5-Minute Read
There is a relentless stream of news tracking the Coronavirus and the heroic containment measures underway globally. Combined with roughly a six percent pullback in the equity markets over a two-day period earlier this week, this could naturally put the broader investing public on edge. This piece takes a brief look at how the Coronavirus is impacting the markets. We then share a broader perspective on how to move forward with market volatility.
The Coronavirus and its Impact on the Markets
When the news first broke about the Coronavirus (COVID-19) back in December 2019, market sentiment was not greatly affected. At the time, the vast majority of reported cases were inside of mainland China and that’s still true today. While it’s encouraging that the rate of new cases in China is dropping, increasing outbreaks have now been reported in countries such as South Korea, Italy and Japan. As such, the concern is that this epidemic will turn into a full-blown pandemic.
With epidemics, the top concerns can and should be improving the health of those affected and preventing the spread of the illness. The CDC website is a good resource for individuals and healthcare professionals who have those goals in mind. If we can look at this situation through an economic lens, we’re now starting to see this take a toll on the equity markets. Disruption is seen in several industries, like travel and energy. As Ann Sonders recently noted in Heartbreaker: Spreading Impact of Coronavirus, “complex global supply chains are being put to the test; with the virus representing a massive supply shock”. As you would expect, supply chains that are tied to China have been hit. Revenue and earnings for many companies are expected to come in lower, even if only temporary.
If it’s possible to have an optimistic take on this whole issue, Brian Wesbury may have accomplished that in his recent piece Time to Fear the Coronavirus?. Among several good points, he noted: “Many companies had already been shifting supply chains from China due to the Trump Tariffs. If they weren’t considering it before they will be now as they realize the importance of diversification. Expect this trend to accelerate moving forward.”
Another glimmer of hope is that an experimental antiviral drug is already available and clinical trials have begun. Experimental vaccines are also being tested. Time will tell how effective these measures are, but it is remarkable to consider the speed of our modern medical technology and the global collaborations taking place to produce a workable solution.
There is no way to know for sure how long it will take to contain the Coronavirus. Complex situations like this could get worse before they get better. In the US, federal health authorities are preparing for a wider spread. They are trying to gauge the health threat and whether more severe containment measures will be necessary. All this uncertainty again is starting to get priced in the markets. How do we move forward?
A Perspective on Market Volatility
The Coronavirus is the catalyst at the time of this writing, but a month from now it could just as easily be something else. Most human beings are loss averse. In other words, they feel the pain of losses more acutely than they feel the pleasure of gains of an equal magnitude. While difficult (if not impossible) to change human nature, few of these points below may be helpful to remember when we are amid a period of market volatility.
· Volatility is Normal – Volatility truly is a normal part of investing. But because not all periods of time have the same volatility, it can be easy to forget this. In a weird way, volatility itself is volatile. While it’s only human to feel the pain of a market downturn, we must not let ourselves lose sight of our goals and be held hostage (metaphorically speaking) to the whims of the market.
· Volatility is Necessary – Equities have a higher expected return than most fixed income instruments and cash. This is because investors must bear higher risk of owning companies with no guarantee they will continue to produce cash flows indefinitely. But this is good news! There would be no premium for investing in equities if there were no such risk. We must move forward confidently despite knowing we have no crystal ball. There will always be a dispersion of possible outcomes. A well-constructed plan with a target expected return adapts to the overshooting and undershooting that is inevitable over short periods of time.
· Look Beyond the Headlines – With a long-term investment strategy in line with your goals, there’s no need to react emotionally to the latest news. Working with an advisor can help tune out the noise and allow you to look beyond the news headlines. It comes down to putting in place and cultivating a disciplined investment plan.
· Understand Yourself – Difficult times in the markets also help us to better understand ourselves and our ability to handle risk. There are ways to design investment portfolios to dampen volatility risk to meet your comfort level. Such dampening typically involves making the tradeoff of accepting lesser returns over the long run. But if you are staying on track towards reaching your financial goals, that could be a tradeoff well worth making.
· Stay the Course – When we look back at past market downturns, we often realize in hindsight that our best course of action would have been to do nothing at all. A slightly more accurate way of saying this is we would have been better off just going about business as usual. If you’re regularly saving, continue doing that. In fact, consider saving more if you have the capacity to do so. Downturns are often opportunities to be buy riskier assets “on sale” while others are fleeing towards safety. Another way of staying the course is to use volatility to rebalance your portfolio. If you don’t have confidence or time to do this yourself, work with a qualified investment advisor where this type of work is table stakes.
If you have comments or questions on this piece, please drop me a line at: [email protected]
References
1. https://www.cdc.gov/coronavirus/2019-ncov/summary.html
4. https://www.ftportfolios.com/Blogs/EconBlog/2020/2/25/time-to-fear-the-coronavirus
6. https://www.investopedia.com/investing/calculating-equity-risk-premium/
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