Mar 09, 2020

February Chill: Coronavirus Outbreak Roils Markets

By Kara Murphy, CFA® Chief Investment Officer

The first signs of spring are popping up around me — from the bulbs lining entrances to local supermarkets to the buds on the trees outside my kitchen window.

Key Takeaways

  • The broad U.S. stock market climbed in early February, only to retreat sharply as the coronavirus spread globally.
  • These same fears pushed Treasury bond prices up and pulled Treasury yields to all-time lows as investors crowded into safe-haven assets.
  • The U.S. economy is expected to continue to grow this year, albeit at a slower pace than many originally anticipated.

My kids, meanwhile, have begun to their annual countdown to summer vacation. Yet the promise of warmer, more-carefree days contrasts sharply to the chill that gripped global equity markets recently as concerns about the spread of the novel coronavirus (known as SARS-Coronavirus-2) mounted. Heightened fear and uncertainty surrounding the outbreak drove equity markets into negative territory for the year, pulled Treasury yields to all-time lows, and prompted several high-profile companies to cut their near-term earnings outlook.

This type of volatility can understandably cause some concern about investment portfolios. That said, it’s important to keep in mind that market crises are inevitable, and though each one is unique, they have been surmountable. Selloffs that followed past crises —such as the SARS epidemic, the global financial crisis, the 9/11 terrorist attacks and the bursting of the dot.com bubble — were no doubt painful for investors. But in each case markets and the global economy proved resilient over the long term, much like winter invariably gives way to spring.

Equity Markets

After trending downward in late January, the broad U.S. stock market rebounded during the first half of February, buoyed by reports that Federal Reserve policymakers were cautiously optimistic about the U.S. economic outlook, shrugging off early news of the coronavirus outbreak.

Solid fourth-quarter earnings results for companies in the S&P 500 index also drove the S&P 500 to an all-time high in mid-February. With 98% of companies reporting as of March 9, 70% of companies had beaten their earnings estimates for the fourth quarter, according to Refinitiv. Excluding the volatile Energy and Materials sectors, S&P 500 companies saw their sales climb by nearly 6% during last year’s fourth quarter, according to Goldman Sachs Private Wealth Management Investment Strategy Group (ISG).

The rally, however, proved fleeting. Following reports that the novel coronavirus had begun to spread beyond China and what proved to be prescient warnings from U.S. health officials that Americans should expect a domestic outbreak, the market turned down sharply, ultimately falling into negative territory for the one-month and year-to-date periods ended Feb. 28. The S&P 500 was up by over 8% for the trailing 12 months ended Feb. 28.

As discussed in January’s Market Commentary, this isn’t the first time we’ve seen a viral outbreak fan market volatility. In fact, an ISG analysis of five prior health crises indicates that Treasurys tend to outperform the broad stock market immediately after the start of an outbreak. This only makes sense as U.S. government bonds are generally considered one of the safest investments in global financial markets. Yet according to the ISG analysis, U.S. equities tend to regain their footing and outperform bonds in the subsequent three- and six-month periods.

We shouldn’t draw strong conclusions because of the relatively small number of past viral outbreaks (some of which were more limited in scope than the novel coronavirus outbreak) and the large variation in economic conditions during those outbreaks. But history can be a useful guide during periods of heightened uncertainty.

U.S. Sectors

Not surprisingly, a number of sectors that depend heavily on global economic growth were hit hardest in February. The energy, materials and industrials sectors suffered double-digit losses for the one-month and year-to-date periods ended Feb. 28.

Financials also suffered disproportionately because of historically low interest rates that tend to hurt bank earnings. The novel coronavirus outbreak also threatened to shake economic confidence, which could in turn lead to lower loan growth, among other possible effects on the sector.

The healthcare sector was certainly not immune to last month’s broad selloff, but it held up relatively well, falling -6.3% compared to the overall market decline of -8.2%. Some investors bought up the stocks of companies involved in treating or containing the new coronavirus outbreak.

On a trailing, 12-month basis through Feb. 28, the technology sector, which has been a major driver of market appreciation during this cycle, remained the clear winner, gaining some 23% to outperform the broader market by a wide margin.

The largest 10 stocks in the S&P 500, which include some of the biggest names in tech, now account for about 24% of the index’s market capitalization, approaching levels not seen since the dot.com bubble, according to ISG. This has many investors wondering whether we are on the cusp of another dot.com bust. Not according to ISG, which indicates that one of the key differences between today and the period preceding the bursting of the dot.com bubble is that stock prices of tech giants haven’t detached from company fundamentals.

Fixed Income

The U.S. bond market was a relative bright spot in February, benefitting from strong demand for safe-haven assets, particularly longer-dated Treasurys, which gained 3.2% last month and outperformed the broader domestic fixed-income market for the trailing, 12-month period.

Yields on government bonds, a measure of investor sentiment about the economic outlook, hit all-time lows in late February and early March, before trending upward slightly as the Federal Reserve’s latest rate cut helped to bolster demand for equities. As bond prices rise, bond yields fall and vice versa.

The Economy and the Fed

The U.S. economy is expected to continue to grow this year, albeit at a slower pace than many anticipated at the start of the year. In late February, Goldman Sachs Global Investment Research (“GIR”) division revised its 2020 U.S. real gross domestic product (GDP) estimate lower to 1.3% from 2.1%. At the start of the year, GIR estimated that domestic growth would be 2.3% in 2020.

