The novel coronavirus, now known as covid-19, started as a supply chain issue and is turning into a demand issue as people cancel their travel plans and start to work from home. 

How did we arrive here?

Analysts reduced their earnings estimate for the S&P500 at the end of February and this led a market correction that saw a low on February 29.  The markets then continued their volatility with +/- 1000 point days on the DOW over the next week but overall recovered from the lows set on the 29.

Then over the past weekend, OPEC did not cut production in an apparent effort to hurt the US Shale producers.  This move caused the price of oil to immediately correct $25 a barrel and is expected to lead to a credit issue within the oil sector as these companies are highly levered and already have low credit ratings. 

It is expected that capital expenditures and dividends will be cut from most oil companies and that some of the smaller companies may even default on their debt that is trading at cents on the dollar.  We have been underweight energy and the energy companies we do own are well capitalized with strong underlying assets.

After the drop in the price of oil, all energy related stocks dropped and this fueled even more volatility on all markets across all sectors.  The unwinding of stock valuations we are seeing today, may be more severe because of the high stock market valuations we had prior to the coronavirus Pandemic.

Trajectory of the Coronavirus

The best case scenario is that this virus abates toward the end of March and with the warm weather becomes a non-issue.  If this is the case, this could mean there will be pent up demand and the GDP slowdown we are expecting could be reversed by Q4.  If it drags on into June then possibly a recession could be an outcome.  If it doesn’t abate with the warmer weather then the spread of the virus could lead to a further slowdown in the economy for an extended period of time. 

In a blog post I wrote on February 29, I said the outcome is far from written as it will depend on what people, businesses, and governments do next to intervene.  Our outlook is that people are changing their travel plans, doing simple things like washing their hands more frequently and staying away from large crowds in general.  While these actions in themselves would cause a slowdown in the economy, avoiding further spread of the virus would be a positive outcome.  Businesses are ramping up their health measures by increasing and adding sanitation protocols.  Schools are being closed and professional sports teams are cancelling their seasons.  Governments will be offering fiscal support in the forms of payroll tax reductions and sick pay to help with workers affected.  It is important that small and medium sized businesses avoid a cash crunch and be able to meet weekly payrolls. 

Monetary vs Fiscal Policy

The Federal Reserve Board in the US and Bank of Canada have already reduced interest rates.  Many believe this will be ineffective in this current situation.  Just because interest rates are lower, will not mean you will go out and borrow to invest in your business.  Businesses will borrow and take advantage of low interest rates when they have a positive outlook on the economy.

Many feel that Fiscal policy will now be the medicine the US and Canada need to avoid recession and continue on a growth path.  You will likely read more and more about this in the months to come and as we get closer to the election. 

What to expect next?

I would expect some more volatility.  This volatility is creating another tremendous opportunity.  We are seeing many clients sending us money to invest over the weeks and months to come.  These are astute investors who realize market corrections are not uncommon. 

Source: BMO Mutual Funds

Market corrections are not uncommon

In the above chart we can see many times there is a 10%> intra year decline within a year that ends up positive or significantly higher than the intra year low.  This is where averaging into the market with new money, or having a disciplined approach to rebalancing portfolios is going to create more wealth for many long term investors. 

What we did to prepare for this?

We have been fortifying portfolios for the past 12-18 months.  At times last year when the equity markets continued their never ending march higher, we felt we may have been “too early” with reducing our equity exposures and increasing fixed income in our Private Investment Management portfolios.  We reduced any exposure to high yield bonds and increased our allocation to government bond or Investment Grade rated bonds. 

We are seeing similar volatility in the Volatility Index (VIX) as we did in October 2008.  Back then, the spike in the VIX indicated the bottom of the market.  The message I had for clients then was - 

You have choices:

1. Sell out and move to cash locking in losses permanently
2. Stay the course and do not rebalance 
3. Rebalance back to the strategic allocation you had agreed on during normal market conditions

The more aggressive you got at rebalancing back to target or even beyond, the faster the recovery in your portfolio.  As it turned out, this third strategy was the best one.  It was akin to “holding your feet to the fire”.  It was not a pleasant experience but was an excellent investment discipline. 

The Cycle of Market Emotions

Source: RBC Wealth Management

Remember this important chart.  Human emotions drive financial markets as much or more than market fundamentals.  A diversified portfolio can help protect you from the extreme highs and lows of market volatility, which in turn can help prevent you from feeling the extreme emotions as your portfolio expands and contracts.  Please contact us to if you have questions about your asset allocation.

For other resources on COVID-19 please see our post:

Update on COVID-19

Additional resources:​​​​​​​

Crisis or Opportunity