March 9, 2020
Despite a healthy start to February, stocks sold off violently in the final week of the month. This has also carried over into March with particular weakness in the price of oil and the energy sector. Market complacency with respect to the spread of the Covid-19 coronavirus has evaporated as the virus spread beyond China to the rest of the world.
The level of market volatility currently gripping markets is quite rare from a historical perspective and has even surpassed the selloff experienced in December of 2018 when markets dropped 10% in one month. Unfortunately, when a market dominated by “computerized trading” intersects with an emotionally charged environment related to the spread of an unknown, deadly virus, the combination is a recipe for extreme volatility.
For example, the Dow Jones Industrial Average traded from a 52-week high to a 52-week low in just 10 days, by far the fastest pace on record. At one point during the month, the S&P 500 declined 16% from its highs and traded well into “correction” territory (a decline of 10% or more) before rebounding slightly. The speed of the selloff was unprecedented – and was the fastest such correction in 70 years.
Markets loathe uncertainty. Unfortunately, when it comes to Covid-19, there is plenty of uncertainty to go around. The current crisis is unlike other market downturns in that its origins are not economically based. For example, consumers around the world have the financial resources to travel, but they are simply afraid to do so because of Covid-19. Once the virus uncertainty is removed, economic activity should recover. Some have likened the effects of the virus to periodic natural disasters, with economic activity actually increasing once the worst has passed.
Still, although Covid-19 should be viewed as a transient event, the longer this period of uncertainty lasts the more panic it causes, and the higher the likelihood of an economic shock causing unemployment and demand destruction. As such, governments and central banks now feel compelled to provide support in the form of stimulus measures such as rate cuts.
On an encouraging note, it may be instructive to examine the situation in China, which could provide a roadmap moving forward. China was the epicentre of the Covid-19 breakout. During the height of the virus-induced panic in China, their stock markets declined significantly, similar to the S&P 500 move cited above.
The Chinese government provided substantial support for the economy, which helped stabilize markets. Following containment efforts, which have apparently slowed the tide of infections, the Chinese government more recently had an important message to its people; that it was time to “get back to work” because the economic effects of the virus were threatening to outweigh the health concerns. Since then, Chinese markets have recovered much of their losses, and although recent economic figures from China look quite grim, the worst seems to be behind them.
Unlike China, the Western world is still dealing with the initial panic phase of the virus outbreak. Until we have our “back to work” moment, we would expect volatility in markets to remain elevated.
We have been using the volatility to our advantage, adding to existing holdings and initiating new positions in companies that are now priced with discounts of more than 30% versus only two weeks ago.
Although the market moves in February were unprecedented, the threat of a deadly virus affecting our lives is not. In addition to the annual flu, which is responsible for the deaths of up to 75,000 people annually in the U.S. alone, we can also point to the 2009 outbreak of H1N1 swine flu pandemic. Because it hit during the depths of the Global Financial Crisis and recession of 2009 and 2010, many have forgotten that it infected 60 million people in the U.S., causing 150,000 hospitalizations and over 12,000 deaths.
We don’t want to trivialize the coming hardship that Covid-19 is likely to inflict. The news will likely get worse before it gets better. However, markets are forward looking, as evidenced by the experience in China. Importantly, your balanced portfolios are built to withstand this sort of shock and the members of the Focus team have the experience to navigate this type of environment.