Coronavirus: Positioning Portfolios in Uncertain Times
Over the past couple of weeks, the situation with the Coronavirus has gone from bad to worse. As the friend and relative of a few nurses here in the Boston area, my concerns had been growing as the situation evolved from an unusual case of widespread pneumonia into what is now a global health emergency[1] (“GHE”). However, up until the end of last weekend I would have told you that I was feeling more upbeat. The spread of the virus had plateaued, at least in China, and much of the reporting was optimistic; indicating the worst may already be behind us.[2] Unfortunately, we found out Monday morning that the Coronavirus situation is still in the development phase, and any assessment of the extent of its impact must be re-visited.
The question we now must ask ourselves is whether we should be making changes in our portfolios as a result of this new information. In order to appropriately address that concern, lets review what the fundamental impact could be as well as how markets have historically reacted when faced with a similar situation…
What could be the fundamental impact from the Coronavirus?
I will state the obvious, it is impossible to know what the fundamental impact of the Coronavirus will be given the situation is still developing. Having said that, our belief is major disruption along global supply chains, global travel interference, and store closures in China will each create a drag on productivity and demand in the short term. We have already heard Apple revise their revenue expectations due to limited foot traffic in stores. Tesla, Ford and Nissan have shuttered their manufacturing plants on the mainland and retailers from McDonalds to Burberry have reported closing stores in response to the situation. The information that was disclosed over the past few days only augments these issues.
While the bulk of management teams across the globe have defaulted to reporting “it’s too early to tell”, we believe near-term expectations will be revised down.[3]
How have markets reacted historically to Global Health Emergencies?
First, let me say that a lot of people have put out data related to this topic with different methodologies for identifying the appropriate time period. This has created a multitude of varying results for the same health emergency. For our purposes, we decided to evaluate history using the date that the World Health Organization (“WHO”) declares something a “GHE” and assess from there. For the record, I would agree with anyone who argues that markets could have priced in some uncertainty prior to any declaration from WHO, or that other factors could be driving equities during these time periods. If you’d like to follow up on this point and examine other methodologies, please reach out to us...
Using our methodology, we wanted to explore two ideas. First, how do global equity markets perform following a declaration of a GHE. Second, how bad can it get? Below is a table with the total return of the S&P 500, MSCI EAFE and MSCI EM indices six months after the WHO had declared a “GHE”[4]. I’ve also included what the maximum drawdown was for that index during that time period to see how dicey things can get. For clarity, maximum drawdown is defined by Morningstar as the peak to trough decline during a specific period.[5]
Six months post-declaration, the median performance is positive across the major regions, but investors did have to stomach some bouts of volatility. Still, in more cases than not, investors have been rewarded for sticking with their equity positions during the turbulence, and particularly in the U.S., the drawdowns haven’t been that bad. For example, if you had a position in the S&P 500 index during the 6-month period following SARS being declared a GHE, your position would have appreciated by 23.5%, but you would have had to stomach a 5.3% drawdown during the time period.[6]
Let's expand the time period to assess performance 12-months after a GHE has been declared. Using the median results, investors in any of the three major regions have been rewarded handsomely for maintaining their equity positions. Using the table below, an investor who held their positions in the Emerging Markets saw their positions appreciate by 21%, despite suffering a 14% drop during the time period. Again, the results favor maintaining a position in equities and holding fast through the volatility.
So, what are the key takeaways and are we making changes to our positioning?
We want to first clarify that our clients’ allocations are always assessed in the context of their personal time horizon. We also want to clarify that this situation is still developing, and there could be another “hot zone” identified which will impact the above assessment. Regardless of the market environment, we continue to approach our allocation decisions with an unemotional, objective process. Uncertainty and downside volatility are unpleasant, and the emotional pull to “do something” is powerful when markets swoon and bearish speculation is rampant. It is specifically during times like these that illuminate the value of sticking to a sound, unemotional process for decision making.
Despite the new information that came out on Monday, the impact of the Coronavirus is expected to be transitory, reserved in large part to the first half of 2020. Global growth and earnings in the U.S. are still expected to be positive for 2020, and valuations are becoming increasingly attractive with the recent pull-back. Central Banks have already provided stimulus in regions where the economic impact has been the most dire, and those who haven’t done so have alluded to their willingness to step in if necessary. Last, though each case is unique, history tells us that equities are up somewhere between 13% and 21% across the globe, 12-months after similar situations have transpired.
Considering all the information at our disposal, the weight of the evidence supports a market weight position in equities for the long-term investor. Going forward, we will evaluate any new information as it becomes available and assess its impact on our allocations where appropriate.
Sources:
1) “Timeline: How China’s new coronavirus spread” – Al Jazeera, January 2020.
2) “Tracking Coronavirus” – Goldman Sachs, February 24, 2020
3) “Three Key themes from Q4 2019 conference calls” – Goldman Sachs, February 23, 2020
4) “Coronavirus in the context of sentiment, valuations, and breadth”- Ned Davis Research, February 4, 2020.
5) Morningstar Direct
6) “Coronavirus in the context of sentiment, valuations, and breadth”- Ned Davis Research, February 4, 2020.
Disclosure
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
New World Advisors, LLC (“NWA”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where NWA and its representatives are properly licensed or exempt from licensure.
Past performance shown is not indicative of future results, which could differ substantially.