BMO Family Office
A bruising equity market selloff greeted investors to start the week of February 24 – first in Asia, then spreading to Europe and eventually the U.S. where equity markets dropped by over 3% on Monday. Fast-moving coronavirus developments in South Korea, Japan, Italy, and Iran fueled a reassessment of the working thesis that the outbreak impact would be short-lived, followed by a swift, “V-shaped” recovery for the global economy. South Korea and Italy, for example, went from 104 and 3 cases, respectively, on February 20 to 763 and 124 cases by the 24. The abrupt case explosion understandably led to questions about how far the virus will spread and how deep the economic impacts will be. We too had believed that an economic rebound could come as early as the second quarter of 2020, conditioned on a base case that the virus would not spread aggressively outside China. Given the events of the past few days, that base case scenario is now in doubt.
Meanwhile, back in China, recent news has been positive at the margin. Existing confirmed cases fell by 2,152 on February 24, while newly reported confirmed cases came in at just 508; well off the 3000+ per day seen earlier this month. It may, however, take a couple weeks of favorable, or at least not alarming, global developments for the market to regain its footing. After all, China has yet to fully return to work and the possibility exists that soon-to-be crowded factories could reignite the virus’ spread. The markets may also be inclined to take a wait and see approach, and we expect near-term market moves to be dominated by assessments of how long-lasting the economic disruptions will be.
On the encouraging side, China and other countries are already rolling out monetary and fiscal stimulus packages in hopes of kick-starting their economies once coronavirus concerns abate. Many commentators are apt to reference the SARS outbreak in 2002 and 2003 that had a short-lived effect on the markets. However, we believe the comparison with SARS has limited value. Fundamental elements such as incubation period and similarity of mild coronavirus symptoms with a simple cold or flu make the coronavirus much more insidious, despite having a lower fatality rate than SARS. We do not subscribe to the notion that markets will necessarily follow a similar playbook for all infectious disease outbreaks. “This time is different” should go without saying – every time is different and needs to be evaluated on its own set of merits and considerations.
Experts presume that warmer weather in late spring will result in a less hospitable environment for the coronavirus to live and spread.1 Hopefully this is true, but there nonetheless remains a considerable gap between now and that time. Our view remains that the global economy can regain its footing in the spring and that the coronavirus’ economic effects will not generate a protracted “negative feedback loop” in the global economy. Fiscal and monetary stimulus should kick in before long, thus suggesting a positive environment for equities in 2020. Yet, given the significant unknowns about the virus, we cannot completely rule out the possibility of self-reinforcing downward economic momentum should developments in China, and elsewhere, take strongly negative turns.
In response to these developments we are not making any formal allocation change recommendations, but do acknowledge that near term risk has increased. At a minimum, we encourage clients work with their financial advisor to review current positioning relative to long term targets. Rebalancing may be appropriate should equity allocations have drifted materially higher due to the 2019 and early 2020 stock market run up. In addition, for those extremely sensitive to short term market movements, we would suggest a reduction in emerging market equities given this region will bear the brunt of the near term economic fallout.
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