Q1 Update: Real and Imagined Covid-19 Impact on the Markets and the World
On this edition of Stock Talk, CIO Chris Perras addresses the recent Corona Virus driven market correction. Chris provides much needed perspective on what’s happening in the markets.
Chris Perras: Good morning. My name is Chris Perras. I’m the Chief Investment officer here at Oak Harvest Financial Group in Houston, Texas. Welcome to the February 28th edition of our weekly Stock Talk podcast: Keeping You Connected to Your Money. This podcast is an update on first-quarter stock markets in the recent COVID-19 virus and dupes market correction that has happened over eight trading days.
As of this recording, we are sitting near 2,980 on the S&P 500 down about 7% year to date, and about 12% from the all-time closing high of 3,385 made only a little over a week ago on February 19th. This rapid decline comes on the back of eight days of dramatic selling and increased volatility due to heightened concerns of the spread of the COVID-19 virus and its effect on global growth supply chains and consumer consumption. The stock market sell-off has been 100% indiscriminate with regards to sector strategy or the health of companies’ financials.
We have a situation where the financial statistics and the health data are both being ignored by financial markets as they focus squarely on the virus. The disease is showing a 97% to 98% survival rate, with those stats driven largely by a much higher chance of critical issues caused an already vulnerable, already sick individuals who have been affected with pre-existing conditions of heart disease and other serious conditions.
Listeners, trying to predict the final outcome of events like this is nearly impossible, as is market timing events like this. The speed of the decline has been historically rapid and is one of the many reasons why we, at Oak Harvest, do not believe in market timing strategies that promise to get you out of the market and then get you back in. In this podcast, we try to provide some historic data on prior events while we continue to monitor and assess the impact on economic activity in the markets going forward.
Economically, a better start of the year after a slowing in the fourth quarter is being totally ignored. The virus or more recently renamed COVID-19 fears intensified starting mid-last week and more dramatically throughout all of this week, sending US stocks tumbling with headlines, dictating almost all of the price action. Technology advances have led to 24 hours a day, 7 days a week access to information. It is to the point that websites are running counts in real-time of the flu virus and death rates by country. Imagine if we did this every flu season state by state in the United States.
One of the unfortunate by-products of this increased short-termism among investors is the short-term mindset is dangerous because it lacks discipline and planning, which in our view is something we have found typically beats those trying to react to short-term market moves. We have gone from low volatility and a new all-time high in stocks less than two weeks ago to retracing year today gains, as well as most of the third quarter 2019 gains, and only eight trading days. This move down of over 12% from an all-time high in eight trading days is the fastest in the history of the market.
On January 17th, after almost four months of linear up moves in the market with the S& P nearing 3,350, the team at Oak Harvest previewed our concerns for our first quarter pullback in the market. This podcast was entitled It’s Rotation Nation Time, Goodbye, Old Friends, It’s Been a Good Ride. Listeners can review that podcast by heading to our website at oakharvestfg.com and searching the investment management tab for our podcasts.
In that podcast, we outlined how the team was allocating our client’s exposure out of small-cap growth stocks due to the huge run they have had the prior nine months. In addition, we were selling some assets that were up and extended. We also sold some consumer discretionary stocks, harvesting losses for our clients. We tried and redeployed these assets into more boring real estate assets and consumer staple companies that have been cast aside during the big fourth quarter of 2019 run in the stock markets, which was led by technology and cyclical. This proved to be a good move as the small-cap growth stocks, consumer travel stocks, and other aggressive growth stocks have been among the worst-hit the last few weeks.
However, the speed and magnitude of the current quarter market decline is beyond what we expected to see during the first quarter. The markets are now down about two times the normal first quarter pullback and have already reached correction territory as of yesterday. However, disturbing short-term this might be, the sudden market downturn is still within the range of historic events like this. Oak Harvest can go ahead and log into our web portal and see the stats. I will have more detail on this a little later in the podcast
The speed and the magnitude of the decline is being magnified by three classes of short-term investors. One, many large, leveraged institutional called risk parody strategies that we’ve spoken of in the past, buy more stocks as volatility is declining and is low, and then they are forced to sell stocks when volatility is rising or high. These investors were pyramiding stocks throughout the strong up move and low volatility in the fourth quarter of 2019.
The second class of investor or trader has been likely a big factor in the recent market sell-off. Those are new millennial investors. Many new millennial investors have been enticed into the markets by no-cost trading services first offered by Robin Hood and more recently offered throughout the brokerage industry. This group of new investors has just felt their first spike in real volatility since entering the trading markets throughout 2019.
Finally, the last group of investors is a lot of trend-following momentum strategies and traders who simply got too aggressive and too leveraged with borrow money at the short-term top in late January, right in front of an uptick in the spread of the virus beyond China’s borders into Korea and Italy. These three classes of investors are being forced to de-lever and sell stocks all at the same time.
This virus outbreak is many things, including a new strain and unknown, two, an ongoing and still changing environment, three, very disconcerting for investors who see the big spikes in volatility, and four, and most importantly, a tragedy for those who get critically ill. I want to put this market move in an economic perspective, comparing it to past global health issues we’ve experienced.
Listeners, we have experienced global health issues in the past. This isn’t the first time nor will it be the last. In fact for the last 20 years, the team at Oak Harvest has compiled a list of pandemics that have hit the world over the past 20 years. There has been an event every two years since the year 2000, and while no two events play out in the same fashion, and China and our supply chains are much more intertwined than they were 10 to 15 years ago by a factor of three to five times, we can usually turn to history to get a good general idea of the length and magnitude of what has happened to stocks during and after such outbreaks.
