The First Wave Has Passed — But More Is to Come

The headlines this week have been consistently reporting on the spread of the coronavirus, yet the market reaction has been muted. I’ve been quoted this week in The Washington Post, The Wall Street Journal, on Bankrate.com, and Morning Consult. Is the spread of the coronavirus going to impact the markets? Yes, certainly. And today, Thursday January 30th , as a write, we are beginning to see the second wave of impacts.

On Monday, as the number of reported cases increased dramatically over the weekend to over 2,800, the markets went into a “sell first, ask questions later” mode and opened down roughly 1.5%. There was no panic, and the markets traded in a very narrow range. Still, the classic “risk off” trade indicators appeared: the tech-heavy NASDAQ was down meaningfully more than the broader S&P 500, gold prices rose, and treasury yields fell as money piled into safe havens. By the end of the day on Monday, the markets finished roughly where they opened.

Monday’s trade made some sense. The markets took a step back to assess risk. Tuesday and Wednesday, however, the markets, collectively, seemed to think the impact was done. It appeared as though this was yet another instance, in many over the past ten years, whereby investors used the pullback as a buying opportunity. Indeed, a case could be made that the market reaction on Monday was irrational, while the action on Tuesday and Wednesday was more indicative of the economic and market outlook. But there is still the distinct possibility that the “whistling past the graveyard” mentality may prove too hasty.

Today markets started down and climbed through the day, and tomorrow will see the major mainland Chinese exchanges, the Shanghai and Shenzen, re-open following the Lunar New Year holiday. Those Chinese markets, which should be the most impacted by the coronavirus, have been closed all week for holidays. It seems reasonable to expect a sizeable drop in those markets as they “catch up” to the news. That selling could lead to an additional round of selling in the US and beyond. Or the catch up by the Chinese markets could be the end of it.

Still, a potential third wave of the coronavirus impact may materialize if manufacturing begins to slow down elsewhere in the world due to supply-chain impacts emanating from China. It takes 30,000 parts to manufacture an automobile, and each individual part is needed. In other words, you aren’t going to buy a $60,000 pickup truck with a missing glove compartment and a sticky note saying “we’ll get this last part to you when our supplier in China catches up.” Many manufacturers have multiples sources for parts, but shifting production costs money and takes time.

The “worst case” scenario for the markets is that business, consumer and investor confidence is shaken as these waves of supply-chain impacts move through the economy. I’ve written before that it’s important we not talk ourselves into a recession. When people become fearful, they don’t spend as much, and as consumers spend less, corporate earnings suffer. Downward corporate earnings revisions can, in turn, lead to layoffs, which exacerbates the softness in consumer spending. This is the vicious cycle that policymakers, like the Fed and the federal government, strive to avoid. There’s a reason that George W. Bush encouraged people to go out and spend money after the attacks of 9/11. That spending supports the economy.

With the markets counting on almost 10% earnings growth for 2020, is it possible that a seemingly minor (relatively speaking) coronavirus can be a catalyst to a downward re-valuation for stock prices? It’s certainly possible. Could it lead to a global recession? I don’t think it will, but the possibility is certainly there. The causes of any economic deceleration are rarely obvious looking through the windshield; they only become apparent in the rear-view.

But history shows us that, with very few exceptions, the market impact of an epidemic event is limited and transient, and even the hardest hit stocks recover within a year. Long-term investors should keep this in mind, and have a shopping list ready. However, caution may be warranted due to any potential economic shock if for no other reason than valuations are quite high after a 10-year bull market.

Our best advice is that investors should stick to their discipline, not taking more risk than is appropriate for you and the stage in your investment life. While the markets might begin whistling “We’re in the Money” again next week, this story seems far from over. At Farr, Miller & Washington, our research and analysis keep us grounded, and we will be with our clients through this story, whatever the future holds.