Right now there are a ton of headlines but little clarity on what matters for investors.
This post shows how markets have performed after similar events and details two risks I’m looking out for.
“Why did the market react so strongly this week?”
It became obvious the virus wasn’t contained to China. There are now large outbreaks in South Korea, Italy, and Iran. This translates to a higher chance we’re dealing with a global pandemic rather than an isolated epidemic.
An analogy to the common flu understates potential risk. The coronavirus has a mortality rate of 2.3% compared to ~0.1% of the flu. It’s correct that the flu currently kills a (much) larger number of people. The issue is that investors are starting to expect an outcome where a lot of people catch the coronavirus.
It’s a super remote possibility – but markets reflect the future and there’s a small chance that’s our future.
“How will the coronavirus impact the economy?”
Three main ways:
- Lower Spending: More people stay home and delay discretionary purchases.
- Less Tourism: Nobody wants to travel when they’re worried about getting sick.
- Disrupted Supply Chains: Closed factories and restricted transport slow down business activity.
Companies like Apple and Mastercard have made it clear that we should expect lower earnings. At this point it’s impossible to put concrete numbers on how much of a drag on growth the virus will be.
I’ve seen a few economic comparisons to SARS in 2003 but they’re not relevant. China’s share of the global economy has tripled since then and at the time we were coming out of a recession. It was a completely different environment.
“Where will the stock market go next?”
My best guess involves zooming out to see what’s followed similar market volatility.
Here are headline-driven periods where the S&P 500 fell more than 10% within three months:
The average drop was -21%, lasted 46 days, and recovered +23% over the next year.
Across all 10% market corrections since 1929, half of them developed into a more significant 20% drop:
I’ll be the first to say that the above studies have low sample sizes. But when setting expectations it’s better to start somewhere rather than wildly guessing.
In the short-term, it’s a coin flip if the market bottoms here or develops into a larger correction. When looking at the long-term, historically there’s been a much higher probability of a positive outcome.
“Should investors panic?”
The market does an incredible job of transferring money from emotionally unstable investors to those with long-term discipline.
The stock market is the only market where things go on sale and all the customers run out of the store.Cullen Roche
Situations like these are why investors make money over time. If there was no risk there would be no return.
Movement portfolios are built to weather this volatility:
- Stock exposure is diversified. Energy stocks are down 25% in 2020. Airline stocks are down 22%. The core U.S. stock fund I use, VTI, owns 3500 stocks and is down 7%.
- Bond funds avoid credit risk. High quality fixed income like Treasuries and muni bonds have risen during this selloff, partially offsetting stock losses. These are the only types of bonds I use.
Investors with a mix of stocks and bonds matched to their time horizon should not adjust their portfolio based on this correction.
“What are you looking out for?”
Trump’s election odds will fall if the virus gets worse. This has nothing to do with Trump and everything to do with how people vote. Americans typically reelect presidents when the economy is strong and vote out incumbents if economic data weakens leading up to election day:
The U.S. will report an increase in cases. Yesterday the CDC made it easier to test for the virus. More testing likely means more reported cases. We’re behind other nations like South Korea that were quicker to screen people, so don’t be surprised if the number of U.S. cases jumps over the next few days.
- The coronavirus is not contained to China and will negatively impact economic growth in 2020.
- A long-term portfolio shouldn’t be guided by short-term impulse decisions.
- Expect an increase in U.S. coronavirus cases.