The coronavirus (COVID-19) outbreak entered a new phase over the past week. Although the growth rate in cumulative cases has slowed in China, many more cases have been confirmed outside of China, raising fears of a global pandemic. Global economic uncertainty related to the ever-evolving public health crisis continues to roil equity markets around the world. Yesterday’s 4.42% drop in the S&P 500 was the worst one-day return since August 18th, 2011 and it officially locked in the fastest correction (down over 10%, over 6 days) in the history of the U.S. stock market. Indiscriminate selling has moved the percentage of internally oversold stocks in the S&P 500 to their 4th highest level since 1957. The only period in recent memory where we’ve experienced a similar waterfall of selling pressure was in November 2008 following the collapse of Lehman Brothers, the confirmation of a recession and the bailout of insurance company AIG. At that time, the very foundation of our economy was in danger. We suggest this is not remotely the case today.
By virtually all measures, the market is now in historic oversold (below true value) territory. These deep oversold conditions have traditionally created strong forward returns, especially when underlying trends are as solid as they were prior to this selloff. We feel this is an important reference point because the question we must ask ourselves is, “Are we entering a scenario where extreme oversold conditions no longer matter, or do we use history as a guide and stay the course?” The equity risk premium (the excess returns over a ‘risk free rate’ that one gets for investing in stocks) is now very high as the markets have corrected while interest rates have gone down as well. In the long term, lower interest rates are supportive of equity valuations. As a result, it is fair to say that the equity markets look significantly cheaper. Even if there is no corporate earnings growth in 2020 due to the virus damaging the economy for some portion of the year, stock valuations relative to interest rates should provide some measure of protection. That being said, we cannot offer any certainties around what happens next and we continue to monitor developments and client portfolio allocations on a real-time basis. However, the long-term earnings potential of the economy is intact at this point and we do not feel being overly reactive is appropriate at this point.
We’ve often stated over the recent past that our base case, strategic perspective is lower returns from both equities and fixed should be expected, as should an increase in overall market volatility. Because of this late cycle outlook, we have emphasized broad diversification, flexibility among underlying investment strategies and income generation in client portfolios. Nothing about the COVID-19 outbreak has caused us to change these core themes. We believe it is highly unlikely that this virus outbreak will permanently impair the global economy’s capacity. Economic forecasts and earnings expectations will no doubt be lowered but both should rebound as the year progresses and investors will need to remain patient. We also believe there should be attractive investment opportunities for our clients resulting from the market drop and related dislocations.
Please contact us at 216-861-1148 or firstname.lastname@example.org with any questions or if you’d like to have a one on one conversation with the investment team.