How we’re thinking about coronavirus

The public’s concern about coronavirus (COVID-19) is increasing. As is often the case, concerns are frequently magnified by what’s called “negativity bias,” an evolutionary mechanism in the brain to minimize risk. More often than not, people over-react to potential risks. But sometimes the reaction is warranted. Regarding coronavirus, it is too soon to tell how justified these worries are, and the appropriate level of concern at any point in time will depend on how governments and citizens respond now and as things unfold. Don’t panic. Do use a healthy dose of precaution.

What complicates the tensions about coronavirus is that it involves two intertwined concerns, physical and financial, making people and markets nervous. Let’s talk about both.

Physical risk:

Despite the fact that this week a Northern California woman contracted coronavirus without a clear cause, experts say that risk still remains low. However, it is a fluid situation. Whether or not risk remains low depends on a variety of factors, including both government actions and personal precautions.

When fatalities have occurred, as is often the case with dangerous viruses, it has generally happened to people with higher risk characteristics. That includes people with compromised immune systems, weak respiratory systems, those that practice less self-care, and other factors. The higher your risk category, the more careful you should be until coronavirus is contained. For more prevention tips and updates on the outbreak, visit the CDC.

Nerves are not helped by the mixed messages the public is receiving from authorities. We think the CDC is a very reliable source for science, decisions and prevention.

Financial risk:

Markets don’t like uncertainty. That’s because people don’t like uncertainty.

In our view, markets had somewhat over-shot on the upside prior to the coronavirus. The coronavirus related market pull-back is likely to over-shoot on the downside.  Over the last decade after the Global Financial Crisis, we’ve been in the longest bull market or market run-up ever. Consumer confidence and investor complacency have been high, leading to unusually low volatility, all of which typically occurs when market valuations are a stretched and usually precedes a period higher level of market volatility. A common phrase in the last year or two is that many investors have been “waiting for the other shoe to drop.” In other words, feeling like market returns have been too easy and wondering what will trigger a market correction. Well, now they have their answer. This last week was the largest 1-week drop since 2008, falling 10-13% depending on the stock index, and included the largest point-drop in history.

How much of the market response to the coronavirus is attributable to “the other shoe” vs. effects purely attributable to the coronavirus? There will never be a clear answer to that. Past events may give us some clues, even if different. The SARS virus epidemic in 2003 led the S&P 500 to fall 14% over 2 months. The market was up 20% a year later. The Asian flu, Zika and Ebola initially pushed markets down 5-7%, but markets bounced-back 10%- 36% a year later. In other words, health events can make markets nervous, but generally not for extended periods of time.

The coronavirus may, however, merit a more negative investor/market response than other epidemics or pandemics in recent history.  The question is how much, and the answer will depend on how things develop. With the increased global dependency on China for the manufacturing of key components of product supply chains, anything that slows China’s productivity has the potential to dampen the earnings of companies who rely on China for parts. When there is weakness in the demand side, central banks such as the US Federal Reserve can stimulate consumption, i.e. demand, by lowering interest rates or other methods. However, such stimulation has little or no impact on the supply-side. If factories in China slow down or stop, then sales of smart phones, clothing, materials, pharmaceuticals, and so on, will slow as well.  

How should you react to these markets?

If you have a long-term plan designed to meet your goals that already periodically expects and accounts for a certain level of volatility, the answer is that you should stay the course, if your goals remain the same. If you are an investor without a plan or long-term strategy that took on excessive levels of risk beyond your risk tolerance, possibly because you didn’t understand the risks, well, that might be a challenging situation, and the first step would be to develop a long-term plan.

Market downturns can be short or extended, but even extended downturns generally occur within a short-term period of months or just a few years. Market returns were much higher than the long-term averages in the last 10 years, and some of what’s happening now may just be bringing things back to a more normal level.

We’re long-term thinkers. We encourage you to be the same.