Coronavirus Update: Weighing Medical, Economic, and Market Perspectives

March 09, 2020

This piece covers:

  • Recent coronavirus news creating market volatility
  • Reports from the medical community and coronavirus task force
  • Potential economic effects of the virus in the U.S. and globally
  • Federal Reserve rate cut in response to the virus
  • What the recent stock selloff and drop in interest rates mean for investors

Impact of the coronavirus is being felt throughout all parts of the world and all facets of life following news this past week continuing to show geographic expansion of the virus as well as increasing infection and mortality rates. As a result, the equity markets experienced one-week declines not seen in more than a decade, stemming from downwardly revised expectations of U.S. and global economic growth, as well as the general uncertainties accompanying a potentially deadly virus that the biological community is still learning about.

With major indexes such as the S&P 500®, Dow Jones Industrial Average and NASDAQ having fallen 12%–14% from their record highs of just two weeks ago, followed by a strong one-day rebound of more than 5%, it is important to assess evolving information pertaining to the coronavirus (also now being called “COVID-19”) from a medical, economic, and market perspective. In this regard, we believe investors should focus on these key areas.

From a Medical Perspective

As of March 2, there are now approximately 90,000 known coronavirus cases and 3,000 fatalities across all continents except Antarctica. Depending upon sources, total cases in the U.S. are at about 80 and the first two deaths were reported in the state of Washington this past weekend. Cases outside of China now outnumber those within as some of the highest infection rates are now being seen in South Korea, Iran, and Italy.

Case numbers will undoubtedly rise in the weeks ahead as there is now evidence of community spread, defined as infection not directly linked to a known case, which is similar to how common strains of the flu can be transmitted. News that COVID-19 had spread in this manner played a role in the market volatility over the past week.

In a presidential press conference that included the White House coronavirus task force on February 29, Department of Health and Human Services Secretary Alex Azar stated, “The risk to any average American is low…The vast majority of individuals who contract the novel coronavirus, they will experience modest to moderate symptoms and their treatment will be to remain at home treating their symptoms the way they would a severe cold or the flu…A smaller percentage will require hospitalization.”

Perhaps the most important information from the press conference came from world-renowned immunologist and National Institute of Health Infectious Disease Director Dr. Anthony Fauci, who said pertaining to the morbidity profile of COVID-19, “ If you look at the totality of the cases that have been reported, particularly from China, about 75–80% of them would do really quite well, they were sort of just like a bad flu or a cold, you get anywhere from 15–to 20% (somewhat) who are going to go on to require advanced medical care, hospitalization, possibly intensive care. For the most part the people who get in trouble and would ultimately tragically die from this are elderly and/or have underlying conditions, heart disease, lung disease, diabetes…However every once in a while you’re going to see a one off, a 25-year-old person who looks otherwise quite well that’s going to get seriously (fatally) ill, but the vast majority of people who get into trouble do have underlying conditions”.

In responding to a question about whether infected patients could become reinfected, Dr. Fauci also responded, “There’s no indication that is going on at all, if this virus acts like other viruses, which I have no reason to believe it won’t, once you’ve been infected with the virus and recover you’re not going to be infected with the same virus.”

News of the coronavirus is likely to continue at a fast and furious pace in the days and weeks ahead. While the media will be covering a combination of numbers-oriented headlines and individual cases of tragic natures, both deserving of attention, we feel it is also important to listen to the medical experts closely tracking the virus from a more widespread perspective.

From an Economic Perspective

There is close to universal agreement that the coronavirus will have a negative impact on both U.S. and global economic growth during 2020. However, there is little consensus as to how much. Most revisions to 1Q20 U.S. gross domestic product growth seem to be hovering in the .50%–1.00% range of impact, perhaps taking down first quarter economic growth from 2% to low-to-mid 1%. Should that be the case and the COVID-19 infection rates decline or appear contained, we would view such a scenario as more of a speed bump in the U.S. economy than a slowdown.

Global growth estimates will likely be affected to a greater magnitude and are difficult to determine, hence the lack of official downward revisions at this point. Most agree China will see little or no growth in 1Q20 compared to pre-virus expectations of about 6%. This will certainly put China’s CY20 growth rate well below previous forecasts also of about 6% for the first time in almost 30 years. Overall global growth will likely also be well below initial expectations of 3.5%, though few are willing to take a hard guess. If pressed, we would say for now the low-to-mid 2% range seems realistic. Keep in mind these estimates will all be moving targets in the weeks ahead.

It is also important to note the coronavirus is threatening economic growth in non-traditional ways, as it is creating more of a supply issue to the global economy than a demand issue. If workers cannot get to their plants and factories in China, either out of illness or fear, then other parts of the world may not be able to source goods to meet existing demand. This is a far different dilemma than most economic threats that are demand-oriented, though there is some of that here as well, particularly relating to the international airline and travel industries.

