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The latest headlines surrounding the COVID-19 virus have highlighted a growing number of infections outside of China. Over the weekend, South Korea, Italy, and Iran each reported a spike in the number of cases, increasing fear among market participants that this may escalate into a pandemic that causes a material drag on the global economy.

So far, the economic impact in China has been significant. Car sales have fallen 92%air travel in Beijing is down over 80%, and VC investor funding for Chinese start-ups decreased by 60%. However, what makes this epidemic particularly concerning is that it comes at a time when the global economy is already in a fragile state.

Economic growth in Japan was contracting and German GDP was nearly zero prior to the emergence of COVID-19. Subsequently, Japan’s economy has contracted further and Deutsche Bank—Germany’s largest bank—is now forecasting a recession in Germany.

Furthermore, the US economy has not been immune to this contagion. Last Friday, the preliminary forecast for the Markit Services PMI showed that the US Services industry contracted in February. Another similar economic indicator, the ISM Non-Manufacturing PMI, will be disclosed on March 4, 2020. This data could confirm a contraction of the US service economy, which has not occurred since 2009.

Late-cycle phenomena such as fifty-year lows in unemployment, an inverted yield curve, and high valuations create a window of vulnerability where exogenous shocks like COVID-19 have the potential to push economies into recession. Bad news matters more when growth is slowing than when it is accelerating, and global growth has been slowing for the better part of the past two years.

In the absence of data indicating that a sustained economic reacceleration is likely, we continue to generally recommend remaining defensively positioned by being overweight long-term government bonds, gold, and equity sectors like REITs and utilities. These assets have outperformed broad equities since the US economy began to slow in 4Q18, and they have performed particularly well during the past week as volatility has increased, helping to preserve capital in portfolios.

As always, we’re happy to discuss our process and how particular events influence your portfolio. If you have any questions, please do not hesitate to call us.

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