The Alliance Bernstein investment research team explain to us the Coronavirus Market Impact.
The spread of the coronavirus beyond China and a realization of the longer, and sizable, impact on global economies has driven a sharp increase in volatility across markets and a strong flight to quality.
As of Sunday, confirmed cases of coronavirus (officially COVID-19) topped 110,000, with the virus claiming more than 3,800 lives. News in the next few days is unlikely to bring much relief, with reported infection and death rates ticking up. Supply and demand disruptions are real, and so is their economic impact. For example, oil prices recently dropped to ~$30 (given disruptions to short-term demand) with the economic impact being felt globally. Backward-looking payroll data has been strong, but data going forward is anticipated to deteriorate and firms will continue reducing earnings guidance.
In short, the direction is clear but the magnitude and end date aren’t. In the absence of clarity, there seems to be little reason for buyers to come in and support equities in the immediate term (though stocks are still up about 10% over the last 12 months). As much as anything, that assessment seems to be driving volatility.
Over time, stocks are valued on earnings and cash flow, and history is clear that this relationship will return, no matter how long and deep the dislocation is. Many measures of investor sentiment and positioning have gone from overbought/bullish to oversold/bearish, with some indicators suggesting the market is already discounting no earnings-per-share growth again in 2020.
We hope the next few weeks will reveal more about the virus and perhaps we’ll begin seeing a slowdown of new cases. That development, combined with strong support from central banks and government officials and a generally solid economic foundation, would give us reason to believe that sentiment will improve.
MARKET OUTLOOK & FED ACTIONS
Last week’s Fed rate cut was an attempt to reassure markets, and we think more cuts are coming—in March and beyond. The US economy should rebound in the second half of the year, though at a lower full-year pace.
We expect another cut at the March 18 Fed meeting, with the size based on the amount of economic and financial disruption over the next two weeks. Our initial thought is for another 50 basis point cut. But while rate cuts are normally good news for investors, we need to be realistic about what central banks can and can’t achieve. Governments will likely turn to a fiscal policy if monetary policy isn’t enough.
Ultimately, we think the US economy will resume its previous growth trajectory but simply be missing a few months as a result of the coronavirus impact. We’ll reassess expectations as more data emerges.
WHAT ARE WE DOING IN OUR PORTFOLIOS?
We’re being cautious and deliberate in our portfolios. In some cases, we sold stocks most exposed to potential demand destruction from COVID-19. In other cases, we’ve identified new opportunities that have become more attractive. Lower asset prices will create opportunities to reposition the portfolio for future success at more conservative valuations.
Bond yields could still decline near term (the next few months or the rest of the year), but we could see some mean reversion, with yields potentially rising modestly. It would be hard to time, so we’re keeping structural duration in portfolios. With risk assets selling off recently, we’ve tapped opportunities to add to our high-yield corporate exposure. We still find securitized assets attractive, given their greater insulation from global risks.
Our investment teams will continue to monitor the evolving situation and its impact on client portfolios closely
