Market Update: February 2020

02.25.2020 - Ronald J. Sanchez, CFA

Market dynamics

After a year in which US equities rallied by more than 30%, stocks continued to move upwards and set new highs in 2020.  Last Wednesday, February 19, the S&P 500 Index hit another all-time high, gaining 5% year to date.  US equity markets have proved to be more than resilient in the face of the global health scare stemming from the coronavirus.

Following news in January that coronavirus fears had widened to areas outside China, the Dow Jones Industrial Average fell 600 points, but soon fully recovered and continued to move higher. Equity investors looked past the risk associated with the coronavirus and, instead, focused on the supportive backdrop of reasonable economic growth, a better than expected corporate earnings, ideal financial conditions and growing confidence surrounding the policy response. Investors believed the combined effect would offset a virus-induced period of economic weakness.

Risk on or risk off?

While it has generally been risk-on for equities, mainly for the S&P 500 which benefits from tech sector leadership, other segments of the financial markets have been reflective of a more risk-off manner suggestive of a flight to quality by investors. For instance, oil prices have been falling as the US dollar, Treasuries and gold have all been rallying. These market moves had seemingly been at odds with the movements in U.S. equity prices—at least until yesterday, when the S&P dropped by over 3.3% and the year-to-date gains in stocks were completely erased.

What changed?

Equity investors had been operating under the assumption that the impact from the virus would be isolated, contained and transitory, just like other recent global health scares. This premise is now coming under some pressure and investor complacency is being challenged.

Recent information has suggested that the spread of the virus had accelerated beyond China, with large numbers of cases being reported in South Korea, Italy and Iran. This raises the risk that containment could be more difficult and protracted than originally thought. Multinational corporations with global supply chains can certainly weather disruptions for some amount of time, but with the virus spreading further, equity investors have moved to discount a more meaningful impact to production and consumption.

Yesterday’s decline in equities brings them more into agreement with the views signaled by fixed income investors year to date. The trend in 2020 had already been lower and lower yields in Treasuries and yesterday’s move drove 10-year US Treasury yields near their all-time lows. Testing these new levels suggests that fixed income investors may have priced in a more severe economic impact from the spread of coronavirus than implied by equity markets.

What does the short-term outlook look like?

We think that a period of increased volatility is likely in the near term as markets continue to discount new developments. Given the strength of US equity markets leading up to and persisting through the evolution of the coronavirus outbreak, and the shaken confidence of investors, we believe an immediate bounce-back to be unlikely. We feel it is too early to determine the full scope of the coronavirus and acknowledge that there is now a wider range of potential outcomes.

At this time, we continue to approach markets with a heightened degree of caution and patience. Volatility had largely been absent from markets until yesterday, and prudence would dictate allowing time before we can make a determination of the duration and magnitude of the epidemic to more fully understand the risks presented by further spreading of the virus. Our base case would be to view the outbreak as an admittedly growing, but still manageable setback and not yet likely to alter the pre-coronavirus economic thesis.  

Current positioning

In client portfolios, we are currently underweight both equities and fixed income in favor of cash. Our elevated cash position provides the flexibility to tactically take advantage of increased volatility and possible market dislocations, while also buffeting against downside risks.

The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.


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