On the Coronavirus and Rocky Markets

On the Coronavirus and Rocky Markets

By the time the Toronto Stock Exchange powered down this past Friday, the S&P/TSX Composite had shed over seven percent of its value on the week and its US cousin, the S&P 500, was down over nine percent. As a result, questions in client meetings have become focused on the coronavirus and these recent market declines so we thought it was a good time to reflect on the current situation, bring some perspective, and outline our plan from here.

Why did markets fall?

The most straightforward answer is that markets have become increasingly concerned that the coronavirus (also known as COVID-19) could materially reduce global economic growth. There are a few ways that the virus could do this.

The first is by interrupting trade flows. Given the epicenter of the outbreak is in China, and China has responded by shutting down certain large swathes of both its geography and economy, there is a heightened risk that Chinese goods stop flowing to its trade partners. Many businesses rely on a healthy global supply chain, with a steady movement of those goods to keep store shelves stocked, or component parts enabling goods to be finished in domestic industries. If the freighters float on the coast or worse, don’t come at all, the whole economic ecosystem is at risk.

The other way that the coronavirus could slow growth is by the virus itself spreading outside of China. Until a week ago, reports of infections were spotty around the globe. Italy, Iran, and South Korea all reported increases this past week, however, with the New York Times reporting on Friday the total estimated cases in the three countries at 3,500, double the level of two days prior. As of Friday, fifty-six countries had reported 83,000 cases and on Saturday, the US reported its first death, in Seattle. Two thousand, eight hundred have died globally, the vast majority of which have been in China – a region that itself has reported decelerating growth in reported cases. The bigger fear of a potential pandemic has taken hold of markets, however, and driven the recent losses on the markets. 

One of the psychological triggers that may be driving investor behavior is the relatively low levels of GDP growth that had been forecast for this year, before COVID-19 became a factor. With less than 2% growth forecast in both Canada and the US, it wouldn’t take much of an interruption to push either or both economies into a technical recession (two consecutive quarters of negative year-over-year growth). The R-word always spooks markets, even if it’s temporary.

How did markets fall?

The first place that recession fears show up is in the fixed income markets. This past week government bond prices rose, showing both a demand for certainty and a view that central banks will need to lower rates further in 2020 in order to support the economy. The premium required to hold corporate bonds also increased, reflecting investor nervousness about carrying the risk of default – but only rose back to levels seen in recent months.

The recent declines in equity markets have been global in nature, as the coronavirus mutated from a health scare to a financial one. Both high- and low-quality stocks dropped, irrespective of how exposed they might be to changes in economic growth, how vulnerable they might be to fluctuations in their cash flow (i.e., highly indebted and net cash companies alike), what their growth profile is, their level of management skill, and so on. For investors like us with a long time horizon and a keen understanding of the underlying intrinsic value of each of the companies in our universe, this type of environment creates opportunities to add to good businesses when they cheapen. More on that below.

What are we doing?

The first thing we’ve done is to start buying a short list of stocks at depressed prices, and slowly increasing our exposure to equities overall in balanced portfolios. With the TSX now down (-4.2%) in 2020 and the FTSE Canada bond index up 3.6%, it has been a good time to rebalance portfolios to their optimal mix of each. Stocks may fall further, but this rebalancing discipline enables us to ensure clients maintain exposures and in practice, “average in” through market and economic cycles. Our focus has been on adding to quality holdings with prices that have been particularly hard hit, deploying any latent cash or trimming holdings that haven’t fallen as far to fund purchases.

What should you do?

Our advice is to keep perspective, stay invested, and resist the urge to tinker with your investment policy. The real value of an investment policy is that it is established during calmer seas to guide decisions when the storm arrives, and permits you to capitalize on the opportunities the storm brings.

The coronavirus may fizzle out in a month, or it could get much bigger. We could see trade flows normalize, or we could see a further global economic slowdown. Markets could give us another 20%+ year or they could fall another 10%, 20%, or more. As alarming as that sounds, this would not in fact be a reason for alarm – or to touch your investment policy.

The reason is that when you are investing for the long term, market fluctuations – even large ones that persist for quarters or even years – will just prove to be bumps on the way to your ultimate goal. Market corrections are a normal occurrence, but lenders and investors always find a bottom; business builders move on and build again; and markets rise again – ultimately to new highs. In late 2018, we wrote that the sky is not falling (forever) to deliver this same message of hope, as the advice applies at all times in all market phases: markets go down, and markets go up, but over the long term, they go up.

As long-term value investors, we have the benefit of knowing the value of businesses without the benefit of a stock quote, so our homework pays off when others are losing their heads and selling good companies out of fear. We use these corrections as opportunities to buy those quality businesses when they’re on sale. Beyond that, it’s business as usual.