On March 3, the Fed enacted an interim meeting rate cut of .50% on the Fed Funds rate two weeks prior to its scheduled March meeting. Now with a current target range of 1.00%–1.25%, this move is likely to set a path for short-term rates to once again move below 1% a level not seen since early 2017. Based on the Fed Funds futures, the market is expecting further reductions. It is important to note that pending rate cuts by the Fed, while potentially helping credit markets and equity valuations, probably will not necessarily address supply side issues in the economy nor will they convince consumers to act against judgments based on health-related criteria.

Finally, we also stress the U.S. economy, particularly in regard to the labor market and consumer spending, had been progressing at a strong pace prior to the coronavirus crisis, and all else being equal this should help to withstand it on a transient basis. Rate cuts by the Fed should also provide some added insurance. However, we caution the effects are unlikely to be as additive as they were during the three Fed Funds rate reductions in 2019. The key focus points will likely be how quickly COVID-19 can be contained to some degree, how fast production can come back on line in China, and how much consumer behavior might change in the interim. While nobody has hard and fast answers to these questions, investors should know there is still a realistic opportunity of favorable outcomes on these fronts by the second half of the year.

From a Market Perspective

Stocks have endured brutal and relentless selling over the past week. The S&P 500 closed out the month of February with a 13% decline from its record high on February 18. This occurred amid a dramatic decline in bond yields, as evidenced by the 10-year Treasury rate having fallen to 1.12%, its lowest point in history and well below its previous record of 1.37% in July of 2016. High-yield credit spreads have also widened considerably to approximately 4.60%, a full 1% higher than in mid-February.

Investors should realize that calling a bottom following the worst week in the markets since the 2008 financial crises is a tenuous undertaking. Falling markets of this nature can always decline further based on incremental news, momentum, or raw emotion. The question investors should be asking is more along the lines of at what point markets could be reflecting an attractive entry point, as in a price level representing a higher probability of above average returns over longer term periods.

While the news on the coronavirus continues to be fluid, here are a few points in support of the recent selloff having potentially created a favorable entry point for stocks:

  • Given the recent decline in long-term bond yields combined with the selloff in stocks, the S&P 500 dividend yield is now at a meaningful premium to the 10-year Treasury rate. That differential closed on February 28 at .92% (2.04% vs 1.12%). This is the second highest spread the S&P 500 has yielded above the 10-year over the past 62 years, dating back to 1958. (The only other higher spread was at the depths of the great recession in March 2009). In fact, over the past 60-plus years, this has only been the fifth occasion S&P 500 dividends have yielded above 10-year Treasurys, the others originating in 2008, 2012, 2015, and 2016, all of them preceding large upward moves in the market.
  • With the recent selloff, the S&P 500 maintains a current earnings yield of more than 5% based on latest 12-month corporate profits. This now represents about a 4% premium to the 10-year Treasury yield. Historically speaking, over the past 50 years equity risk premiums above 3% have resulted in three-year annualized returns for the S&P 500 averaging above 10% annually and those above 4% averaging better than 15%. While this simple calculation is far from sophisticated and obviously must be taken into account with other factors, it has proven to be directionally accurate over time.
  • To be clear, we continue to believe that even with the economic risks of COVID-19, it is unlikely the U.S. will go into recession this year and will probably not see conditions anywhere close to the depths of the Great Recession of early 2009, which saw S&P earnings declines of more than 90% amid a backdrop of a 2.80% 10-year Treasury yield. Even in that scenario, the S&P 500 dividend yield only reached a 1.20% premium to the 10-year Treasury. This tells us we could be pushing the extremes in terms of pricing relationships between stocks and Treasury bonds. In just a pure mathematical sense, assuming the 10-year Treasury yield stays at present levels, each .10% convergence in dividend yield by the S&P toward the 10-year Treasury represents about a 5% appreciation in the index.
  • It’s also relevant in our opinion to note that while high-yield and investment-grade bond credit spreads have risen materially in the past week, they are still nowhere near levels of previous equity selloffs in recent memory. At differentials to Treasury bonds of approximately 4.60% for high yield and 1.20% for investment grade, these spreads remain well below where they were during the financial crises of 2008, the global recession scare of early 2016, and the Federal Reserve tightening selloff of late 2018. In addition, the Fed’s .50% reduction in the Fed Funds rate should also be viewed as an incremental positive to the high-yield and overall credit markets. While there is clearly some increasing angst in the credit markets from the coronavirus, these credit spreads have yet to fundamentally confirm the precipitous decline in last week’s equity markets.
  • Timing of containment could also play a meaningful role in a potential market recovery from current levels. Even if U.S. and global growth were to be materially and negatively impacted in 1Q20 by the virus, should containment be apparent by mid-year the markets would likely soon discount a return toward pre-coronavirus growth rates.

The fall in equity prices was so immediate this past week following the continuing news of the virus that investors have been left to assess the damage and rationale after the fact. While economic and earnings forecasts remain in flux, we believe the market’s base case may have rapidly shifted to a scenario of 1% economic growth in the U.S. with flat earnings and global growth of less than 2%. If one believes there is upside to such downwardly revised expectations, as we believe there could be, and of course this would occur amid a backdrop of dramatically lower short- and long-term interest rates, then a favorable entry point could be upon us.


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