The global economy essentially just got a one-two punch to the face. The psychological impact of the spread of the Coronavirus on the general public and the actions being taken by governments to contain it have reached the point where a health concern is now morphing into an economic concern as events are cancelled and people stop spending on everything except hand sanitizer and toilet paper. On top of that, Saudi Arabia basically launched an oil price war on Sunday. The world has a glut of oil right now and the Saudis decided not to scale back production after Russia flooded the market with extra oil. So oil prices plunged 30 percent, the largest one-time drop since the 1991 Gulf War.
There’s still a chance the Coronavirus could run its course and the world returns mostly to normal by the summer, which could trigger a global financial rebound. But many international economies, some already in a frail economic state, have virtually ground to a halt. In an ever more connected global world, even though the U.S. economy was in better shape at the outset of this event, it’s becoming increasingly likely we will see negative effects to our growth. In fact, at this point many economic experts now expect the U.S. economy will stall to zero — or even turn briefly negative — in coming weeks. If that happens, it would not take much to fully knock it into a recession. That’s a big reason why there’s so much volatility in the equity markets. Stock prices are a reflection of the expected growth in future earnings, and the multiple investors are willing to pay for a share of those future earnings. When the confidence in those future earnings is called into question, it becomes very difficult to calculate the price an investor should pay.
Consumer spending powers 70 percent of the U.S. economy. If the negative effect of a slowing economy causes companies to cut back their workforce and people lose their paychecks, or even just grow fearful of losing their income, they rein in their spending. That can start a very quick downward cascade. Less-affluent households will struggle to buy the basics. Middle-class Americans start saving and cooking at home instead of going out to restaurants. People start running around the block instead of going to the gym. They start purchasing cheaper products instead of “luxury” items. And they typically stop buying big items like washers and dryers, cars, furniture and homes.
Congress passed an emergency spending bill last week that included about $1 billion for the Small Business Administration to make loans to companies that are struggling. The President and Congress are discussing what additional fiscal actions might be necessary, including potential direct aid to families in need and access to low cost financing for U.S. companies in systemically important industries like the energy sector. The Federal Reserve is also stepping in to provide $1.5 Trillion in extra liquidity to financial institutions and the Treasury market to ensure the financial system “plumbing” continues to function as it should during this time of heightened stress.
Never before have the major indexes dropped more than 20% from previous all-time highs so quickly… as measured in days. It seems without question the impact of 24/7 media coverage and the proliferation of social media – the fast, super-connected pace of our modern world – have been a significant catalyst in this event. A headline here… A news alert there… A press conference over there… All day long. Investors have more opportunities than ever to succumb to emotion.
But when you stop and think rationally about the bigger picture, a sell-off due to a virus that’s disrupting all sorts of economic activity – including travel and oil markets – the weakness seems entirely rational when taken on its own. When examined in that context, it would almost be weird if the investment markets were rising during all this uncertainty. While it’s important to understand, and not underestimate, the short-term risks from increased volatility in the investment markets, it’s also vital to remember the purpose of investment portfolios is for long term future growth.
It’s reasonable to think that things will get back to “normal” at some point. We don’t know when, but in the interim we have reviewed each client’s portfolio to ensure the allocation is aligned with individual risk tolerance and time horizon, and we continue to focus our equity related efforts on identifying quality companies with low debt levels and great cash flow to add when their valuations look attractive.
With these regular notes, we have tried to keep our clients informed of our thinking about the market environment during this volatile time period, but as always we are available for personal discussions by phone or in person with any client that wishes an individual consultation. All of us at YHB wish you and your family good health.
Randy has more than 15 years of experience managing financial assets for individuals, retirement plans and businesses. Randy joined YHB | Wealth Advisors in January of 2018 and serves as the Director of Wealth Management. Prior to entering the professional wealth management field, he enjoyed building entrepreneurial business ventures from start-up to eventual sale and providing accounting services for public and private firms.