INSIGHTS

On March 02, 2020

Market Corrections are Sharp and Ugly – Is the Worst Over?

“There is nothing to fear but fear itself” was a statement championed by FDR in the throes of WWII. It also has significance when dealing with the coronavirus panic we now face.

Over the past week global equity markets melted down. The move, although not unprecedented in magnitude, was incredibly swift and painful. Last week was very emotionally packed as the threat of a global pandemic seemed to spiral higher each day. The unknown risks of the virus and the speed at which it was spreading exacerbated the selling pressure.

Traditional safe havens such as U.S. Treasury obligations surged in price while their yields plunged to all-time lows. Gold had superior performance as well. Volatility, as measured by the VIX index, often referred to as the “fear gauge” spiked to a high of 49.48. Readings this high are rarely seen and denote extreme spikes in volatility. All in all, by the end of the week many were calling for emergency Fed action to loosen monetary policy by dropping rates by at least 50 basis points.

China validated their economic slowdown due to the virus with both manufacturing and services PMI (Purchasing Managers Index) data for February coming in much weaker than expected. As we know, a significant effort to quarantine areas where the virus has been concentrated has been undertaken which has had an immediate slowing effect on economic activity. Other countries have limited or canceled travel to and from China. This leaves many to wonder what is next for China and the spread of the coronavirus.

At times like this it has been my experience to try to keep your wits about you while others are losing theirs. My first experience with an emotionally charged crash came in my second year in this business. The ugly, single-day crash occurred in October 1987. Since then I have witnessed several emotional drawdowns in the market and have learned one very important lesson. Fear, being a much more powerful emotion than greed, causes people to put aside logic and judgement in order to try to escape the impending emotional pain. As with other emotions, fear is quick to gather strength and likely to abate quietly leaving behind all the damage caused. When you see spikes in fear such as what we have witnessed, they generally should be embraced and resist the temptation to succumb to its pitfalls.

Let’s look at what is underlying the fear. The coronavirus, albeit a medical challenge, is not particularly troubling. Yes, it moves swiftly and makes people ill, but the mortality rate is very low. I am not minimizing the effect on human health and life. Viruses tend to act this way, they come on strong, spread quickly and then dissipate. This is not Ebola, nor is it influenza. The mass hysteria will likely subside as the virus falls from the headlines.

Looking at yield curves when yields have dropped precipitately, we would expect a flattening as economic growth slows; what we are seeing is the opposite. Both long-dated and short-dated curves have steepened materially over the past week. Steepening curves tend to be coincident with growth, not slowing. Interest rates are telling us that global central banks are about to embark on a huge easing. As we have said over the years, “Never fight the Fed.” We haven’t fought them before and won’t now. We anticipate that the coming monetary and fiscal ramp-up in stimulus will deliver a return to growth.

So, has our view for the markets changed given the challenges presented by this virus? At this point, we have not changed our view. We think that any economic weakness due to the public reaction to the virus will prove to be ephemeral. We continue to stress Cyclical, Materials, Industrial, Energy and Consumer Discretionary sectors of the market. In addition, we would now add Transportation and Technology, which have been especially impacted by this panic. We believe there continues to be a generational investment opportunity in Commodities and Emerging Markets.

We continue to lighten exposure to sovereign debt and duration. Record low interest rates provide little opportunity for superior returns to continue. The fact is there is a huge amount of duration risk with no potential reward. Rates may go to zero, but that is just a few basis points from here. The Fed has publicly stated that they have no appetite for negative rates in the United States.

Finally, we would continue to minimize exposure to Utilities, Consumer Staples and other interest rate sensitive industries.

CRN: 2020-0302-8074R