We want to share a short note on our thoughts.
With the coronavirus now above the fold of every national newspaper, the complacency that’s dominated markets over recent months is finally being challenged. This is also evident in the sharp ETF outflows – over the last 3 days, some $16bn has been pulled from the SPY and nearly $3bn from the HYG (both records). As we wrote yesterday, a decent chunk of the market is sufficiently oversold, but it takes more time to chip away at sentiment. With some evidence above that the latter is starting to materialize, what’s important from here is how the market absorbs (what in all likelihood will be) worse news flow (e.g., Microsoft warning, POTUS press conference, etc). We wrote in yesterday’s work that our best guess is the market is about 80% of the way there to finding a tradeable low. That still seems fair, with major S&P support in the 3050 neighborhood.
While bond yields and Oil didn’t bite with the market’s rally attempt yesterday, there are some notable areas of strength elsewhere. Emerging Markets have actually been an outperformer of late (particularly KWEB and ASHR), the Healthcare sector (equal weight) is making multi-year relative highs, and while they’re correcting with the broader market the Homebuilders are doing so from a strong technical position (we’re buyers of this weakness).
The sharp rally in safe haven credit and concomitant selloff in global equities is sure indication that a panic rotation is afoot. This is not to suggest it has not been warranted, but in periods of heightened uncertainty we are compelled to return to first principles. With that in mind, then we are inclined to navigate developments with three qualifications in mind:
- We know what we don’t know: the virological elements of coronavirus are well beyond our capacity to predict.
- While not always unconditionally supported among the political class, governments generally offer proportional responses to exogenous events, and…
- …individuals will generally, though not universally, exercise an abundance of caution.
Through this prism we would offer four observations:
- We have likely not seen the worst of the human impact from the spread of coronavirus. We anticipate the number of confirmed cases (and, sadly, the number of deaths) reported to grow both in volume and in geographic dispersion; the bond market is discounting this now.
- In the aggregate, 1Q’20 economic and corporate data are likely to be disappointing; the equity market selloff reflects this shift in consensus.
- Additional monetary policy accommodation – generally a demand-side salve – is unlikely to provide much assistance (i.e. within their mandate the Fed’s response is proportional).
- Ironically, nationalist economic policies may help to both mitigate the longer-term fundamental drag (softer growth, weaker profits) and, support a sharp recovery when – and only when – the global consensus agrees the risk presented by the virus have abated.
Investors will be positioning ahead of this:
- We continue to believe the building blocks are in place for a late-cycle recovery to develop this year, but…
- For investors focusing on intermediate-to-longer-term outcomes, our base case will look very wrong in the short-term.
- We are acutely focused on the need for business investment to rebound sooner than later. Should the c-suite remain unmotivated to engage capital in profit maximizing endeavors, we fear the natural properties of economic gravity may take hold sooner than we thought.
Lastly, we have attached a number of reports that we think will provide perspective. If you would like to discuss any of this material, please email or call us.
Time to Fear the Corona Virus
Crisis and Events
Staying the Course