By Bill Hornbarger, Chief Investment Officer at Moneta
Sentiment is such an important thing for the financial markets. On February 19, the S&P 500 reached a new record-high level and several other markets (NASDAQ, Dow) followed suit. Less than a week later, stocks suffered one of their largest point losses on record with the S&P 500 falling 111.9 points on Monday, February 24, 2020.
What changed over the three full trading days between the record high and the abysmal Monday? Did some new news become known and does it signal a permanent shift in the investing landscape? We suggest the narrative evolved rather than changed; the bigger shift came in sentiment. With the S&P 500 down 4.7% from its record high in mid-February, we identify the following as contributing factors:
- Coronavirus fears/news – Apple recently warned revenue may fall short of previous forecasts in the fiscal second quarter because production curtailed and consumer demand for iPhones slowed in China. Apple’s stores in China are either closed or operating on reduced hours. There is also a great amount of uncertainty surrounding the spread of the virus. There is now news of significant outbreaks in Japan, Korea and Italy, specifically near Milan, which is the financial center of Italy and relatively close to Switzerland and southern Germany. While the novel coronavirus is a tragic outbreak with unimaginable and unmeasurable implications on the many affected, the markets appear to be most concerned about the relative lack of solid information and the speed (or lack thereof) in which it is disseminated and the impact on global supply chains. Through most of the outbreak, the general narrative was that – while tragic – the human death toll is not on pace to be one of the worst in history. The market’s concern is how global markets and economies react to borders being shut and how to do business in this environment.
- The emergence of Bernie Sanders and his policies as a viable candidate for President – Senator Sanders success in the Nevada caucus and the demographic breadth of his support there currently have him as the favorite to run against President Trump in this year’s election. The websites that make markets in political races and outcomes currently show him as the favorite by a relatively wide margin, injecting a fair amount of uncertainty into the election and potentially providing a series of policies very different from those of the current administration.
- Signals from the bond market – The 30-year Treasury Bond broke to record-low yield levels in recent sessions and the 10-year Treasury Note is on the cusp of doing the same. Certain portions of the yield curve remain inverted with shorter-term maturities yielding more than longer-term maturities. The futures markets are now signaling multiple rate cuts over the balance of this year. This has been the case for much of this recovery but yields continued to decline since late last year even as domestic equity markets surged to new highs. Market participants are now asking if the bond market “knows” something that equities don’t. Other “safe haven” assets such as gold and the U.S. dollar are also benefiting from a flight to safety bid.
- Economic concerns – There was evidence that the economy was slowing in the second half of last year. Those concerns remain and are heightened by the disruption of global supply chains and the “closing” of certain foreign economies from the coronavirus.
It is important to put Monday’s (February 24) loss in perspective. While it was the second largest on record in terms of point declines, it doesn’t rank in the top 20 on a percentage basis. It is also important to note that recent weakness comes from record highs for the S&P 500.
The larger question is whether investors should make changes to their asset allocation mix in light of recent developments. We advise against doing that based solely on coronavirus fears. Equity valuations are extended, which is to be expected after a 10-year bull market. The global economy appeared to be slowing prior to the emergence of the coronavirus. Balanced against this are historically low (and sometimes negative) bond yields globally, central banks that appear poised to reduce already low rates when/if necessary and a domestic economy that continues to chug along fueled by very a strong employment environment.
In summary, we expect elevated volatility as investors speculate on the potential economic impacts of the coronavirus. After the very strong gains of 2019 and in the context of the length of this recovery and bull market, we believe investors should be focused on managing risk versus reaching for return targets in 2020. That viewpoint remains unchanged. Given the fluidity of the situation, we favor adhering to a disciplined long-term investment strategy and keeping equity allocations at/near long-term targets. As we mentioned previously, history suggests that market impacts from virus related events tend to be transitory and any weakness tends to coincide with a peak in the growth rate of reported cases, which in our experience also tends to be the peak of media hysteria. Looking at the U.S. stock market after the avian flu, SARS, MERS, H1N1 and most recent Ebola outbreak, in all cases it was higher six months later. We will continue to monitor the situation closely, but to date we see nothing that indicates this time will be different.
- The U.S. Treasury curve fell with the 10-year rate finishing at 1.51%. Expectations of a U.S. Federal Reserve rate cut in 2020 rose on growth concerns.
- Falling rates helped domestic core fixed income returns. Risk-off sentiment detracted from non-investment grade bonds.
- International bonds rose as investors flocked to quality. Emerging markets fell on concerns of the Coronavirus inhibiting growth in China.
- Large cap domestic equities were flat and small cap fell on fears that the Coronavirus will hinder global growth; however, strong earnings reports buoyed some large cap stocks.
- Growth broadly outperformed value during the month. Technology, utilities and consumer sectors led while energy, healthcare, financials and materials stocks lagged.
- International equities tumbled as investors reacted negatively to slower-than-expected Eurozone GDP growth and the Coronavirus pandemic in China.
- Commodities fell sharply on global growth concerns and volatility driven by fears that the Coronavirus will impact long-term demand from China for raw materials.
- Real estate rose on falling rates and a strong streak of housing data.
- MLPs dropped on sinking crude oil prices, amid subsiding U.S. – Middle East tensions leading to higher supply and fears that the Coronavirus outbreak will dent demand from China, the world’s largest oil importer.
Financial Market Performance
© 2020 Moneta Group Investment Advisors, LLC. All rights reserved. These materials were prepared for informational purposes only based on materials deemed reliable, but the accuracy of which has not been verified. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. Past performance is not indicative of future returns. These materials do not take into consideration your personal circumstances, financial or otherwise.