How contained is the coronavirus outbreak? That’s the question that rattled markets on Monday, sending the Dow industrials down more than 1,000 points, or 3.6%. The S&P 500 index declined by 3.4%.
While coronavirus, or COVID-19, has been in the news for weeks, until recently stock investors seemed confident it would be contained. After a brief market drop in late January, the S&P quickly resumed its upward climb, reaching new record highs in February.
“Complacency has been evident with regard to the stock market’s behavior and the impact of the coronavirus on global growth,” says Schwab Chief Investment Strategist Liz Ann Sonders. “The initial outbreak of the virus conspired to shake that optimism, but after a mild 3.3% pullback in late January, complacency built yet again on hopes of a containment of the virus.”
Containment is key
On Monday, the World Health Organization said the virus had infected more than 79,000 people worldwide and killed at least 2,600, mostly in mainland China. However, outbreaks also have been reported in other countries, including South Korea, Italy and Japan; there have been 35 confirmed cases in the United States.
“Other than during wars, the scope of the shutting down huge swaths of the world, associated with the virus, is unprecedented,” Liz Ann says. “There are about 60 million people in China alone that are quarantined.”
Many comparisons have been analyzed between the coronavirus and the SARS outbreak in 2003. However, in the years since that outbreak, China has become a much greater global economic force. It’s now the world’s second-largest economy, behind the United States. Not only is China a key player in the global supply chain, Chinese consumers play a big role in global demand.
And the virus is no longer just China’s problem. “Italy and South Korea—the eighth- and 12th-largest economies in the world, respectively—have shut down public buildings, sporting events and schools in parts of those countries. In the case of Italy, at least 10 towns around Milan have gone under lockdown,” Liz Ann says.
Beginning late last week, investors accelerated their embrace of “risk-off” investments, flocking into defensive equity sectors such as utilities, and to perceived “safe haven” investments such as Treasury bonds.
However, long-term investors should not overreact, Liz Ann says.
“We continue to recommend that investors focus on diversification and rebalancing, and an emphasis on quality growth at reasonable prices, with a bias toward more defensive larger-cap stocks at the expense of more-cyclical smaller cap stocks,” Liz Ann says.
The yield curve has inverted
Although stocks rallied in February, bond investors have been steadily concerned about the virus, says Kathy Jones, Chief Fixed Income Strategist for the Schwab Center for Financial Research.
“Yields have been falling since early January when news of the spreading virus first surfaced, and they have headed steeply lower ever since,” Kathy says. “Ten-year Treasury yields fell by 11 basis points1 last week alone, falling through the 1.50% support level, while the 3-month/10-year yield curve inverted again.”
An “inverted” yield curve is when short-term Treasury yields are higher than long-term yields. Historically, a yield curve inversion often—although not always—has signaled a recession in the next 12 months or so. Because of recession concerns, the Federal Reserve is likely to cut short-term interest rates in an attempt to stimulate economic activity and offset the impact of the virus on global growth, Kathy says.
“The market is discounting two rate cuts of 0.25% each this year, which seems likely if economic conditions worsen,” Kathy says. “The Fed may wait a bit longer to see if the situation improves, but rate cuts seems more likely now that economic growth abroad is slowing.”
However, even if the Fed cuts rates, it may have a limited impact, Kathy says.
“There is only so much central banks can do when a supply shock hits the economy,” Kathy says. “Central banks are adept at handling demand problems. When the economy falters, the prescription is to cut interest rates, make money cheap and widely available, and eventually people will begin to spend, invest and lend. Supply shocks are different. Monetary policy can’t restore output and production.”
What if the epidemic is contained?
If governments can manage to contain the coronavirus, and it follows a pattern similar to other epidemics tracked by the World Health Organization in the past, the effect on markets could be relatively short-lived, says Jeffrey Kleintop, Chief Global Investment Strategist at Schwab.
Historically, the number of confirmed cases in various epidemics typically has risen sharply for eight to 10 weeks, then peaked. A short-term dip in stocks has tended to be followed, after the peak, by continuation of the upward trend.
Past epidemics have tended to have a short-term impact on stocks
Note: MSCI World Index scale is reflected in the left vertical axis.
Source: Charles Schwab, Factset data as of 2/21/2020. Past performance is no guarantee of future results.
Again, containment is key. If national governments and health experts can manage the outbreaks, it’s possible that growth will be less negatively affected than feared, Jeffrey says.
“The potential for a delayed, but not derailed, manufacturing recovery in the coming quarters could fuel a rebound in commodity demand and the relative outperformance by emerging-market stocks,” Jeffrey says. “However, there are still a lot of unknowns, and the extent of the near-term impact on economic data has yet to be assessed.”
What to do now
Market drops are an unavoidable feature of investing. What matters is how you respond—or, more to the point, don’t respond. Sometimes the best action to take is no action at all. If you’ve built a portfolio that matches your time horizon and risk tolerance when markets are calm, then a surge in turbulence may not feel so rough to you.
However, if you’re looking for something specific to do now, check out some steps that every investor should consider. What if you’re near retirement, or have a short investing horizon? Here are some things to consider if you don’t have much time to recover from market volatility.
1 A basis point is one hundredth of one percent, or 0.01%.
Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.
Investing involves risk including loss of principal.
Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see www.schwab.com/indexdefinitions.
Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
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