When the Federal Reserve voted to leave interest rates unchanged at its January policy meeting, it cited a strong labor market and moderate growth in household spending and economic activity. But then the threat of coronavirus hit American shores, prompting the central bank to pivot abruptly and cut its benchmark interest rates by 50 basis points, or 0.50%. In describing their decision, Federal Reserve officials noted the “evolving risks" to economic activity posed by the novel coronavirus outbreak, and their determination to support a potentially weakening economy. And the Fed was not alone. Its counterparts in other parts of the world, including the People’s Bank of China, have either announced stimulus measures or are expected to do so.

It's not hard to see why there is so much consternation surrounding the novel coronavirus outbreak. Even after months of this epidemic, there is still a great deal of uncertainty regarding fatality rates, incubation periods and forms of transmission. In recent weeks, the number of countries affected by the virus has risen, as have the number of infections and fatality rates.

Importantly, according to GIR, the number of new cases of infections in mainland China appears to have moderated recently. But the country, which accounts for an estimated 17% of global GDP, has seen its economy grind to a standstill because of the outbreak.

We’re also seeing anecdotal evidence that the U.S., Europe, South Korea and other markets are beginning to feel some economic effects as businesses curtail travel and conferences, consumers rethink travel plans and certain companies struggle with supply-chain disruptions. ISG found that sectors such as airlines, cruise lines and casinos tend to be negatively affected by viral outbreaks as consumers pull back on travel and entrainment, not to mention restaurant and mall visits.

In its analysis, ISG also found that at the global level, the impact of virus outbreaks on economic activity is difficult to detect and isolate from other pre-virus trends. U.S. growth rates weakened modestly around recent epidemics (such as the SARS outbreak of 2003 and the Ebola outbreak of 2014) and rebounded the following quarter.

Conclusion

To be sure, we’re following current developments closely to assess how the novel coronavirus outbreak might further impact markets and the global economy. Given the lingering uncertainty surrounding this health crisis, we believe there will be more market volatility, which only increases the risk of investors making rash, fear-based decisions. As always, it’s important to stay focused on your long-term goals in spite of the daily drumbeat of troubling headlines.

During times like these, I can’t help but think back to my first days on Wall Street as an equity analyst, which happened to coincide with the bursting of the dot.com bubble. At the time, the market seemed to be headed only in one direction, down. But, as we now know, investors who weathered that storm eventually saw sunnier days.

Of course, we’ll continue to monitor your portfolios, and if you have any concerns about your personal financial plan, please reach out to your advisor. That’s what they’re here for.

Invest well, live richly – and stay healthy,

Kara Murphy, CFA

Chief Investment Officer

Important Disclosure

United Capital Financial Advisers, LLC (“United Capital”) is an affiliate of Goldman Sachs & Co. LLC and subsidiary of the Goldman Sachs Group, Inc., a worldwide, full-service investment banking, broker-dealer, asset management, and financial services organization. United Capital does not provide legal, tax, or accounting advice. Clients should obtain their own independent legal, tax, or accounting advice based on their particular circumstances.

For clients with managed accounts, United Capital has discretionary authority over investment decisions.

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Economic and market forecasts presented reflect the judgment of Goldman Sachs Investment Strategy Group as of the date of this material and are subject to change without notice. Return expectations are based upon ISG’s capital market assumptions. They should not be taken as an indication or projection of returns of any given investment or strategy. Forecasts are estimated, based upon assumptions, and are subject to significant revision and may change materially as economic and market conditions change. We have not obligation to provide updates or changes to these forecasts.

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Index Definitions

S&P 500 Index: A broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a capitalization-weighted, unmanaged index that is calculated on a total return basis with dividends reinvested. The S&P 500 represents about 75% of the NYSE market capitalization.

Russell 2000 Index: This index measures the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks; the index serves as a benchmark for small-cap U.S. stocks.

MSCI Europe, Australasia, and Far East (EAFE) Index: This index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.

MSCI Emerging Markets Index: This index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of June 2009, the MSCI Emerging Markets Index consisted of the following 22 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

Bloomberg Barclays U.S. Aggregate Bond Index: This is a market capitalization weighted bond index of investment-grade, USD-denominated fixed-income securities.

U.S. High Yield Corporate: The Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.

U.S. Investment Grade Corporate: The Bloomberg Barclays U.S. Corporate Bond Index measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility, and financial issuers.

Bloomberg Barclays Municipal Bond Index: The Bloomberg Barclays U.S. Municipal Index covers the USD-denominated, long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.

S&P 500 GICS Sectors Level-1: In 1999, MSCI and S&P Global developed the Global Industry Classification Standard (GICS) to offer an efficient investment tool to capture the breadth, depth, and evolution of industry sectors. GICS is a four-tiered, hierarchical industry classification system. It consists of 11 sectors, 24 industry groups, 68 industries, and 157 sub-industries. Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity. MSCI and S&P Global use revenues as a key factor in determining a firm’s principal business activity. Earnings and market perception, however, are also recognized as important and relevant information for classification purposes and are considered during the annual review process.

Kara Murphy
ABOUT THE AUTHOR

Kara Murphy, CFA® Chief Investment Officer

United Capital Financial Advisers, LLC d/b/a Goldman Sachs Personal Financial Management (“GS PFM”) is a registered investment adviser and an affiliate of Goldman Sachs & Co. LLC and subsidiary of The Goldman Sachs Group, Inc., a worldwide, full-service investment banking, broker-dealer, asset management, and financial services organization.

The information contained herein is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. GS PFM does not provide legal, tax, or accounting advice. Clients should obtain their own independent legal, tax, or accounting advice based on their particular circumstances. Please contact your financial adviser with questions about your specific needs and circumstances.

Information and opinions expressed by individuals other than GS PFM employees do not necessarily reflect the view of GS PFM. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice.