Markets React to COVID-19 Virus
March 05, 2020
• Market volatility has jumped as investors gauge the impact of the COVID-19 virus.
• More equity market weakness is possible, though we believe downside is limited.
• The best plan is to work with your financial professional to ensure your plan, financial objectives, and life circumstances are in alignment.
Since hitting an all-time high on February 19, U.S. equity markets have experienced significant volatility as investors gauge the potential negative effect of the COVID-19 illness on the global economy. While we believe there is a potential for more downside in the stock market, there are multiple reasons in our opinion why this downside may be limited. While the Federal Reserve (Fed) cannot cure the virus, they have taken action to help offset panic and aid market liquidity. From an investment standpoint, we do not think now is the time to change long-term strategies. Instead, working with your financial professional to navigate market fluctuations is the best course of action.
The COVID-19 virus has impacted human life and daily activities worldwide. The financial impact has also been felt as investor optimism and pessimism has led U.S. equity indices to experience multiple days of greater than 2% moves to the upside and the downside. On the positive side, stocks have rallied as signs grow that the number of worldwide cases and deaths have started to plateau. On the negative side, stocks have sold off as concerns rise about the impact on the outbreak on a fragile global economy still digging itself out of a trade war-induced malaise.
While we would like to paint a positive and rosy picture about the equity markets, we do acknowledge multiple reasons why the recent selling could continue. First, there are many unknowns about the causes and transmission of COVID-19. Equity investors might worry about a sudden jump in cases. Second, this outbreak has the potential to impact both the demand side and the supply side of the global economy. Prior market disruptions, such as the Global Financial Crisis, have usually affected one or the other and not both. In China, quarantines and other social isolation has led to a sharp drop in consumer spending. Similarly, these quarantines have limited people going to work and disrupted supply chains. If the outbreak jumps globally and forces similar drastic actions from other countries, these pressures on demand and supply chains may rise substantially. Lastly, corporate earnings tend to drive stock prices. As earnings rise, equity markets tend to move higher and vice versa with declining earnings. With the impact of the
COVID-19 disease likely to affect corporate earnings, we expect analysts to further slash their earnings targets for the first quarter. Overall, these factors may lead to more market volatility.
With that said, we do believe any downside pressure in the equity markets would be limited for multiple reasons. First, as seen by the plateauing number of cases and deaths in its borders, China has provided the world with a game plan on how to deal with the virus including reduced social contact and monetary stimulus. Second, the U.S. consumer remains on solid footing. Unemployment levels remain at near 50-year lows, the recent ADP jobs report on March 4 showed an increase of 183,000 jobs in February, and the housing market remains robust with low mortgage rates leading to very manageable debt servicing costs. Third, the decline in stock prices has led to a more reasonable market valuation. At the high on February 19, the S&P 500 had a price-earnings ratio of 19.5X on forward earnings. Today, it hovers around 17 times earnings. Fourth, the economic impact of the outbreak could be limited to just the first quarter and subsequent quarters might see an economic rebound. The last reason that we believe market downside may be limited is due to monetary stimulus from global central banks, including the Federal Reserve.
As the virus has grown worldwide, multiple central banks have indicated that they stand ready to provide stimulus when necessary. These include the Bank of England, the European Central Bank, and the Bank of Japan to name a few. Other central banks have already taken action, including the Fed, the Bank of Australia, the Bank of Canada, and the People’s Bank of China. In a proactive move, the Fed surprised the financial markets with a one-half of one percent interest rate cut, its first such inter-meeting move in its rate decisions since 2008. The Bank of Canada followed with a similar move the day after and boosted optimism that other global central banks might also provide stimulus.
Again, central bank stimulus will not cure the virus, however, it may help to boost market sentiment and reduce the risks associated with it. While markets have rallied on this possibility, we continue to expect volatility to remain elevated as investors continue to gauge how COVID-19 may impact global economic growth. In periods of increased volatility, being diversified with a long-term plan is still the best hedge against uncertainty and unease. Your Cetera financial professional can help you ensure your plan, financial objectives, and life circumstances are in alignment and help you—no matter what happens around you—chart a clear path for the future.
This report is created by Cetera Investment Management LLC
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Glossary The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry grouping (among other factors) designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe The MSCI All-Country World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The SMCI ACWI consists of 46 country indexes comprising 23 developed and 23 emerging market country indexes. The developed country indexes include: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States. The emerging market country indexes included are: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. The MSCI EAFE is designed to measure large and mid cap equity market performance of 21 developed markets, including three regions (Europe, Australasia, Far East) excluding the U.S. and Canada. The Index is market-capitalization weighted, covering 85% of the free float-adjusted market cap in each of the 21 countries. MSCI Emerging Markets is designed to measure large and mid cap equity market performance in global emerging markets. The Index is market-capitalization weighted, covering 85% of the free float-adjusted market cap in each of 24 countries.