Markets have been rattled by the worsening Coronavirus outbreak around the world. The steep decline occurred more than a month after news of the virus first surfaced, as the market initially believed the virus would be contained to China. Reports that the virus has spread to 48 countries dimmed hopes that the rest of the world would be spared. Below are some issues to consider to navigate the current sell-off.
Investors are not overreacting considering the risks
The S&P 500 is down 11% in one week, which represents one of the most severe declines over the past 90 years. Similar declines occurred in 2008, 2001, 1987, and the 1930s.
S&P 500 had a 1-week decline of 11%, among the highest since 1930
The Coronavirus impact and consequent path of economic outcomes is highly uncertain. Economic activity is already being affected, with several companies lowering guidance for 1Q, including Microsoft, Apple, and Mastercard. Likewise, Goldman Sachs now expects no earnings growth for US companies in 2020.
Company fundamentals are being negatively impacted as consumers avoid public places, stay home from work and avoid travel. Logistical bottlenecks, manufacturing outages and material shortages will likely hamper supply chains.
Whether the Coronavirus will cause a recession in the US or globally depends on many factors that can’t be handicapped with confidence at this point. The epidemiological factors are the most critical, and they are virtually impossible to predict at this point. How many people will ultimately be infected and how quickly? How severe is the mortality rate? How many people will be effectively quarantined? Will the government effectively allocate resources to sickened patients?
Another important factor is how aggressively Central Banks (CB’s) will enact measures to counter a risk spike and tightening financial conditions. On this front, it’s likely CB’s will act quickly and decisively. Currently almost every CB leans dovish, and evidence of an impending slowdown caused by the virus will be met with lower rates, QE, and liquidity swaps.
VIX at 39 is one of the highest levels since 1992
The next Fed decision is scheduled for March 18, but the Fed will likely lower rates before the meeting if the market sell-off persists. Currently the futures market is pricing a 75% chance of one rate cut in the next meeting, and 25% chance of a 50 bps cut. (For an excellent discussion about the Fed’s response to Coronavirus, see Kevin Muir’s blog post.)
Fed Funds Futures imply a 100% probability of a rate cut in March
Investment themes to consider
On a thematic basis, there are several important trends worth highlighting. Yields in the US are making all-time lows as investors rotate into bonds for safety. The 10-year yield touched 1.29%, while the 30-year yield is 1.79%.
US yields are at record low levels
Sector performance is tightly correlated and generally in-line on a beta-adjusted basis. The two exceptions are Energy and Tech. Energy is the worst performing sector, down 17% since Feb 21, pressured by WTI oil prices falling to $47. Tech is the 2nd worst performing sector because of investors’ concern that coronavirus will impact corporate tech spending.
Sector performance is highly correlated since the sell-off started
Within Tech, the internet sector is a good candidate to look for longs (or investors can buy the FDN ETF as a proxy). Looking to China as a roadmap, Chinese internet stocks outperformed during the worst part of the Coronavirus outbreak. Logically this makes sense since consumer spending and time spent on the internet should be less affected than other segments that rely on physical spending. A valid argument is that time spent on the internet might increase if people stay home more than normal.
Internet has outperformed in China, and in the US
Not all stocks have sold off because of the Coronavirus. Biotech stocks that investors perceive might benefit from the outbreak have surged. That includes companies such as Gilead (GILD), Moderna (MRNA), Co-Diagnostics (CODX) and Vir Biotechnology (VIR). Investors should be careful if buying these stocks because the potential benefit for these companies is highly uncertain.
Whether or not the current pandemic causes a recession is almost beside the point, as the global pain is sure to be significant in human terms and financial ones. Investors shouldn’t try to time the bottom and instead focus on long-term investments that will likely withstand the downturn such as Internet stocks.