Oak Harvest clients, please go to our website at oakharvestsfg.com and log on to our web portal to see the accompanying slides I’ll be referring to. The first slide is titled Market Reactions to Virus Emergencies, and it is provided by Citi research with data compiled by FactSet. There have been six large virus emergencies since the year 2000. The least impactful global event was the 2014 Zika outbreak. The S&P 500 declined about 6% during the early 2014 Zika outbreak, and that fall-off lasted about 23 days.
At the other extreme were two events of SARS in the first quarter of 2003 and Zika in 2016. The SARS outbreak lasted 38 trading days, and the Zika lasted 60. During both of these events, the S&P 500 declined close to 13% to its absolute low. We were sitting near those levels as of this morning. Please note that all of these events, excluding the MERS outbreak in 2012, so five out of the six outbreaks all took place in the first quarter of the year, SARS, the avian flu, Ebola, in the first quarter of 2014, Zika in early 2016, all were first-quarter events. It looks like unfortunately, society should come to expect one of these larger outbreaks and events to occur at least once every four years in the first quarter.
As of yesterday’s close at around 2,980 on the S&P 500, if a short term investor had taught tick and bought the S&P 500 at the very top on February 19th, the peak to trough so far as of this morning was a market induced correction of about 12.25%, which while these events are not enjoyable, it does put this in line with previous health events. Did our team see this event or its outcome happening in advance of it? No, not by any chance. However, we were selling higher prices, smaller cap, growth stocks in advance of it because it is our discipline to sell or trim when we’re seeing things that get extended or others, or too optimistic, or just too enthusiastic as we saw in mid-January pre-virus fears taking hold.
What now, you ask? Admittingly, these events are not enjoyable, and while the team here at Oak Harvest is certainly concerned about this event, its effect on market volatility, effect on the general economic growth and earnings for stocks in the first half of 2020, we had never expected the first half of 2020 to be a big earnings growth event, causing lots of market upside. We had expected the growth in 2020 to be back and loaded as the hangover caused by the 2019 tariff fight with China would linger throughout the first half of 2020, but would begin being comped in the second half of this year at the same time, as some pent-up demand would start helping the economy.
Do we see this dynamic changing? At this time, we do not. We are monitoring the events in the economy in real-time and will provide updates if we do. Clients can log in and view the table titled Markets Heal Quickly From Disease Outbreaks. This data compiled by Charles Schwab show one month and six-month returns in the MSCI world index post-disease outbreaks. The SARS outbreak, which saw an almost 13% negative return over 38 trading days during the outbreak, is pretty similar in length to what we’re seeing now in the COVID-19 virus outbreak if you place a starting point in mid-January when the Chinese finally started publicizing.
Post-art SARS outbreak stock return saw a one-month rebound of over 8.5% and a six-month return of +21.5%. The post-Zika virus of 2016, the market was back to flat six months later, and of course, 24 months later, we all know what happened. The market was up almost 30% from the virus panic lows in mid to late February of 2016. Have the last two weeks been fun? They certainly have not.
These are the events that bring increased anxiety to savers, investors, and our communities in general. However, over longer periods of time, these are the opportunities that present themselves to longer-term savers and investors. This longer-term outlook enables investors to compound their savings at higher rates than average. From our perspective, while volatility is high is surprising to us as it is to most people. It hasn’t been this high since December 24, 2018. We believe we remain in a secular bull market and do not currently see this price weakness morphing into a recession-like down move in the economy or in stocks.
Unfortunately, this is what long-term buy and mold entries have looked like during the last 10 years. One of the volatility indicators we follow started giving one of its extremely rare buy signals late Thursday. The last time this indicator reached these levels was December 24, 2018, which also happens to coincide with the market lows for the last two years. With this reading so extreme, we have started purchasing some stocks that we’ve been waiting for months to buy.
Listeners, please remember, the team at Oak Harvest prides itself on being comprehensive long-term financial planners. What this means is that our client, you, and your financial advisor should have a financial plan that is independent of the daily, weekly, even monthly volatility of stock markets. It is why in mid-January, that our 2020 market outlook summit, I stood in front of a group of our clients when the markets were at new all-time highs, when stocks have been trending higher and almost straight line for four months, and said, if stock market volatility concerns you, now is the time to meet with your advisor to adjust your portfolio allocation away from higher equity allocations.
The time to do that is when volatility is low, not when the market is down and volatility is high. It is currently too early and too unpredictable in its nature to assess the final impact of the virus on economic activity and corporate earnings. The sooner that this virus is confidently contained, which some statistics already point to, the quicker the recovery in the economy in the stock markets will be, particularly given policy stimulus that will no doubt begin to be employed to assist the world in its recovery.
However, the more the virus affects activity in other regions and the longer the period of reduced travel to restrict the transfer of the infection, the greater will be the impact on corporate earnings, and the greater the impact on stocks. For now, investors should maintain a balanced approach to asset allocation. Given the uncertain nature of the outbreak, anxiety and risk aversion is likely to continue if more countries see the number of cases rise in the days ahead.
With that, I come to the conclusion. We are financial planners here at Oak Harvest, we create financial plans, try to balance risk rewards, use tools, whether they’re insurance, stocks, bonds, mutual funds, ETFs, to create an allocation that helps you stabilize your retirement. If you’re retired or in the process of retiring, give us a call at 281-822-1350. We’re here to help you plan for your financial future and helps smooth the financial path you have into and through your retirement years with a customized retirement planning. Many blessings, this is Chris Perras at Oak Harvest.
Operator: The preceding content expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, statistics, and sources are not guaranteed. Content, ideas, and strategies discussed may not be right for your personal situation and should not be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities. Investing involves the risk of loss, and past performance does not guarantee future results.
Chris Perras
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.