The stock market started out strong in 2020, but the past few days have seen significant weakness. It is our view that this is due to two primary factors. First, it appears the stock market is reacting to growing concerns about the Coronavirus epidemic in China and the increasing odds that it may become a global pandemic. We also feel the market may be responding negatively to what appear to be increasing odds that Bernie Sanders could be the Democratic nominee for this fall’s presidential elections. Sanders, a United States Senator from Vermont, is a self-avowed democratic-socialist who advocates radical change across U.S. society.
While the virus outbreak in China appears to have peaked in terms of the growth rate of new cases being reported to the World Health Organization (WHO) and the U.S. Centers for Disease Control (CDC), we are now unfortunately seeing new cases spike in other countries, such as Korea and Japan, as well as Italy. Investors appear to be increasingly concerned that the virus cannot be contained within the countries currently impacted, and that a more widespread pandemic appears likely.
Unfortunately, we know from experience that we cannot necessarily trust as accurate the data we are seeing from China. The WHO does have personnel in China, and we can only hope that its presence will shine a bright light on what is happening and push the authorities to disclose all of the available information.
Global economies have become so interdependent in terms of trade and supply chains that it is hard to envision a scenario where the Coronavirus doesn’t have a negative economic impact. As we see it, the question at this point is how quick the recovery will be. Major companies such as Apple have already said that the Chinese outbreak will cause them to miss their expected earnings for the March quarter due to the temporary closure of Chinese factories serving their supply chain. In addition, Apple’s Chinese retail stores were closed for a period of time, and some may remain closed.
With some products, it seems likely that ultimate purchase by consumers will merely be delayed. Apple’s iPhone and other iconic products would appear to fit into this category. But there are other more service-oriented purchases for which lost sales might not ever be recouped. One example of this would be the annual mobile phone conference held in Barcelona (The Mobile World Congress). Last year, over 100,000 attendees came to Barcelona for the annual conference. That is a lot of economic activity taking place over the course of about a week; think of the taxi drivers, cooks, maid and laundry staff in the hotels, waiters, etc. etc. who provided service to those conference attendees. This year, the conference was cancelled due to concerns about the potential spread of the virus, and the conference won’t be held again until 2021. Similarly, the Tokyo marathon was recently canceled except for elite class runners who will still be allowed to compete, with some 38,000 attendees being asked to stay away.
There are no simple precedents to examine for a guide as to how this may play out in terms of its market or economic impact. We have a good idea of the impact SARS had in 2003, but at that time China’s economy was far smaller in an absolute sense, and since then it has become far more integrated with the rest of the world. Our current thinking, which is subject to change, is that most of the economic impact is likely to be felt in the first quarter, and that much of the growth lost in will be recouped in subsequent quarters. So far, the number of cases in the U.S. is exceedingly low (about 35 confirmed), and a majority of the U.S. cases (21) are quarantined repatriated people who have come in on recent evacuation flights from China and Japan. Another 329 patients from the Diamond Princess cruise ship who were repatriated from Japan to the U.S. remain under quarantine, and the CDC believes some of those people are likely to come down with the virus.
The CDC recently asked labs in six U.S. cities to start testing laboratory samples from any patients with flu-like symptoms to determine whether the coronavirus may already be established in the U.S. If the virus is established in the U.S., we are concerned that we could see much more of an impact than we have to date on people avoiding large public gatherings, airline travel, restaurants, etc., and the follow-on impact upon domestic economic activity in general.
Even before this virus outbreak, global economies were experiencing significant monetary and fiscal stimulus, and the outbreak may even accelerate this sort of activity. It’s important to keep in mind that despite the scary headlines, this too will eventually pass, and our economy remains quite healthy among all developed economies globally. Interest rates and unemployment are both exceptionally low today, and inflation remains largely absent. These benign conditions should help support a continuation of the economic expansion that we’ve had since the end of the financial crisis in 2009.
We believe that the market may be in for some rough weather in the near term, as investors digest reports about the spread of the virus and its likely impact upon global economic growth. At this time we do not expect to make major changes in our investment portfolio as a result of the virus outbreak, although that could change. We believe that our portfolios have the ability to weather virus-related weakness, and we will continue to monitor developments.
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