The trigger of recent volatility and the market sell-off that we’ve endured for the last several weeks is the convergence of two black swan events: the rapid spread of the coronavirus and the collapse of the oil price. As a result, this has been a shock to markets on two fronts.
- First, it’s a supply shock. Initially, concern centered around China, where the virus originated. The shutdown of production facilities ultimately resulted in supply chain disruptions.
- But as the virus spread globally, it has also spread to the demand side. And as we’ve seen over the last week or two, the responses by both the public and private sectors have enacted several risk mitigation policies to stem the tide of the virus.
- Responses included canceling events, closing schools, travel bans, telecommuting, and the unprecedented move by the Italian government to lock down the entire country and attempt to stem the tide. This extreme but warranted measure will have a material impact on current economic activity.
- The global reaction created a demand shock in the energy industry. At the same time, the OPEC+ Alliance collapsed, which caused Saudi Arabia and Russia into a “pricing war.” The result is a new supply shock as the Saudi’s announced they would increase supply by more than 2 million barrels per day.
- This quickly became an issue for U.S. energy producers, who were already struggling to be profitable.
As of Thursday’s close, the S&P 500 traded down 23.5% from its all-time high in a matter of only 22 days. Before this episode, the fastest drawdowns of a similar scale were:
- 28 days in 1929
- 31 days in 1998
- 38 days in 1987
In times like this, it’s easy to become emotional, which creates a tendency to focus on the very short-term. But even in a volatile climate, correctly diagnosing where the overall trend is going is paramount. To better understand the situation, we focus on four key areas:
1. What we do know:
- Markets are repricing to reflect this growing risk and extreme uncertainty.
- This is a classic flight to quality — defined as the indiscriminate selling of risk assets (in this case, global equities), and the buying of safe-haven assets in bulk.
- Markets are trading on extreme uncertainty, emotion, and panic. 4% swings are nearly a daily occurrence. It is unprecedented.
- Consumption is getting hit as households are adjusting their normal economic lives. The hardest-hit services segments are recreation, leisure and hospitality, and food.
- Investors have not witnessed such extreme volatility since 2008, which we believe is easily contrasted by the relative health the economies exhibited entering this period. The economic environment, pre-coronavirus was on solid territory. Although it’s hard to assess where we are today, it is somewhat reassuring knowing that we entered this period of market stress from a position of strength. Unemployment is at record lows, and the financial system is much better capitalized than it was 12 years ago.
2. What we don’t know:
- It is difficult to assess the ultimate impact both on the economy as well as markets since the situation is evolving quickly. The magnitude and duration are what is on investors’ minds, and other than knowing this virus will be transitory, we don’t know what impact the containment process will have on the economy.
3. What we expect:
- We anticipate the spread will continue and should contribute to elevated market volatility that is likely to persist for several weeks. Thus, it is too early to make a call on the market bottom.
- Concerning the government response, we think there are some crucial dynamics here that will unfold over the coming days that will incorporate fiscal and monetary policy measures.
- On the monetary side, we anticipate further action to support economies globally. To date, we’ve seen several central banks take monetary policy action, including the U.S. last week as well as Canada. But we also expect more central banks to take decisive action, including the European Central Bank this week. The Fed could move quickly yet again; a meeting is scheduled for next week.
- Not only do we expect them to cut rates, but we expect them to continue to expand liquidity (the Fed announced further Treasury buying in order to provide further liquidity) as well to the banking system and not just monetary policy but combined with fiscal policy.
- On the fiscal side, to date, there has been around $54 billion in appropriated funds to fight the coronavirus. We expect there to be additional measures to be taken and more targeted. For instance, there’s some consideration of various cuts to taxes, but we think it could come in the form of a temporary expansion of the paid sick leave, tax rebates, or policies that are aimed at ensuring credit availability to small businesses that are feeling the full brunt of the event.
- We also expect that there is the likelihood that the negative shock that currently is being experienced may prove to be largely temporary. At some point during the second half of the year, we expect a resumption of growth and consumption. We also believe that the long-term impact on growth rates may be modest. With the potential for fiscal and monetary policy along with low rates and low energy costs, this could be quite supportive of a resumption of growth. We have likely seen a little bit of the early signs of this dynamic unfolding in China.
4. What we need to focus on:
- Long-term perspective
- While always hard to do during these periods, we need to recognize the situation is fluid. It is headline-driven, and we must recognize that this is a moment in time and refrain from emotional and price-driven investment decisions.
- Patience and stay the course
- At this point, we think developments need to play out to assess both the immediate and long-term impacts on economic and corporate fundamentals. Short term disruptions are certainly going to cause economic pain, but this should prove transitory, and growth should resume once the oil conflict is resolved and the virus is contained.
- Portfolio positioning
- We are comfortable with our positioning on several fronts:
- Pre-coronavirus, our outlook, positioning, and portfolios were reasonably cautious and defensive.
- Our overemphasis on both quality and diversification — we know what we own. Our strategies focus on companies with strong cash flow and balance sheet strength that we believe will prevail during periods of market stress, such as those we are currently experiencing.
- Pennsylvania Trust constructs balanced and diversified client portfolios that are intended to preserve and grow wealth over a long-term horizon. Clients should be well-positioned with their current allocations.
- We are comfortable with our positioning on several fronts:
We have the conviction and confidence to weather the storm and, quite frankly, the ability to capitalize on opportunities that will inevitably present themselves over the period ahead. Being said, we always encourage clients to communicate with their wealth manager to discuss portfolio positioning and future liquidity needs.
Again, we would like to thank you for your relationship and interest in following our thoughts. We encourage you to contact your wealth management team with any investment questions, concerns, or perspectives as 2020 continues to unfold.
Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome — including performance — is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.