After making a new, all-time high just last Wednesday, the S&P 500 index is now down roughly 12% over the last week. Most of the recent pressure and volatility can be attributed to concerns that the coronavirus epidemic that started in China could have significant spillover to the rest of the world. Despite initial concerns from the market in late January due to the virus, the market regained its footing over the course of just a few days and appeared to be unconcerned about the viral threat. However, a recent increase of cases outside of China sparked concerns that additional steps would be needed to prevent further spread.
What we know at this point is that the death toll from the coronavirus is likely to be less than just the normal flu season in the U.S. While over 2,000 have died from the COVID-19 virus, more than ten times that number have died from influenza through this flu season to date. Additional deaths will result from the virus, but the disease will eventually subside, and the world will return to normal.
We also know that market corrections are normal. A correction of 10% in any given year is typical, and even more common in presidential election years. Given the strong run the market has had since early 2019, it has been increasingly clear that the odds of a pause or pullback were increasing. As uneasy as it feels when they occur, periods like we are experiencing today are a normal part of investing.
Economist Ed Yardeni maintains a list of ‘panic attacks,’ and notes that this is the 66th such attack since 2009. The previous 65 panic attacks left uncomfortable feelings, but the market was ultimately able to move beyond them. Not all panic attacks result in a correction whereby the stock market falls 10% or more, but the chart below highlights that the market has experienced 14 corrections during the current economic expansion. This helps us remember that the market tends to react and overreact, yet advances long-term.
Corporate earnings and the economy will grow slower than previously forecasted. The extent to which they will be reduced isn’t yet clear. Collectively, the reductions that some have made so far in their 2020 earnings outlooks for the crisis are on the order of 1%-3% reduction in earnings growth. The best estimates so far are that the COVID-19 disruption might lower 2020 U.S. inflation-adjusted GDP growth from 2.0% to 1.7%.
Lastly, despite volatility and periods of increased downside risk, we know that stocks look attractive relative to alternatives. The 10-year U.S. Treasury bond currently yields 1.29%, the lowest level on record. As you can see in the chart below, over 65% of stocks in the S&P 500 currently have a dividend yield higher than the 10-year bond. The level has never been this high, and companies have the capacity to continue paying and increasing their dividends. More income and the potential for long-term returns from stocks remains front of mind for us and provides us with comfort despite the recent selling pressure.
Source: Strategas Research Partners
What we don’t know is how long the virus-related disruption will last and the magnitude it will ultimately have on the economy and earnings. While tragic, the deaths from the virus won’t meaningfully impact the economy. What will have a significant impact are the steps that governments around the world take to limit the spread. There is no precedent for quarantining tens and hundreds of millions of people in China and around the globe.
Beyond the drop in consumer consumption due to quarantines and fear, manufacturing and supply chain interruptions will have a negative impact on the economy and earnings. Factories in China were shuttered and have been slow to get back to full capacity. The recently announced closure of schools in Japan and Hong Kong could significantly impact productivity as workers are forced to stay home to care for their children. Travel plans that have been cancelled may never be rescheduled resulting in lost growth. Additional steps will likely be taken which will be a further drag on economic and earnings growth.
While social media and the 24-hour news cycle allow people to stay informed on important topics like the virus, they can also induce panic and lead to behavioral changes. As we have acknowledged many times before, catchy headlines and sensationalism sell. It is possible that consumers in the U.S. and around the globe become less confident and meaningfully change their behaviors due to these headlines and the fear they can incite. The consumer makes up nearly 70 percent of the U.S. economy and has been a key driver to economic growth. Significant changes in their behavior could send additional ripple effects through the economy.
The market is always looking into the future and discounting potential events and outcomes. As the presidential election gets into full swing, political and policy outcomes that could impact corporate earnings and the economy are beginning to be priced into the market. We set political views aside when making strategic decisions and focus rather on understanding whether a candidate and his or her policies are being viewed positively or negatively for stocks and the economy. We have access to portfolios that help us interpret what the market is pricing in relative to specific candidates and their proposed policy changes. We'll be keeping a close eye on what markets are saying between now and November.
While one never knows, we are hopeful that this is just another panic attack and not the start of something more. We will continue to monitor the situation and the companies we are invested in very closely. If we believe there is a cause for action, we will act. But, if the underlying cause of concern for the markets gets resolved as we expect, the market should resume tracking general economic conditions and earnings growth. We believe the U.S. economy is still on solid footing, and we know our objectives of Security, Income and Growth have helped build your portfolio to withstand environments like we are currently in.
If you still have any questions or concerns, please don't hesitate to contact your Advisor.
DCM Investment Policy Committee
This report was prepared by Donaldson Capital Management, LLC, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information in these materials are from sources Donaldson Capital Management, LLC deems reliable, however we do not attest to their accuracy.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results. The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation by Donaldson Capital Management, LLC.
S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.