To my clients:
It was a down week for North American stock markets with the Canadian TSX finishing down 8.9%; the U.S. Dow Jones Index down 12.4%; and the U.S. S&P 500 down 11.5%.
In the wake of recent developments, this week’s update will be short and concise…
Coronavirus concerns have gripped governments and investors worldwide. Community spread is now occurring in several countries outside of China. Frankly, given the ease with which the virus spreads, it looks unlikely that a true global pandemic can be averted. Thankfully the death rate, although much higher than seasonal flu, is still orders of magnitude lower than prior epidemics (SARS, MERS, Ebola). Current estimates suggest a 97% survivability rate. Ultimately it is believed the survival rate may be as high as 99%. Time will tell. Nonetheless, at 1 to 3%, the preliminary estimated death rate is 10 to 60 times higher than seasonal flu (I’ve seen statistics suggesting the seasonal flu death rate to be between 0.05% to 0.1%... stated another way, between a rate of 1 in 1,000 to 1 in 2,000).
As the weekly market statistics in my customary opening paragraph reveal, markets have had a very nasty response to these developments. I took defensive measures on behalf of discretionary clients early Tuesday morning of this week, prior to a CDC (U.S. Centre for Disease Control) announcement that accelerated the market sell-off. Equity was reduced 10 to 15% for most clients. This followed three prior reductions of about 5% each over the preceding 1.5 years. All clients are now underweight their long-term equity target. Recession, the “bogey” at the centre of our investment strategy and the economic environment we have long wanted to protect against, is now both a credible and imminent threat. It’s not yet a certainty, but it is enough of a threat to justify the aforementioned defensive measures.
I am strongly disposed toward further defensive measures. While acknowledging that what follows is speculation, I strongly suspect that the U.S. Federal Reserve will act imminently with an emergency rate cut – possibly in coordination with other global central banks. I further speculate that such announcement may come as early as Sunday evening, ahead of market open on Monday. I finally suspect/hope that any such announcement, if and when it comes, will spur an initial positive response from the markets. Should such positive response be forthcoming, I will reduce equities more.
The reason I would sell into any Federal Reserve inspired market strength is because I’m not sure such a move by the Fed will materially alter the economic course. In the face of fear of infection, lower rates will not encourage consumers to visit malls, go to music and sporting events, get on airplanes, go on a cruise or, even, go to work in some cases. In other words, at the very least, there will be a significant economic impact from this outbreak in spite of Fed actions. At worst, we may indeed see recession.
Two final thoughts:
1) whatever level of equity exposure I ultimately settle upon for clients, there will likely be a notable shift toward defensive sectors – particularly utilities. In fact I began this process while reducing equities on Tuesday this week by also increasing Fortis (a regulated utility) to a full position weight in client portfolios. I furthered the process yesterday by selling outright the lone Canadian oil producers in client portfolios – Suncor and Canadian Natural Resources; and
2) we will come out the other side of this outbreak. The time will come when equities should be added back to portfolios. Whenever that time comes, it is almost certain to be an uncomfortable move for clients. Consider this a “heads up”.
That’s all for this week. All the best,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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