Monthly Markets Memo - February 2020
by Dan Zalipski, CFA
The markets got off to a great start for 2020. Investor’s cheered as the phase-one trade deal deescalated the trade war with China. Fourth quarter earnings growth were expected to come in slightly negative (-1.7%) but have thus far come in slightly positive (0.7%). There are still several companies that have yet to report their results, so these numbers can and will change. As of now, however, the results are encouraging. The January jobs report also surprised investors, easily exceeding the forecasts and highlighting the ongoing resilience of the U.S. economy.
Furthermore, the ISM (Institute for Supply Management) reported that U.S. manufacturing activity expanded for the first time in January after contracting for 5 consecutive months. There were broad expectations that the global economy would stage a rebound after a year of sluggish growth, and then the world learned of the Coronavirus. A rebound in global growth is still possible, but the uncertainty has increased as the world confronts the virus, and the potential effects it may have on the global economy.
The virus first started showing up in late December. Chinese authorities identified the virus on January 7th, with the first confirmed death occurring four days later. The next few days saw a rapid rise in cases, with the Chinese authorities taking unprecedented moves to contain the spread. Flights have been halted, trains are at a standstill, factories are silent, and an estimated 60 million Chinese citizens remain quarantined. Numerous U.S. airports are screening passengers, and the major U.S. Airlines have suspended service to China. The disruptions are visible, but the impact is still unknown.
The extent of the virus’s impact on China’s economy has yet to be determined. Estimates are varied but consistent in one conclusion; this will be the biggest hit to China’s GDP since the 2008 global financial crisis. Just as the virus has managed to cross borders and oceans, so will the economic pain. Wuhan, a city with a population of 11 million and the epicenter for the virus, is heavily involved in the production of automotive parts, electronic components, and semiconductors. The potential exists for disruptions to ripple through numerous industries, impacting sales and earnings throughout the year. The next several weeks will be critical in determining if the virus has been contained, and therefore its potential impacts on economies, companies, and markets.
As always, perspective is important. The virus makes for great headlines with frequent updates as to the latest number of infected and deceased. The numbers are getting larger, faster, and people are scared. Consider, for a moment, our own flu season. The CDC estimates that from October 1st, 2019, through February 8th, 2020, that 26 to 36 million people have contracted the ‘traditional’ flu, with 14,000-36,000 people succumbing to the illness. Compared to the Coronavirus, at the time of this writing, 73,000 people are infected with 2,000 deaths. The virus is serious, and should not be discounted, but we do not believe panic is warranted. The market is operating under the assumption that the virus will be brief and the economic impact short-lived. China’s central bank has been taking steps to stimulate their economy while limiting the economic impact. Deviations from those expectations would almost certainly increase volatility with a negative market reaction.
For the disciplined investor, these types of disruptions have the potential to create opportunity to gain exposure to securities experiencing temporary impacts related to the Coronavirus. Analyzing data for similar outbreaks over the past 20+ years, including Ebola (2014), Swine Flu (2009), and SARS (2003), revealed that global equity indices were broadly positive 12-months following the outbreak. Specifically, MSCI All Countries World Index increased an average of 0.4% in the month following an epidemic, 3.1% after six-months, and 8.5% after a year. Of course, the severity of the virus will ultimately determine its impact on the market. For now, we believe caution with an eye towards opportunity is the best path forward.
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” - Warren Buffett
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