Episode description
This is our second podcast dedicated to COVID-19 (coronavirus) as renewed fears dragged stock prices down last Friday and again on Monday, February 24th. The dow jones industrial average closed down more than 1000 points. The rising coronavirus fears are likely resulting from significant new outbreaks in Italy, South Korea, and Iran. Political rhetoric from Bernie Sanders over the weekend likely added fuel to the sell-off in health insurance stocks – Senator Sanders won the democratic primary in Nevada on Saturday where he described his Medicare for All – calling for the elimination of private insurance.
Stocks staged an impressive rebound from initial coronavirus fears, but concerns about the global economy are compounding as the virus spreads to many continents and countries. Companies ranging from Apple to Ralph Lauren to Procter & Gamble have cautioned that upcoming earnings will be impacted by slowed retail sales and supply chain disruptions. These companies are proof that effects of coronavirus are moving beyond the more obvious travel-related industries like airlines and cruise ships. The classic risk-off response several weeks ago was quite modest but we said in our first podcast that “no one has a crystal ball when comes to pandemics or epidemics”. Just like then, we have a world filled with emotion, and emotion is driving much of what we see at the moment. I think it is important to consider two behavioral emotions – first is confirmation bias and the second is known as a herding bias.Confirmation bias is simple, we make decisions based on information that reinforces what we believe. Herding bias is just like it sounds. We tend to follow the herd, regardless of where and why it is moving.
Over the last several weeks, the leading question is whether the economic and profit impact of coronavirus will be more than a one-quarter event. What we know so far is emerging market equities, airlines and oil prices have continued to cool since the day Chinese officials confirmed the virus can spread from person to person. Now, the not so obvious companies are beginning to feel the effects of supply chain disruptions and slowing retail sales. Even with this recent bout of selling, stocks remain near record highs. On the other hand, gold, bonds and commodities are suggesting increased fear and a more-sluggish period of economic activity over the next few months.
Ultimately, we expect the virus impact to take the path of other major outbreaks, that is, a short-duration impact). Lest we forget, the Fed’s low interest-rate policy and rebounding corporate profits, in our opinion, continue to offer a sound long-term backdrop for stocks. Also, 437 S&P 500 companies having announced fourth-quarter earnings, it is our understanding that 71% of those companies have exceeded the consensus, above the long-term average of 65%. Basically, if the current trajectory holds, the final result versus expectations will be among the strongest of 2019.
Giving a little more confirmation to stable economic conditions, the Empire State manufacturing index rose sharply to 12.9 in February, up from 4.8 the prior month, with strong gains for both new orders and shipments -- although the component for future business conditions was essentially unchanged. Housing starts remain strong and new home permits were up a strong 9% in January. Consider rising home permits, higher consumer confidence, reduced unemployment applications and high stock prices, it is unlikely that we are headed for an extended sell-off. However, I should mention that the producers manufacturing index feel to 49.4 in February. Anything below 50 is said to indicate contraction in the economy.This is the first time we have seen this number below 50 in four years. There is no question that coronavirus is starting to impact several industries.
On the whole, we expect the economic damage from coronavirus to be moderate and mostly contained. In our opinion this means the economic rebound is not being derailed, rather it is more akin to a delay. From our view, additional disruptions to global economic growth will occur in the next few months, especially as it relates to manufacturing and trade. But, keeping this in perspective, we are talking about a change in global GDP or .2 - .3%. You should also be aware that the most severe damage is occurring in the Chinese economy - according to Reuters, analysts expect the outbreak to cause significant damage to China’s growth in the first quarter and hinder their global trade for months to come.Europe is also feeling significant effects due to their export-oriented economy. Finding a silver lining in all this chaos and distress seems improbable. But consider this, all these economic worries have driven bond yields to near record lows. In fact, 10-year yields have landed at 1.38%. If nothing else, yields at these levels most likely delay any possible shifts to tighter monetary conditions. As we see it, Central banks around the globe remain extremely accommodative despite resilience in the service and consumer sectors.
In our first coronavirus podcast we shared a number of things gleaned from other global disease epidemics. You may recall what we found was encouraging - economic growth and markets have historically responded with a V-shaped pattern. Our research showed that initial reactions tend to include a slowing of consumer spending with a rebound that happens almost as rapidly as the downturn. Pent-up demand eventually helps fuel the rebound. History tells us that recoveries are typically led by retail and manufacturing sectors. It is safe to say that reduced flow of people and goods due to travel restrictions and quarantine measures are already affecting demand in the short term and that trend will likely continue for a few months. Similar to the 2002/2003 SARS epidemic, the fear of slower global growth is plausible but we firmly believe this is transitory.
Coronavirus is a serious threat with the potential to create catastrophic results. As with any outbreak, gauging the impact will take time. The severity of this outbreak will bring significant consequences but according to the Johns Hopkins research, we are beginning to see what appears to be a slowing of new cases and recoveries are rapidly increasing. That’s not to say we are out of the woods, but the virus is being hit with vigilance from all corners and the results are positive.
From our perspective, we remain more optimistic about longer-term growth prospects and most investors and consumers seem to believe that central banks will remain accommodative, helping avoid recession, despite coronavirus-related risks. Of course, there is always the chance that we are overly complacent and confident. At this stage, the sell-off is not overly concerning and, in fact, we will not be surprised to see additional volatility and more corrective selling. Still, we don’t see any near-term catalysts that would cause a recession or end the equity bull market.
Bottom line: We still see global growth edging higher this year, given easier financial conditions, a break in global trade tensions, and generally positive economic data. 2020 kicked off with an encouraging start but predicting a virus would be impossible and the markets were priced to perfection. So, why is everyone so edgy and disappointed – corrective selling is a natural part of investing. Nevertheless, emotions get the best of most people and we quickly forget about long-term strategies and focus on every minute. The corona virus outbreak has reached more than 80,000 confirmed cases and some 2,700 deaths. Conversely, total recoveries have risen to nearly 28,000 as of this podcast. Though transitory, outbreaks such as this creates downside risks to our optimistic outlook for continued growth. For the near term, we believe U.S. Treasuries are severely overvalued, thus keeping interest rates lower. For longer-term investors, we feel that opportunities are presented when stock prices decline. Nevertheless, market declines should not be considered a universal endorsement to buy. Rather, it is an opportunity to looks for companies with strong balance sheets, those capable of sustaining during recessionary periods. What does it mean for OmniStar strategies? Basically, when anxiety increases, implied volatility also increases. This provides an opportunity to deploy sidelined assets, adjust strike prices in our option strategies, and monitor our strategic allocations. What it doesn’t mean is knee jerk reactions. Volatility can be our friend, as long as emotional behaviors are kept at bay. One thing we do know from recent trading history: every time the VIX has doubled, since 2012, buy opportunities were created.