Coronavirus Update

February 28, 2020 | Richard So


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What do the latest headlines mean for investors?

This blog is a follow-up to our initial entry titled "Coronavirus: Some Context for Investors" from January 28th.

There has been no lack of news surrounding the coronavirus this past week. Therefore, rather than spending time echoing what many of us have been reading about, we would like to continue to explore the impact the virus has for investors.

Labelling this week’s market action as volatile may be an understatement. After just hitting record highs, it took only 6 trading sessions for the S&P500 to drop over 10%. Technically, this was the fastest drawdown investors have seen since World War 2, and the worst weekly performance since the 2008 financial crisis. In our last coronavirus-related blog, we highlighted our expectation that this virus’ impact should follow a similar course as previous epidemics observed since the 1980s. This included a temporal slowdown in economic growth and stock market drawdowns, however, markets eventually found a bottom and rallied higher. Investors have a difficult time deciding what triggering event will form the bottom. As of now, it appears that the markets are attracted to the notion of a cure or vaccine, with certain biotech stocks rising impressively. With that said, there have been no cures for other past epidemics (HIV, SARS, Zika etc…) and markets appear to have always been able to recover. Therefore, investors should not be waiting for a cure to coincide with the recovery. We had previously written that market turnarounds may coincide with the data reaching “peak deaths,” which should signify that the virus has been contained and the rate of new cases has slowed down. The recent news that the number of newly reported cases in China is now lower than the reported new cases outside of China is encouraging to hear, perhaps signalling that the epicentre of the outbreak may be trending towards containment. We are, however, not epidemiologists and the virus and contagion are still unpredictable.

Our anecdotal observations lead us to believe that the majority of professional money managers expect that this virus will eventually be contained. Due to the uncertainty regarding containment, key economic bellwether stocks like Apple and Mastercard have already made announcements of lower revenue and earnings guidance. With this, analysts are forced to adjust their models and readjust expectations lower. Goldman Sachs recently released a report highlighting that the coronavirus could cause earnings growth for the S&P500 to fall to 0%, whereas previously the street estimated 7+% earnings growth. With that said, they are far from signalling a disaster, as Goldman’s Year-End price target for the S&P500 is still 3400, which is about 10% higher from these levels.

Our office often makes the analogous observation that markets take the stairs up and then take the elevator down. In other words, markets always fall faster than they rise. This current market pullback is no exception. However, at these market levels, we do think that it is important to point out the following observations:

  1. TSX and S&P500 2021 PEs have fallen back to 14-15X

For those investors who have been waiting for a pullback to add equities in their portfolio, market valuations have become much more attractive.

  1. 10 Year Treasury fell below 1.20%

Hitting an all-time low in ten-year yields is one of the loudest advertisements in favour of dividend paying equities.

  1. Market pricing in 3 rate cuts

The market has moved from expecting one Fed interest rate cut, to now pricing in 3 rate cuts. Regardless of how many cuts are seen, it appears that the Fed will likely keep rates lower for longer, which has traditionally led to a strong equity investment environment.

  1. Technical indicators on many stocks showing oversold levels

Without naming actual stocks that may not be suitable for all investors, it should be noted that many popular stocks with strong fundamentals have hit “oversold” levels on the basis of their relative strength indicator.

  1. Economic data looks good

Economic labour statistics continue to show sustained labour market strength, with 225,000 jobs created in January with more people entering the workforce.  Although this is considered to reflect the “past,” it is important to note that the economy is still considered to be on solid footing.

Ultimately, it is too difficult to say when a sustained recovery to potentially new highs will begin. During sharp market drawdowns that put pressure on investor psychology, markets do not tend to trade on fundamentals. Hence, we spend a little more time watching technical indicators, which at certain levels may trigger broader machine-algorithmic buying. Overall, we do not believe that the latest week’s developments will alter the prospects for long term investors. As we have seen in the past, a disciplined rebalancing process, dividend income, and time are usually the keys to success during periods of volatility.