In Lewis Carroll’s novel Through the Looking-Glass (the sequel to the classic, Alice’s Adventures to Wonderland), Alice once again enters another fantastical world of adventure. Key themes throughout the novel include the reversal of logic and of course, chess. Chess at its heart is a game based on logic and combines both short-term actions as well as setting up long-term endgame scenarios. This is very much similar to investing and specifically applies to portfolio construction, being aware of the tactical short-term opportunities in the current market environment while keeping an eye on the long-term.
As we noted in our last Market Action Update: Don't Panic, investors have been warily watching the data on COVID-19, the official name of the novel coronavirus. Fears accelerated over the weekend, as new pockets of the infection cropped up in South Korea, Iran, and Italy. To stem the outbreak, Italian authorities have locked down citizens in the region of Lombardy, south of Milan, closing schools and canceling public events. Meanwhile, several nations, including Turkey and Iraq have closed their land borders with Iran. It’s important to note that the World Health Organization (WHO) came out recently to state that COVID-19 is NOT a pandemic. Currently there are 79,339 cases in 30 countries which have resulted in 2,619 deaths. At the end of January those numbers were around 14,000 cases in 23 countries with 300 deaths.
As we have progressed through the fourth quarter earnings season, companies have begun to increasingly digest the financial impacts of the coronavirus. Though the overall death rate remains relatively low around 3%, as events are canceled across the globe on account of health concerns, the virus's impact on global growth seems like it could be more meaningful than initially thought. Companies are already warning that production will be impacted due to the virus – auto parts, fabrics, and electronics are not being produced or are sitting idle in factories with no workers. Service industries have been impacted by travel restrictions, and as this drags on, supply chains will become a bigger issue. It takes about 21 days for a container ship to travel from Shanghai to the port of Los Angeles.
Despite the stimulus Central Banks stand to provide, the economic environment that was believed to be on tap for 2020, has significantly been adjusted – the IMF now expects China’s GDP to come in at 5.6% in 2020 versus 6.0% – and the Central Bank capacity that was thought to have been reserved to stem an economic slowdown will likely be spent to cushion the virus' unexpected economic shock. Expectations of rate cuts by the Fed have increased overnight, with investors now pricing in a 23% chance of a March rate cut (up from 11%), a 95% chance of at least one rate cut in 2020, and a 75% chance of at least two cuts.
Outside of health concerns, U.S. political uncertainty into the 2020 Presidential election remains.
Warren Buffett spoke to CNBC this morning and said, “The real question is: ‘Has the 10-year or 20-year outlook for American business changed in the last 24 or 48 hours?’” He and Charlie Munger have famously taken advantage of market dislocations, “You’ll notice many of the businesses we partially own… those are businesses and you don’t buy or sell your business based on today’s headlines. If it gives you a chance to buy something you like and you can buy it even cheaper then it’s your good luck.” He also noted in his annual shareholder letter to Berkshire Hathaway investors, “If something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments.”
With today’s market volatility, the 10-year U.S. treasury is now yielding 1.36%, further morphing a historically viewed long duration asset more into a short-duration asset (the 2-year U.S. treasury was yielding 1.35% yesterday!). Over the last year we have orientated our asset allocation strategies more defensively for moments of disruption. Our generally optimistic base case scenario for 2020 hasn’t changed and we continue to monitor the data vigilantly. Stay the course and always remember about the long-game.
As always, we appreciate your confidence in us. Please don’t hesitate to reach out to your wealth advisor for questions.