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We are closely tracking developments relating to the COVID-19 outbreak, the global economy, and the financial markets. Our concerns go out to those who have contracted this virus and to those families who have been affected.

As you know, equity markets and other risk assets tumbled this past week. While the spread of the COVID-19 virus is capturing most of the attention, the contagion is occurring against a backdrop of global growth that was already weakening beginning in late 2018.

Our investment process dictates close tracking of the rate of change in economic growth and inflation around the world which are the most important drivers of asset class performance. Over the past 18 months, these indicators have caused us to favor defensive assets such as long-term Treasury bonds, gold and utility stocks whereas we have recommended significantly reduced equity exposures.

The double whammy of decelerating growth and COVID-19 may create just another opportunity to adjust asset allocations, or it could hasten the next global economic recession. We will stay true to our investment process and as the news headlines and economic data develop, we will continue to adjust portfolios in either direction as needed.

For those interested in more background about what we are following, please read on.

Please know that we are at the ready and watching markets closely. We encourage you to reach out if you would like to discuss these developments with us.

Key Asset Class Performance Last Week

  • Last week, the MSCI All-Country World Index declined -10.1% and the S&P 500 Index declined -11.5%. For equities, this was the fastest 10% decline in history.
  • Emerging markets equities declined -6.2% and high-yield bonds declined -2.6%
  • Safe haven assets, namely US Treasury bonds, saw so much demand that the yields on 10-year and 30-year Treasury bonds dropped to all-time lows of 1.15% and 1.67%, respectively.
  • Gold had a volatile week, rising to all-time highs versus over twenty paper currencies, only to finish the week down -4.7%. WTI crude oil declined by -16.1%.
  • The CBOE Volatility Index which measures the market’s expectations for volatility over the next thirty days, surged to levels not seen since the 2008-09 financial crisis.

COVID-19 Update

  • Johns Hopkins has an excellent interactive tracker of the COVID-19 outbreak. Click here for the desktop version or click here for the mobile version.
  • Confirmed cases worldwide surpassed 85k. Deaths are approaching 3,000.
  • COVID-19 has now spread to 60 countries where it is impacting health and economies.
  • The US CDC indicated it is not “if” but “when” the US experiences a COVID-19 outbreak.
  • Organizations are implementing containment measures and governments, especially those with weak medical infrastructure, are struggling to implement procedures to manage the contagion.
  • On a positive note, the illness has been relatively mild in its symptoms; those most at risk have been the elderly or those otherwise medically at-risk.
  • Although this is uncertain, there is a chance that the coming warmer weather could create a more favorable environment for containment and disease dissipation.

Economic Impact

  • The economic impact and global government and central bank policy response are unclear. It is simply too early to know.
  • As mentioned in our last email, economic growth in Japan was contracting and German GDP was nearly zero prior to the emergence of COVID-19.
  • The preliminary forecast for the Markit Services PMI showed that the US Services industry contracted in February. More data is due this week.
  • China’s first official estimates of post-COVID-19 economic activity came out Friday night. Both PMI indices tumbled to their worst readings on record.
  • However, China claims to be making progress getting people back to work but it is hard to know for sure.
  • 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.

What’s Next

  • Markets are getting whipsawed and there’s major uncertainty going forward. The next news items and economic data could send stocks sharply in either direction.
  • As of 6:30pm this evening, equity markets are weakening as Monday’s trading gets under way in Asia. Futures contracts on Japan’s Nikkei 225 Index and the S&P 500 Index are currently both lower by around 1%. This could change significantly by the time trading begins in NY tomorrow morning. We expect equity markets to continue to be volatile in either direction in the coming days.
  • As we have written in recent months, the risk of recession has been rising. Add in COVID-19, and the risks grow further.
  • Expect central banks and governments to do whatever they can to rescue the global economy. Whether or not they can provide enough stimulus remains to be seen.
  • Here’s what we’re watching:
    • The bond market: The credit markets have been concerned about growth for many months, whereas the stock market has been anticipating a growth reacceleration. In general, we give more credence to the credit markets so if the panic buys of ultra-safe bonds eases, this may be a sign that this rout in risk assets is over.
    • Credit spreads: High-yield bond spreads can be a harbinger of risk to come. Since high-yield bonds are relatively illiquid and are more difficult to sell, significant weakness in this market can indicate more serious economic concerns are developing and defaults may increase. High yield spreads have increased, but not to panic levels.
    • Market volatility: Expected volatility surged this week to levels not seen since 2008-09. In other words, the cost for an insurance policy against portfolio losses soared. This condition can persist while the market is seeking to reduce risk, but measures such as the CBOE Volatility Index often collapse once selling has abated. This can be a telltale sign of when it is safe to add to risk positions.
    • Economic data, primarily out of Europe: Europe is in the midst of what appears to be a significant increase in outbreaks. It appears the aggressive actions of the Chinese have pushed that economy into stall speed, but how will Europe fair? Data scheduled for next week should shed some light.

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