Sadly, the adage of, “when the U.S. sneezes, the rest of the world catches a cold” has been turned on its head with the recent advent of the COVID-19 virus, which took the globe by surprise over this past month. Setting aside the tragic human toll and growing concerns about a potential pandemic for a moment, we wanted to focus on the impacts on client portfolios due to the sudden reversal in the equity markets, now that we have officially entered correction territory.
In times of market volatility, it is easy to let emotion trump logic and often, investors feel a need to “DO something.” Rest assured that we have already been preparing our client portfolios for increased volatility over the past several months. Over 2019, we reduced equity exposure, shifted to a more defensive nature in our remaining equity profile and added in uncorrelated assets such as gold, hedge funds, hedged equity and private capital where appropriate. These sorts of assets help provide ballast in times of market selloffs and smooth an overall portfolio return stream over time.
Secondly, our financial planning and portfolio modeling systems incorporate stress-tests and shock scenarios into our clients’ long-term probabilities of success. If you are feeling any unease about current events, it’s a great time to revisit with your relationship manager and review your financial plan with your Capital Planning Advisors’ team.
In terms of markets, corrections are fairly common. That fact is easy to forget after a year like 2019, where everything seemingly went up and volatility was abnormally low. This study from our partners at Ned Davis Research provides some perspective on the history of markets:
Figure 1: The S&P 500 averages 3 corrections of 5% a year…
Markets, much like the human body, have a way of counteracting system shocks so they can start to heal themselves. In the case of this latest situation, bond yields have declined to all-time lows, with the 10-year moving below 1.3% today. These sorts of declines in interest rates tend to help support growth after initial market scares have passed.
Figure 2: Cyclical Growth rebounds after rates plunge…
Of course, concerns about supply chain disruptions, short term economic and Q1 earnings hits are well justified and have now largely been priced into equity markets. That said, much of the bad news is out there and there are some budding positive signs of abatement. Our research partners at Cornerstone Macro provided some real-time insights today about forward expectations.
Figure 3: Yes, Q1 earnings will be hit…
Figure 4: …but fewer Chinese companies announcing Supply Chain Disruptions and Closures
Figure 5: The stock market has historically proved resilient in prior epidemics
Source: First Trust, Bloomberg
Markets despise uncertainty and this current bout of volatility is certainly reflecting that fact. Nobody knows when, where or how this issue will end, but hopefully it will subside soon. In the meantime, it is important to not lose sight of the broader economic backdrop: we still have tremendously accommodative monetary policy, persistent low inflation, full employment, rising incomes and confidence remains resilient. Recession risk still remains exceedingly low. Those factors make for solid conditions for positive long term equity returns. Technically speaking, the equity markets “relieved an overbought condition” this past week and now appear to be a bit “oversold.” While we’re fairly certain most investors would have been perfectly content to remain in a permanent state of “overbought-ness,” this recent correction will make for healthier markets in the long run.