So, do I wear a face mask on my weekly Ryanair run to London? Will I eat Italian for lunch? Not sure. Will it matter in the long run? Probably not. Welcome to the world of human emotions, fear and temporary loss of reason. Sadly the human cost of the Coronavirus is very permanent just like measles, malaria and the flu. However, in the context of financial markets, a new virus and an understandably fast-moving learning curve can generate real fear and uncertainty. And that is a markets killer.
More than a month ago we tried to warn and quantify that very impact in “Charting a Dose of Flu” and we are already halfway there in terms of wealth destruction on US equity markets. Now, it’s time to move ahead of the CNBC “Markets in Turmoil” chyrons and apply a bit of historical perspective. This wide-angle history lens should calm investor nerves as financial headlines scream “Panic”. Firstly, investors are correct to interpret the quasi-shut down of the master cog in the global supply chain, China, as financially damaging for companies.
However, the likelihood is that depressed economic activity will catch up on lost production/demand in later months in the year. What is less rational from an investor perspective is that the valuations of major companies with multi-decade cash flows ahead of them have suddenly changed. That makes no sense as equities discount the long-run cash flow returns of a company. In a nutshell, the financial impact, unlike the human impact, is temporary, not permanent. Fear is the driver and markets almost every year experience the same. We thought the following data points, many from the excellent Charlie Bilello on Twitter, would provide some interesting context:
- The S&P 500 is down 6.28% over the past 2 days. That’s the 109th largest 2-day decline going back to 1928
- The S&P 500 is now down 7.6% from its recent all-time high. Now consider the average intra-year drop for the S&P since 1928 is 16.3%.
- Volatility has been very low in recent times thanks to central bank support. In fact, there had not been a 5% pullback for a whopping 8 months. Have we become spoilt by zero volatility?
- 1000 point declines for the Dow Jones Index sound scary but consider inflation and the growth of capital markets over the past 40 years. A daily 1000 point decline in percentage terms(3.56%) ranks as merely the 229th worst day since 1900.
- Since 2009 markets have experienced 5% plus declines on 26 occasions. We’ve been here before, many times.
- Investors are not quite abandoning capital markets. Bonds are hitting all-time highs, Zoom the video conferencing app is flying so business and capital markets will adjust to current conditions.
- Remember in a previous article we highlighted the research from Fidelity that its clients with the best returns were dead ones ie those that can’t react to headlines and emotions. Non-professional traders should try to avoid emotional reflex actions or panic selling.
If one were to be slightly constructive on serious economic disruption there a number of less obvious positives that could emerge. First, ultra low-interest rates have kept zombie companies alive and stifled productivity and investment in better companies. A short sharp shock might force some franchises (or their bankers) to finally call time on their activities. Second, an uncomfortable concentration of global manufacturing capacity in China needs to be reviewed. With ESG investment criteria coming down the tracks it might force some real conversations/negotiations on China’s track record on human rights.
Of course, Warren Buffett will also tell you time is your greatest investment tailwind and that the time to be greedy is when others are fearful. It will be interesting to see what he does with his $128 billion cash pile sitting on Berkshire Hathaway’s balance sheet. So, buckle up, things are moving fast but keep an eye on financial history and you’ll avoid the fearful holes others will fall into.
“One slip, and down the hole we fall/
It seems to take no time at all”
– ‘One Slip’ from Pink Floyd’s Momentary Lapse of Reason