Coronavirus: Potential options for investors

 

Jurrien Timmer | Director, Global Macro

This article is an adaptation from a webcast featuring Jurrien Timmer, Director, Global Macro on the recent market volatility related to the coronavirus.

Are there risks of a potential recession?

In the coming weeks we may see that word pop up - “recession” - but I believe it will be more of a technical recession. As demand falls, because people stay home or stop travelling, we may see a quarter or two of negative growth.

I would caution that investors tend to extrapolate the past. When we hear “recession,” we think of the financial crisis. For younger investors especially this is an issue, because we have only had a couple of recessions in the past 20 years, in 2001–2002 and in 2008. Both recessions resulted in negative market returns which is known as a bear market. But those were very unique periods.

If a technical recession happens, it is not a cause for distress, because the market can reprice itself -- as it is already doing -- and it can look past that down period. Look at 2016: that was not a recession, although there was a downward trend in earnings and a contraction in global trade. This could be a better comparison to current market conditions than the financial crisis in 2008.

When I look at a traditional recession, I see companies going through an inventory cycle:

  1. Companies build too much plant and equipment.
  2. Then they have too much inventory to sell.
  3. They can’t sell off all their inventory because demand falls, which normally happens because the Federal Reserve or central bank has over-tightened policies.
  4. Layoffs happen because all the inventory is sitting on shelves waiting to be sold.

We don’t really have that type of economy anymore, especially in the U.S. What we don’t see any more that really turns a traditional recession into a financial crisis is the financial system excessively leveraging debt.

What are the benefits of a diversified portfolio?

If you look at the performance of a balanced investment, around 60% equities and 40% fixed income, over the past two years returns are still up by about 10%. An all U.S. equity portfolio would also be up by the same amount when you look at two-year returns. If you have a diversified portfolio consisting of stocks and bonds, you don’t need to do that much right now. Since the ten-year yield in the U.S. is about 1.08% and the S&P 500 has seen some recent volatility, with an all U.S. equity portfolio there’s an opportunity to rebalance with bonds.

Are we less likely to see a market shock?

We’ve already seen the market shock. The general thought is that it’s safe to buy the market when the global growth rate of the coronavirus peaks. In China, the growth rate of the virus already peaked one or two weeks ago; the market was down around 4% and later it started to rally. Then, we got word that Italy and South Korea had rising cases of the coronavirus, which meant the market had to re-do the math. Now we’re waiting for the growth rate of the virus in other countries or the global growth rate to peak. It’s too soon to know where we are, we’re still in the discovery period. No matter when it peaks, these virus outbreaks are temporary. Eventually, the warm weather in the summer is expected to bail us out.

How big is the hit to growth and earnings?

I’m following the progression of earnings estimates very closely, as we now will likely get what we call a “kitchen-sink quarter”. I believe companies will use market down periods, like this one, as an opportunity to throw anything negative out there, so Q1 and Q2 will look bad and then it will turn around in Q3. I think the market can base here with that expectation, but it will be interesting to see how that earnings progression actually unfolds.

What is the central bank’s role?

The Federal Reserve (the Fed) has made it clear that it doesn’t want to go to negative rates. I don’t know that we will get to 1% for the Fed funds ratei that the market is pricing in. We may get some other liquidity operations, the Fed may extend its T-bill buying. Certainly, the Fed is there to provide liquidity, and it may coordinate with other central banks to conduct cross-currency dollar swaps, if other banks (e.g. in Europe) are short on dollars. I think the Fed is very comfortable with its operations on the balance sheet side. I think that everyone knows deep down that negative rates don’t work and the bank would be much happier conducting liquidity operations than cutting rates. If rates are cut, then they have to be raised again and markets don’t always react well when that happens. Globally, we may see central banks conducting more fiscal stimulus than monetary stimulus.

9/11: Best comparison to current market conditions

If you look back to 9/11, the stock market closed and there was a big hit filled with uncertainty. In 2001, market rates fell by about the same amount for around the same amount of time. We had a similar contraction in the P/E ratio and a similar spike in financial conditions. Earnings fell, but they were already in a downward trend, because of the dot.com bubble. After 9/11, the market recovery occurred within a few weeks, which provides some hope for current market conditions.

Investment grade and high-yield bond market

Industry wide there have been lots of outflows from high-yield bonds and the bank loan segment. Without a traditional recession or a financial crisis, maybe a technical recession, I don’t see a credit event happening. A lot of high yield and investment grade companies are fairly solvent.

Work with a financial advisor

Investors should have a diversified portfolio, that’s why it’s good to have a financial advisor. The worst thing you can do, when you have this fight-or-flight impulse, is to end up selling during lows. It is important to have that voice of calm and reason to call, market selling is a difficult task.



i The interest rate at which depository institutions lend reserve balances to other depository institutions overnight--around the target established by the FOMC. Board of Governors of The Federal Reserve System, October 31, 2019.

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