The index of leading economic indicators (+0.8% monthly increase) and construction activity (+1.8% monthly increase) surprised to the upside in February, while ISM surveys of the US manufacturing and services sectors remain roughly neutral (not expanding or contracting), implying that the new coronavirus COVID-19 is striking the US at a time of economic stability.
As the new coronavirus became a global concern and China's economy faltered, US shares saw their biggest weekly drop since 2008 (down 11.4 percent for the S&P 500), wiping out January gains. Analyst predictions for S&P 500 profits growth in 2020 have fallen but remain optimistic, ranging from flat to up more than 7%.
Non-US equities also tumbled in Feb., although emerging markets (EM) outperformed developed markets. EM stocks were somewhat insulated by signs that the spread of coronavirus is slowing in China, relatively attractive valuations, and a generally smaller role in investor portfolios.
The 10-year US Treasury yield fell to about 1% after investor’s poured money into safe-haven assets as the Federal Reserve cut rates by 50 basis points in early March, with another two cuts now projected in 2020. High-quality bonds have outperformed stocks over the last year.
Real assets were not spared from the red ink, as infrastructure, oil transportation, toll road, and airport operators declined as a result of weaker global growth and travel expectations. Commodities provided portfolio variety through soft goods (coffee, sugar) and agricultural products.
In general, hedge funds outperformed equities. In February, relative-value strategies were flat, while macro and event-driven strategies triumphed. Given the weakness in equity markets, long-short equity strategies fell 3.8 percent on average, far less than the decrease in US stock market indexes.
The most significant event in the last week, and what proved to be the tipping point for financial markets, is the assumption that the new coronavirus, COVID-19, will spread further throughout the world, including the United States. Despite early hopes, it is now obvious that the problems caused by COVID-19 will not be remedied in the coming months.
According to the most recent reports, COVID-19's overall fatality rate is higher (3.4 percent) than that of other coronaviruses (SARS, MERS) (less than 1 percent). It also has a relatively extended incubation period (up to two weeks) and symptoms that are similar to the seasonal flu. As a result, it is difficult to diagnose and contain. Vaccine development might take months, and testing can take even longer.
What makes the new coronavirus so dangerous to the economy is somewhat puzzling. That's because efforts to contain and stop the virus – by governments, businesses, and individuals – may wreak havoc on the economy and financial markets, particularly in an interconnected and globalized world. Consumers are hunkering down, businesses are experiencing output constraints, and governments are restricting travel and mass gatherings.
We see COVID-19 as a severe danger to US and worldwide GDP because of the possible impact on consumer spending and the global supply chain, and thus corporate earnings.
The good news is that the rate of coronavirus infection appears to be slowing within China, and more people are gradually returning to work. This is encouraging, given that China has the world's second largest economy (about 16% of global GDP) and is critical to the supply chains of many US companies, ranging from big tech to pharmaceuticals. It is possible that February 2020 will end up being the worst month for China's economic performance, with both manufacturing and service activity contracting sharply.
There are two main caveats: (1) is it possible to rely on data from China? Perhaps in the case of coronavirus infections. World Health Organization (WHO) epidemiologists are in China, where they appear to be validating data showing a slowing of infections.
(2) Will efforts to contain China outside of China – in South Korea, Europe, Japan, and the United States – prolong and deepen the global economic impact? It's difficult to see many countries doing what China did, which amounted to quarantining a whole US state. However, there will be an increase in the number of containment efforts undertaken by governments.
The plunge in the S&P 500 was swift and savage during the week of February 24. In reality, this was the quickest correction (a decline of 10% or more from the top) in US stock history (see chart below). Given the increased uncertainty induced by the coronavirus, the forthcoming US Presidential campaign and election, and continued geopolitical tensions, we expect volatility to remain high this year (albeit perhaps not at previous levels) (escalation in Syria, Iran, and North Korea).
Higher market volatility is something that TC Capital Partners portfolios are designed to manage with, largely through diversification, but also through the risk-reduction strategies we have implemented over the last year. While we are not making significant adjustments to our portfolios at this time, we did reduce our tiny position to commodities last week, which we believe is one of the most vulnerable asset classes to slowing global growth. We used the funds to enhance our fixed-income allocation, which we feel minimizes our near-term risk. Nonetheless, our understanding of the impact of coronavirus, the US presidential election, and other uncertainties is evolving on a daily basis. We remain watchful and ready to take additional steps to strengthen portfolios if necessary.