Stock markets around the world are selling off as a result of pandemic fears related to the Coronavirus. This morning, the stock market breached the 200 day moving average1. To us, this is an indication of more downside risk.
Our take here is that global markets have traded ahead of actual economic growth and earnings for over a year. In the U.S., 2019 corporate earnings grew at less than 5%, yet the S&P 500 increased by 30%. Corporate earnings estimates for 2020 are not much better, yet stock markets flew out of the gate, increasing nearly 5% in the first 45 days of the year. We have been communicating that a correction was overdue and likely.
The bond markets have been predicting a slowdown in economic growth for some time, prior to the Coronavirus outbreak. The yield curve inversion that occurred in the spring of 2019 indicated a recession was likely to happen in the next 12-18 months. The LVW research team has had a lot of dialogue prior to this week about our concerns that the equity markets have been disconnected from the implications of disruption in the global economic supply chain. We concluded this weekend that our positioning continues to be conservative and that when, and if, we had an opportunity to rebalance, we were prepared to do so from both cash and high quality bonds.
Timing is a tough thing to predict, but the downturn this week is likely the result of three things:
- Mega Cap growth stocks, from Apple last week to Microsoft today, have issued earnings warnings because of global disruption in the supply chain.
- A realization that the Coronavirus could turn into a pandemic that results in throwing the global economy into a recession.
- Central banks, which have largely fueled the global equity rally, have a lot less room to maneuver.
It is important to put the Coronavirus outbreak into perspective—the media is not always the most reliable source for what is fact versus what is perception. Brian Westbury, Chief Economist at First Trust said, “Much of the pessimism surrounding the virus focuses on the Chinese under-counting the number of infected to save face. However, it’s important to note that a shortage of specialized test kits has caused health officials in many countries to rely on observable symptoms for diagnoses, and because coronavirus mimics the flu and pneumonia in its early stages, it’s also possible that authorities may be over-counting as well.”
Instead of looking at it from a total confirmed case perspective, we think the number of total active cases provides a better look into what is happening. This measure takes total confirmed cases and subtracts deaths and recoveries. This gives the total number of people who have the potential to spread the virus further. We will continue to monitor the spread of the virus throughout the globe, in addition to the impact it has on economic data.
Having said this, we are fairly certain that any drop in earnings or economic activity will spill into the second quarter and that global economies (including the U.S.) have already been weakened by the Trump tariff negotiations ahead of the virus outbreak.
We have not felt the need to rebalance in fully allocated portfolios but we are getting closer to that point. For those who are overweight cash, we have begun to rebalance on the edges of our equity allocations today. Fortunately, going into last year we had exited any lower quality credit positions and our defensive allocations have been rallying during this risk off period and provide a place from which to rebalance back to equities.
We want to assure you that while this may be troubling, our team is experienced and that times of turbulence come and go. It is how you prepare before they occur and what you do during them that matters.
Please feel free to reach out to any of us on the LVW team if you would like to further discuss our take on the Coronavirus and the implications. We thank you for your continued trust and confidence.
1 A moving average (MA) is a widely-used indicator in technical analysis that smooths price histories by averaging daily prices over a specified period of time.
Disclosure: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult with your financial advisor. Past performance is no guarantee of future results.