After an initial global equity market sell-off at the end of January, stocks rebounded as a result of better-than-expected earnings results. Stocks began pulling back last week on news that the virus was spreading beyond China at a faster rate than expected. The global sell-off intensified today with emerging markets down over 3.5% and U.S. equities down 3.3 – 3.7%.
With equity valuations slightly stretched and investor sentiment still at modestly elevated levels, stocks are undoubtedly vulnerable to a correction. We do not believe this is the beginning of a longer-term pullback or bear market, as recessions and credit crunches are what tend to end periods of economic expansions. Global bond yields have fallen as fears of a prolonged economic slowdown drive demand for safe-have investments. The 30-year U.S. Treasury yield closed at 1.91% last Friday, hitting an all-time low, and was down another 11 basis points today. The 10-year Treasury note yield also declined hitting 1.36%.
A History of Epidemics
There have been a reported 79,000 cases and 2,623 deaths relating to the coronavirus, making the death rate after catching the disease around 2%. As noted in our first update on the coronavirus, this virus seems less deadly but more contagious than the 2003 SARS outbreak, which had a mortality rate of 8%. While it is still too early to tell when the virus will peak or when an effective vaccine may materialize, history tells us that both economies and equity markets eventually rebound as these epidemics subside. Economies typically experience weakness in the near term as supply chains get disrupted with growth eventually snapping back as they regain full capacity.
As anticipated, the major economic impact has been on the supply side, with disruptions in transportation and delivery. U.S. manufacturing and services have taken a hit, as both Markit manufacturing and services indices for February declined. Services was hit particularly hard (-4.0 percentage points to 49.4%), due to travel and supply chain disruptions while manufacturing dropped 1.1 percentage points to 50.8%. Additionally, surveys of purchasing managers also declined in Japan and France. Taiwan export orders, a bellwether for global technology and its supply chain, plunged a more-than-expected 12.8% year over year.
Lower demand may also be a consequence of fear of infection and quarantine. We expect lower consumer spending in both manufactured goods and services. While the economic impact is difficult to estimate, we continue to believe that this virus may take 0.5% to 1.0% off of global GDP in the short run, with U.S. GDP reduced by 0.1% to 0.2%. These estimates may prove to be a bit too conservative, however, as the aggressive steps China and other countries have taken to combat the spread of the virus may put even more downward pressure on growth.
Following what looks to be a better-than-expected fourth quarter earnings growth of 2%, companies are beginning to adjust first quarter earnings. We are also beginning to see its impact on corporate earnings. Most notable, Apple alerted investors that first quarter revenues may fall short of its original estimates. There have been about 50 S&P 500 companies thus far that have announced some risk, stemming from the virus, to their outlook. While we expect the virus may impact earnings of some companies in the short-term, we continue to expect earnings to grow at a modest pace with our S&P 500 operating earnings estimates ranging from $165-175 for the full year 2020.
While we continue to monitor the situation, we are currently not adjusting our portfolio positioning which consists of neutral equity exposure, with a small overweight to U.S. equities, a small underweight to emerging markets, a small underweight to fixed income and a small overweight to diversifiers.
In the end, we believe the economic and earnings weakness will be transitory, but the uncertainty will likely continue to create ongoing volatility. Investors should resist the temptation to exit the market and remain disciplined to their long-term investment strategy. For those underweight their long-term equity targets, the volatility may offer a buying opportunity.