Stock markets declined while bond yields fell the most last week since the financial crisis as fears that the global economy would be severely hurt, maybe even enter a recession, rose as the outbreak of the coronavirus spread across countries other than China, impacting consumers and businesses alike. The flight to safety in bonds pushing rates down to record low levels kicked off programmed trading/selling across the board in all stocks which was not limited by an uptick rule.
Selling was indiscriminate without exception, but for a small number of companies perceived as beneficiaries of the virus: Clorox (NYSE:CLX), Netflix (NASDAQ:NFLX), MMM, and a few drug companies working on a cure for the virus. Economists lowered their GNP estimates which was expected, and Goldman Sachs said that S&P profits would be flat for the year. However, if you look at their forecasts, even Goldman’s, virtually all of the declines would take place in the first half of the year followed by improvements sequentially in the second half of 2020 into 2021.
We continue to ask ourselves if the long-term growth rate of the world economies, including China, will be impacted by the coronavirus. Will the long-term growth rates of most companies be impacted by the coronavirus? And finally, will global consumers shift their long-term patterns of consumption/spending/traveling? Our answer remains no but we expect the return to normalcy to take time. There will be winners and losers along the way creating opportunities to profit from these shifts in mindsets and patterns.
In fact, the first country hit by the coronavirus, China, already appears to have bottomed out economically. China’s economy contracted at the fastest pace on record in February with the Purchasing Managers’ Index falling to a record low of 35.7 but we now hear from Apple (NASDAQ:AAPL), Starbucks (NASDAQ:SBUX), the National Retail Association, and others, that stores and factories are being reopened and supply lines will be for the most part restored by April. China’s economy should improve sequentially as we move through 2020 boosting global growth unless, of course, there are further outbreaks in China which we do not expect.
We are not giving an “all clear” by any stretch, but we still believe that the bottom to global growth and corporate profits will occur by mid-year with better days ahead in the second half of 2020 into 2021. The U.S and other countries are moving rapidly to control the coronavirus which will clearly get worse first, before slowing within a few months, as now occurring in China.
While we fully expect the Fed and all other monetary bodies to ease further in the coming months, it will only backstop financial markets as it won’t be a cure for global growth, including here, until the coronavirus comes under control and fears of further spreading and risks dissipate. But, resumption of growth in China, boosted by huge monetary and fiscal stimulus, is a tremendous positive, especially restoring supply lines, offsetting slowing near term growth elsewhere, including here, caused by the coronavirus. Again, our base assumption remains that we expect a sequential acceleration in global growth as we move into the second half of the year into 2021.
We do not want to minimize the impact of the coronavirus and the number of fatalities from it, but it is important to put the numbers in perspective. There have been less than 100,000 people worldwide affected by the coronavirus with less than 3000 deaths while approximately 40 million people have been affected by the flu in the U.S alone from October 2019 to February 2020 with over 35,000 deaths! The FDA authorized labs yesterday to begin testing specifically for the coronavirus which will give the FDA needed information to evaluate the virus and assist in fast-tracking a cure. Experts now expect a vaccine to be on the market within less than a year which is phenomenal.
While we continue to expect near term dislocations from the coronavirus here and abroad, we are confident that the future potential of the global economy, companies and consumers really has not changed with just a few exceptions. While growth here and abroad will slow dramatically in the first half of the year, our core belief remains that growth will reaccelerate by the second half of the year as the virus dissipates as now in China. The one change that we just made is that China will come online sooner than we had anticipated which is a huge positive removing a huge risk.
Fear and uncertainty are impacting the markets giving investors with more than a six-month time frame tremendous opportunity to profit from buying stocks and selling bonds. Program trading takes no prisoners and needs to be restricted by the imposition of the uptick rule. It is hard to fathom buying a 10- or 30-year treasury bond yielding 1.15% and 1.68% respectively when our economy is still growing around 2% with inflation near that level too. If you tax effect those rates, anyone buying these bonds have huge negative real returns. People are panicking rather than thinking as investors with a multi-year time frame.
The stock market today is selling at less than 18 times projected 2020 S&P earnings. What should the stock market multiple be with a 10-year treasury yielding around 1.15% and bank capital/liquidity ratios at all-time highs? A great deal higher than 18! It is important to note that spreads have not widened much at all even though investors have panicked. While we had lowered our growth and earnings assumptions for the first half of 2020 due to the coronavirus and Boeing’s (NYSE:BA) problems, we felt that the stock market would hold up as multiples rose as interest rates fell. We did not take into account that program selling would engulf the equity markets triggered by declining rates.
We find the stock market tremendously undervalued today for the true investor with more than a six-month time horizon. We did take some defensive actions raising 15% cash early last week anticipating downward revisions to near term global growth and earnings estimates. We sold most of our economically sensitive holdings, especially those with over 20% exposure in the Far East, including China. We began reinvesting the cash toward the end of the week in those areas that will benefit here and abroad from less consumer/business movement as concerns linger over contracting the coronavirus.
We believe that use of the internet one way or another will grow big time everywhere over the foreseeable future. Technology has increased as a percentage of our holdings due to this view. On the other hand, there are many losers too, but we may be too late to short them after the precipitous decline in all stock prices this week.
We have maintained most of our holding in those companies with sound management that are market leaders in growing businesses, have fortress balance sheets generating huge amounts of cash flow and have dividend yields above 3% as well as huge stock buyback programs. We are also looking to deploy our reserves over the next few weeks back into some economically sensitive holdings too especially as we gain more confidence that China is ramping up as now anticipated.
While we recognize that the short-term outlook has changed due to the coronavirus, this too shall pass as the long-term fundamentals for global growth and the vast majority of companies remain intact creating huge opportunities for investors to profit. Be patient and try not to let short term movements in stocks prices influence long term investing.
Remember to review all the facts; pause, reflect and consider mindset shifts; turn off the pundits; look closely at your asset mix with risk controls; do independent research and… Invest Accordingly!
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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