Maintaining Discipline During Short-Term Market Volatility
The recent coronavirus outbreak should remind investors of the importance of remaining disciplined, and that history has shown no reliable way to identify market peaks or bottoms.
Sticking to a broadly-diversified portfolio and not over-investing in any one particular asset class are examples of investment strategy discipline. Portfolios lacking diversification could become vulnerable when the financial world is inevitably hit again by an unexpected crisis.
Staying disciplined may not always be easy. But doing so can keep you from making investment mistakes based on emotions and can help you reach your investment goals. Media headlines are hard to miss, can create feelings of anxiety and may cause some investors who lack proper guidance to lose their long-term discipline.
First and foremost, it is important to acknowledge the human toll that this coronavirus (COVID-19) has taken and the hardship it has caused for many families around the world.
Coronaviruses are a large family of viruses known to cause respiratory infections ranging from the common cold to more severe diseases. While the World Health Organization reports that this virus is not as serious as Severe Acute Respiratory Syndrome (SARS), which had its last outbreak in 20031, today’s coronavirus requires our attention.
Financial market responses
Concerns around the spread of COVID-19 and its impact on the global economy continued to negatively affect markets last week as investors grappled over what the overall impact will be to the economy and to corporate profits. In late January, the S&P 500 Index lost 3.1%, due in large part to concerns about the virus, wiping out gains for the year. The S&P 500 bounced back quickly and set a record by February 19th. Then the spread of COVID-19 cases outside of China sent the S&P 500 back down again, with a loss of over 12.8% as of the Friday, February 28 market close. This correction, over only seven trading days, represents the fastest recorded after reaching an all-time high. Concerns also sent the 10-yr. U.S. Treasury yield to a low of 1.13%.
This week, market volatility continued as the narrative surrounding COVID-19 took new turns. On Monday, the S&P 500 rebounded once again, rising 4.6%. A driver of this increase included the possibility that central banks around the world may move in some coordinated manner to stabilize markets rattled by the coronavirus outbreak. On Tuesday, the S&P 500 then retreated by 2.8% after the U.S. Federal Reserve lowered rates by a half point. This rate cut, which was the first to occur between scheduled Fed meetings since the 2008 financial crisis, has failed to lead markets higher as of Tuesday’s market close. On Tuesday, the 10-yr. U.S. Treasury yield fell further and closed at another low of 0.997%.
While much is still being learned about the virus it appears, broadly speaking, to be slightly more dangerous and contagious than the seasonal flu. The flu has been around for a long time and does cause fatalities every year. As of February 22, the current flu season has seen 32 million flu cases resulting in 18,000 deaths in the U.S. according to the Center for Disease Control (C.D.C.). Public health officials have tried to contain the COVID-19 virus to avoid a second contagious respiratory disease taking root.
The outbreak of COVID-19 in China coincided with the Chinese New Year period. To reduce the spread of infection, China placed significant restrictions on travel and production. However, as factories and other businesses remained closed after the holiday, the loss of Chinese production and consumer spending began to take a toll on global businesses. Some key manufacturing provinces, such as Guangdong, Jiangsu and Zhejiang (which together account for 27% of China’s GDP and 55% of China’s exports), have seen new infection numbers come down significantly. Yet quarantine policy and travel restrictions mean workers are struggling to return to work. This is impacting national and regional supply chains. Many U.S. and other international companies have manufacturing operations in China while also selling to Chinese businesses and/or consumers.
The near-term future direction of markets will depend on the progress of disease control and emerging information on the impact of the virus on U.S. and global businesses. The continued spread of the virus adds downside risk to near-term economic growth estimates and corporate profits. Fortunately, the U.S. economy was on solid footing before the COVID-19 issue began to gain momentum. Also, U.S. valuations appear to be more in line now with historical averages. At its February 19th market high, the S&P 500 was valued at approximately 19x forward earnings estimates. As of its market close on Friday, February 28th, the S&P 500 was back down to 16.5x forward earnings estimates, much more in line with its 25-year average of 16.3x.
Although the overall impact on the economy and corporate profits is still largely unknown, investors should remember that this impact is likely to be transitory. In time, we believe it is realistic that this virus will fade, China will get back to normal, and global markets will move past this shock.
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1Source: World Health Organization Q&A on coronaviruses (who.int)
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