As we close out a week filled with news regarding developments of the global coronavirus as well as stock market and interest rate declines, we wanted to provide you with our perspective on this period of economic and market uncertainty. Our investment team is working hard to gain a better understanding of the potential impact of this outbreak and the effects it might have on markets.
Our current thinking is outlined below:
Concerns regarding the spread of the disease intensified this past week creating a legitimate amount of uncertainty regarding the impact on global economic activity and thus corporate earnings.
The severity of the impact on global growth is as-yet undefined and will be dependent on a better understanding of the progression of the virus and the efficacy of containment efforts. Uncertainty regarding the transmission and severity of the virus isn’t yet fully understood.
This lack of clear and understandable data created uncertainty (read: fear) on the part of investors after a prolonged period of relative calm and progressive risk- and thus return-seeking behavior. Consequentially, equity prices have fallen along with interest rates as risk was quickly re-priced.
As we have written previously, stocks were overvalued relative to historical averages as 2019 ended. The S&P 500’s price-to-earnings ratio (P/E) had expanded to over 18 times estimated future earnings. While a pullback was to be expected, the speed of the decline has been unprecedented. It is a stark reminder of the very human dynamics at the heart of market pricing. Optimism and growth drive earnings and values steadily upward over long periods of time and then they are rapidly punctured by shorter-term bouts of fear and negative volatility.
Not all of the news is bad, but the market has not yet found reliable footing. Emerging evidence of fewer new cases along with stores reopening in China gives us some confidence that virus progression will be contained. It will certainly have a finite life, but the potential economic damage could linger.
The decline in equity prices thus far can be attributed to investors’ expectations of lower future earnings, and the severity of the decline to the difficulty the market has had pricing this. A contraction of company multiples could very possibly lead to another leg lower yet. However, that may not happen given the corresponding collapse in interest rates along with more proactive stimulus. The 10-year Treasury reached new all-time lows this past week and U.S. mortgage rates quickly followed.
We are starting to see some compelling values emerge in areas of the stock market. The next few weeks will generate better data on how the virus is spreading and its actual (not just potential) impact on corporate earnings. In the meantime we are evaluating asset allocations, sectors and potential opportunities as events unfold. We generally do not yet view market conditions as being clearly actionable.