The markets have recently been impacted by the spread of the Coronavirus throughout the world. FIFS Capital Advisor Group is monitoring the outbreak and we wanted to share with you this timely update from Cetera Investment Management:
Coronavirus Spreads and Fears Grow
- Global stock markets price in risks of coronavirus spreading
- Economic data had been improving, but equity valuations were high
- Continue to expect rising volatility to increase as uncertainties grow
Global equity markets began the week with a significant selloff as the number of coronavirus (also known as COVID-19) cases and deaths attributed to this outbreak grew dramatically outside of China over the weekend. We have been cautious towards equity markets for some time now as valuations have been stretched without a marked improvement in fundamentals.
There will be supply-side disruptions out of China with many Chinese workers quarantined at home and unable to work. American companies and other global companies depend on parts and goods manufactured in China. In addition, there are global companies that do business in China. Economic activity in China is already slowing as people are not spending as much money and not leaving their homes. Industries like cruise lines, airlines, hotels, and others will be affected as people are putting their travel plans on hold. The thesis that the global economic impact will be short-lived is fading on news of the virus spreading to Italy, South Korea, Japan, Iraq, and Iran.
As these countries combat the virus, there may be a great economic cost that could derail the global economy. The respective governments of the afflicted nations will likely follow a similar strategy that the Chinese government used. This would include increased monetary and fiscal spending and shutting down large areas of their afflicted regions. Similar to what we saw in China, the likely result will be reduced spending and disruptions to supply chains.
The fears of the virus are coming at a time when equity investors seem to be very optimistic, trading on momentum, and possibly underestimating mounting risks. Earlier this year, the typical relationships between bonds, stocks, and gold had been broken with all three asset classes rising in tandem. Stock prices had been rising on relatively good economic news domestically, with building permits rising to a 12-year high in January, very low unemployment, and consumer confidence at high levels. With the Fed not expected to raise interest rates anytime soon and core inflation at low levels, this is all great news for the economy and stocks.
However, as stock prices continued to factor in this good news, earnings growth has been relatively flat. At the same time, valuations have moved decidedly higher over the last year. Put another way, the prices investors are paying for stocks relative to their earnings streams are getting expensive. Price-to-earnings ratios for S&P 500 companies collectively approached 15- year highs.
On the other hand, bond prices and gold have been rallying this year as risks have been rising, but stocks had largely been ignoring the increased risks of the possibility of a worldwide pandemic caused by the coronavirus. Many investors have been brushing aside the fears of a pandemic and expecting a V-shaped recovery after the financial effects from the virus took hold, like what happened during the SARS outbreak.
Though the impact on human life is at the forefront of everyone’s concerns, the markets are also focused on the potential impact of the virus to the global economy. Keep in mind that the global economy was already fragile from the nearly two-year-long US-China trade war, but January data suggested that the fallout from the trade war was reversing and starting to improve. The spread of the virus now worries investors, especially given the first reading of February’s economy (IHS Markit Purchasing Manager Indexes for both the services and manufacturing sectors of the U.S. economy dramatically fell unexpectedly).
There is some good news though–one cannot underestimate the Federal Reserve. The Fed Funds futures markets have now priced in the strong possibility of three one-quarter of one percent rate cuts by the end of the year. Just last week, one to two possible cuts were expected.
While we will continue to watch the fallout of this virus, we do believe that it may have afforded investors a reason to reduce risk, something that has been missing for some time. While defensive assets are good hedges for market uncertainty, their extreme valuation suggests their effectiveness may be limited. Instead, we would be more likely to focus on the time-tested strategy of diversification and reallocating assets amongst multiple asset classes. Please contact our office for more insight during these volatile market times.
This report is created by Cetera Investment Management LLC
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