footnote_1.pdf)
5https://www.economist.com/finance-and-economics/2020/02/27/markets-wake-up-with-a-jolt-to-the-implications-of-covid-19 (or go to https://peakcontent.s3-us-west-2.amazonaws.com/Peak+Documents/Apr_2020_TheEconomist-Markets_Wake_Up_with_a_Jolt_to_the_Implications_of_COVID-19-Footnote-5.pdf)
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Economic forecasts set forth may not develop as predicted and are subject to change. Investing involves risk including loss of principal.
The Price-to-Earning (P/E) ratio is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means investors are paying more for each unit of net income, thus, the stock is more expensive compared to one with a lower P/E ratio.