Capital Market Comment
March 9, 2020
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer
The financial markets appear to be reacting on a daily basis to the news of the spread of the coronavirus, particularly outside of China. Cases have been reported in Italy, South Korea, Japan, Iran, England, the United States, and other countries. The media continues to highlight the difficulties experienced in places like Washington state and California, as well as the cases in New York, Florida and Heathrow Airport in London.
Events are being cancelled where larger numbers of people are gathering, like South By Southwest in Austin, Texas, which typically draws over 70,000 attendees, with almost 20,000 from overseas. Travel activity has been disrupted, some entertainment venues have been temporarily suspended, a number of schools have been closed for weeks, and we should expect more of the same over the next several weeks or longer.
These ongoing developments are adding to uncertainty about the economic and financial consequences of the virus and its duration. The supply chain has been disrupted, and demand for products and services has been adversely affected, most particularly in China, as quarantines and mandatory actions have been imposed. Currently, the Chinese are going back to work with estimates as high as 80-90%. However, the demand picture is less clear as people remain cautious. For example, most of the Starbucks stores have reopened, but the demand has yet to return.
There are many views of the effects of this virus outbreak, probably more than the number of confirmed cases. Some suggest dire results. In fact, it is very difficult to assess with any degree of confidence how the American public and businesses will react and adjust. Only time will provide the answer.
We recognize the severity of the “real” and “unreal” part of this situation and are monitoring events and reports on a daily basis, attempting to assess the economic consequences. As of February, the report on employment released Friday showed strong job gains of 273,000, and the prior two months were revised higher by 85,000. The job numbers on this report reflect the early to middle part of the month and does not capture the recent events of the virus. However, initial claims for unemployment insurance, which does reflect the end of February, showed no signs of weakness. It will be one of the first data series to indicate the employment effects. How businesses manage their employees in an environment where skilled labor is in short supply and the economic shock is likely to be temporary should provide insight into the upturn.
Even though the macro data has yet to show any real employment impact (some will be coming in future months), the speed of the market’s decline and the collapse of interest rates suggest to us that the market is discounting some of the most dire consequences.
The level of uncertainty and the fear that has accompanied it could move the market even lower. The nature of social media, which swiftly spreads information and misinformation, has created what some people call an “infodemic.” This action could easily set in motion a panic, which may well be what is happening.
The speed of the decline and the structural issues discussed in a previous commentary suggest that once some clarity of the nature of this unfolding event occurs, a swift rebounding should ensue. Following 9/11 (September 11, 2001), the market fell 12% but recovered the full amount in less than 2 months. The Russian default crisis in 1998, and the failure of Long-Term Capital (which was bailed out by the Fed) caused a market selloff. That market recovered within 2 months. It is important to note that each situation is different and the coronavirus will have its unique characteristics. However, once a better assessment of the impact can be made, a sharp recovery should occur.
In the two earlier examples, the monetary authorities reduced rates in response to the crisis. The same thing happened last week when the Fed cut the federal funds rate by 50 basis points (1/2 of 1%). Further cuts could follow. This prospect becomes even more likely given the plunge in oil prices as a result of the failure of Russia to support OPECs quote reduction. Moreover, the deflationary impact of the price decline further undermines the ability of the monetary authorities to achieve their symmetrical 2% inflation target and thus would encourage the lower rate structure. These rate levels, the commitment by the monetary authorities to provide all the liquidity that is necessary, and the efforts by other central banks around the globe to do their part suggests that this market correction should be short lived. Even though some think that the Fed’s ability to influence economic activity is limited by the low interest rates, the tools at its disposal are significant and will be employed if necessary: quantitative easing, direct purchase of other financial assets, and the support of the Treasury in lending to industries directly hit by the coronavirus.
In our judgment, avoiding the pitfalls of fear while maintaining a calm, prudent and focused view of the longer-term fundamentals, will bear constructive results. Short-term thinking and panicked selling could ultimately lead to unnecessary losses. Recently, Bank of America conducted a study of investment behavior. The study concluded that starting in 1930, if investors missed the 10 best days in each decade, the total return would be 91% rather than the 14,962% return for investors who held steady during the downturns. The best days followed the worst days.
If you have a question or need further information, please contact:
Don Keeney, CFA, CFP, Principal & Portfolio Manager in Nashville at 615-866-0882, or firstname.lastname@example.org
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, or email@example.com
Mastrapasqua Asset Management, Inc. does business as M Capital Advisors.
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The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. To our knowledge, none of the information contained in our column would, when it becomes publicly available, have an influence on the valuation of a particular stock. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.