February 26, 2020

Equity markets typically don’t deal well with uncertainty therefore it is not surprising to us to see an increase in market volatility on the back of investor worries that the coronavirus (COVID-19) is spreading outside of China. We have seen this play-book countless times in the past. The critical question in our minds that investors need ask is - how will spread of the virus ultimately affect the path of global economic growth?

 

Equity markets tend to exhibit a strong upward bias when the economy is growing. Conversely in recessionary periods equity markets always experience drawn-downs. Our investment framework is anchored in assessing the probabilities of an economic recession at any given point in time, and giving equities the benefit of the doubt in times of uncertainty, so long as the economic backdrop remains supportive of growth.

 

Following record gains in 2019 amid signs of improving global macro data which included highly accommodative Central Bank policies, and improved U.S./China trade relations, the arrival of the coronavirus gave investors a reason to take pause. Until recently investors have been quite resilient towards the coronavirus outbreak which we feel is a function of:

• China’s unprecedented measures to control the spread of the virus.
• The expectation that once the virus is controlled, the economic recovery would likely follow a V-shaped path
• The assumption that policy makers globally will unleash additional monetary and fiscal stimulus in the event that containment is delayed.

It is still far from clear that the epidemic will have more than a temporary impact on global growth. To that end - RBC Global Asset Management have only modestly revised lower its global economic growth outlook to 2.9% from 3.3%.

 

What are investors to do?

We have been preparing for more difficult days ahead, and in mid-2019 we began building in a modest defensive tilt in our portfolios. Did we see coronavirus coming? Of course not. However, in the context of an unprecedented equity bull market, which is now in its 11th year, we believe that the risk/reward trade-off at this point warrants a degree of caution. With that said, we still believe the economic back-drop remains supportive of economic growth, this includes supportive monetary and fiscal policies, a strong employment market, and decent corporate earnings growth.

 

Addressing the coronavirus more specifically we find it useful to pose the question – how have markets responded to similar situations in the past? In the case of COVID-19 we have a close comparable that we can study - the 2003 outbreak of the Severe Acute Respiratory Syndrome (SARS). At the peak of the SARS epidemic (December 2002 – April 2003), the S&P 500 experienced a drawdown of 4% based on month-end prices, and a loss of 10% off the market lows put in during March 2003. The six months following the containment of SARS (April 2003) however, the S&P 500 rose a robust 14.6% (based on April 2003 closing prices). Separately the S&P 500 increased nearly 12% following reports of the 2006 Avian flu virus.

 

In the near-term we expect markets to remain sensitive to developments concerning the spreading of the virus, and therefore risk appetite on the part of investors may remain fragile. Taking a long-term perspective we will continue to monitor how coronavirus will ultimately affect the path of global economic growth.

 

We believe the set-up for a bounce back in the world economy this year remains intact, but acknowledge that the negative effects of the COVID-19 outbreak on business activity will push back the timing of the global growth rebound. Provided that the virus can be contained in the weeks ahead, we expect the short-term hit to global growth and, by extension, the corporate earnings outlook, will be acute but ultimately transitory.

 

A Final Word

Typically it is in times of heightened market volatility that client confidence can become shaken, and it is in those moments that an otherwise disciplined investment approach can become vulnerable to lack of execution. It has always been our promise to you that we will gladly make ourselves available should you know anyone that may benefit from a conversation with us regarding their financial affairs. We thank you for your ongoing trust and support.