Negative sentiment concerning the coronavirus has been relentless, which has been spurred by media coverage and a variety of governmental actions to combat the contagion’s spread. Most recently, these have included the President’s temporary ban on incoming flights from Europe (which appeared to be a catalyst for today’s -7% trading halt—the second in a week), as well as discussion of a temporary payroll tax cut, sick leave/pay legislation, enhanced small business lending, and deferral of the April tax filing deadline. Several large corporations have also begun to voluntarily request, then require, that employees work remotely. According to a variety of medical experts, such measures can be important in stemming the growth of the virus. While a large proportion of the population that contracts COVID-19 seems to be asymptomatic, the concern is over the elderly and otherwise health-compromised groups, where, as with the common flu, morbidity rates are far higher than in the general population.
As we’ve said many times over the years, financial markets detest uncertainty perhaps more than anything else (even more than immediate terrible news). The threat of and actual, business shutdowns and pullback in consumer activity have reached the core of the global economy. Beginning with Chinese factory shutdowns, which threatened global goods supply chains, this situation has evolved into shutdowns of cruise lines, conventions, business travel, concerts, other public gatherings, and even the NBA season and ban of fan attendance from the NCAA basketball tournaments (March Madness). No doubt, cancellation of such events will have a short-term negative effect on economic growth. The uncertainty lies in the magnitude and the timing, which economists and market strategists are spending a great deal of time attempting to model (with each day seeming to be a moving target). Prior global growth estimates of 3.5% or so have been downgraded to levels closer to 2%, with sharp declines in Q1 and Q2 offset by an assumed recovery in the latter two quarters of the year. This type of fast-changing information and constant revisions tends to spook markets further.
Taking a step back and looking at history provides some context for bear market sentiment and a path for recovery. As of this morning, the S&P has reached bear market territory, with prices down nearly -25% from their peak on Feb. 19. Although the drawdown in December 2018 fell just short of a bear market (-19.8%) and quickly recovered, it has been a decade since we’ve seen such a decline. Historically, they’ve occurred every seven years on average, and we’ve experienced -20% drops or more nine times since 1960. These can be either swift or more drawn out, based on the cause and underlying economic conditions.
The positive to take from this is that, while economic growth wasn’t as strong as it once was, conditions in the U.S. have been relatively healthy—with GDP trend growth of 2%, very low unemployment and tempered core inflation. A sharp pullback in business and consumer spending from virus containment efforts for what could be several quarters may or may not be enough to throw the economy into recession—but underlying dynamics otherwise remain in place. In fact, when valuing risk assets such as equities using a dividend discount model, a very small amount of an asset’s fair value is based on near-term earnings and cash flows. The bulk is based on the long-term growth rate, and more importantly, the underlying discount rate used. While higher interest rates on the 10-year Treasury note could prove challenging for equity valuations, lower rates are supportive of lower prices and higher valuations.
The future is difficult to predict, as Yogi Berra would say, but several historical trends offer guidance about historical past behavior. The historical experience is that financial market sentiment has recovered well in advance of actual conditions—this is important when trying to find that ‘right time’ to re-engage. Since 1950, when the S&P 500 has reached -20% bear market range, the average total decline suffered has been -33% over the course of 15 months. However, in these instances, following the market trough, recovery returns have averaged over 40% in the next year, and over 50% in total over the next two years.
While a cliché, it’s important to stay the course in these types of environments, as opposed to reacting to what’s already occurred and locking in negative outcomes. Investors rely on their advisory relationships in these trying times for guidance and reassurance, so it’s important that these periodic market challenges be looked at dispassionately, and through the lens of a long-term perspective.