From a medical perspective, our thoughts on the coronavirus outbreak have not changed significantly since our preliminary report on the topic on January 28. The virus, now designated as COVID-19, is essentially a stealthy, highly contagious and virulent relative of the common cold, flu, MERS and SARS. It is a “novel coronavirus”, meaning it has never been detected in humans before. According to the World Health Organization:
“Most people (about 80%) recover from the COVID-19 without needing special treatment. Around 1 out of every 6 people who gets COVID-19 becomes seriously ill and develops difficulty breathing. Older people, and those with underlying medical problems like high blood pressure, heart problems or diabetes, are more likely to develop serious illness. About 2% of people with the disease have died.”
Obviously this is a very serious world health issue, but to date the death toll of 3000 from the outbreak is far below that of the flu (causing an estimated 80,000 U.S. deaths last winter). We are hopeful that a combination of focused quarantine, a rapid response from the drug industry (with a potentially effective antiviral developed by CCM holding Gilead Sciences already in Phase 3 trials) and upcoming warmer temperatures will soon halt the contagion.
Unfortunately, the panic from the coronavirus scare will undoubtedly have a detrimental economic effect on both the world and U.S. economies. The market is reacting as one might expect during such duress – there is “blood on the street”. On Thursday (2/27), the market experienced its worst single daily decline in nearly a decade. For the week, it was the worst loss since 2008, with the S&P 500 declining over 11%. For perspective, though, S&P 500 stocks are only down 8.3% – not particularly shocking after a 31.5% gain in 2019.
There is no way to predict the ultimate economic loss from COVID-19. China’s economy is at a near standstill at the moment, and as evidenced by recent warnings from Apple and Microsoft, the effects on the global supply chain will certainly spill over to the United States. We do remain a surprisingly isolated economy, however, and believe we can escape the situation without falling into recession.
In addition to the COVID-19 concerns, the heated rhetoric of the current political climate has only heightened the anxiety. Regardless of one’s political leanings, the inherent tensions of the Presidential election season already had investors on edge. Furthermore, some of the policy trial balloons being offered are not friendly for business, precisely at this time of crisis when the opposite response is indicated. Finally, the recent politicization of the crisis instead of working together to formulize a sound response is troubling. Consequently, many are taking this opportunity to exit risky assets.
With the trio of panicked investors, collateral economic damage and political uncertainty, the market will most likely remain under near-term pressure. To date, though, our clients have lost nothing but some paper profits – it is only when you sell that you realize a loss. CCM maintains a long-term investing horizon and does not sell during times of short-term panic. Even if we did, cash is not an option and we would only be locking in near-certain long-term losses by reinvesting in the bond market. The 10-year Treasury has now declined to an all-time low, with a yield of only 1.15%.
Since we are cautious by default, features were already installed in our balanced portfolios as insurance against a potential systemic shock. Most importantly, even though stocks have consistently been hyper-attractive versus bonds given their dismal yields, we have never made an “all in” bet on equity exposure. We have maintained an overweight (and profitable) position in stocks, but at present we are only maintaining an equity weighting of +10-15% over benchmark. The remainder of balanced exposure has been in conservative bond holdings, which act as a performance “shock absorber” in times of crisis (see our timely Commentary blog article). In addition, we have installed defensive industry positions in a “barbell” strategy to offset our growth-oriented holdings in the technology sector. This includes an overweight in the defensive healthcare sector, as well as limited holdings in the energy sector which have plummeted 24% this year.
Bottom line, no one knows the exact path for the virus, the economy or the markets going forward. The only thing close to certain is continued unease in the financial markets until the contagion shows signs of abating. We are always pre-prepared for crisis, as the risk profile of both our balanced and equity portfolios has always been conservative. In balanced portfolios, bonds are providing significant cushion, and our equity selections are always very high quality. At present we will remain calm while others descend into panic, and rely on the most important attribute of successful long-term investors – patience. In the end, even the profound damage from the financial crisis in 2008-2009 was completely erased within a surprisingly short amount of time.