Fear of the spreading coronavirus spooked investors as the market dropped double digits last week. Reported cases have now exceeded ninety thousand, with three thousand deaths most of which have been specific to China. What really sent the market into a downward spiral was the fact that it is spreading into other countries now including the United States. We currently have ninety-one confirmed cases in the US which have resulted in six deaths. Forty-five of those were aboard the Dimond Princess Cruise Ship. According to the New England Journal of Medicine, the current mortality rate is 1.4%, however they believe the number of cases is much higher which would bring the mortality rate far below 1.0%, and maybe even as low as the mortality rate of the flu. Anytime a new illness hits the world with this many confirmed cases fear is common, but it is important to look at the underlying data of the illness and see how previous epidemics have affected the economy and the market.
Ninety-one thousand cases seem like a lot, but how does that compare to other viruses that have hit the world? Let’s take the common flu for example. According to the CDC there have been fifteen million flu cases this year with over eighty-two hundred deaths. Last year’s flu seasons had close to forty-three million outbreaks and sixty-one thousand deaths. Since the flu is common in today’s world and the mortality rate is low, we looked at a few epidemics with much higher mortality rates. SARS was a scare in 2003 that had a mortality rate of ten percent. Although it was very frightening the market shook off the scare and rebounded in the following six and twelve months 14.59% and 20.76% respectively. Out of the ten plus epidemics that have spired up in the last thirty years, only one resulted in the market moving lower in the following twelve months (Measles 2014 down less than 1%).
Previous epidemics have had little lasting impact on the market and the economy, but how will this affect the economy in the short term? China has shut down production for weeks and currently has only a portion of their operations running, so there will be a decline to their already slowing economy. From a US standpoint it will likely affect supply chains that are housed in China and hit certain areas of the market harder than others such as airlines, restaurants, and casinos. The market had a substantial bounce on Monday due to hopes of Fiscal and Monetary policy worldwide, which came to fruition on Tuesday with the Fed announcing plans to cut rates by fifty bases point (0.50%). Our team does not see rates cuts as being the solution to this health scare and may see another drawdown of three to five percent in the market as cases in the US accelerate. The slower production over the next quarter should result in accelerated manufacturing in the second half of the year, and we expect the market to rebound as we get closer to the presidential election. In the US we currently have a healthy economic backdrop that should be able to weather any negative impacts from the coronavirus. We remain near historical lows for unemployment, have very strong consumer spending, and low interest rates.
Pullbacks in the market are healthy and necessary to keep a bull market going. Over the last thirty-five years, the market on average pulls back by over fourteen percent a year. We tend to not remember those specific drops because the market tends to finish higher in most years. As an investor it is important not to get too sucked into the news and realize that events like this happen and usually have a short duration.
In the managed accounts we remain slightly underweight to equities compared to our longer-term allocations. We added US treasuries back on February 6th to add additional safety to the portfolios. High quality bonds tend to have a negative correlation to stocks, so when stock prices drop bond prices should rise. Although the portfolio values still experienced a decline it was much less severe than the market. When the spread rate declines and the virus seems to be contained, we will likely use this sell off as a buying opportunity. If you have any questions about the markets or your portfolio, please give our office a call.
Like the words of Warren Buffet, “Be fearful when others are greedy, and be greedy when others are fearful”.
Michael E. Kutch, CFA
HPK Provident Advisors