Investing in the Time of Coronavirus

Delwin Graham - Mar 25, 2020
While an epidemic might have economic implications (for example, by destroying market demand), its effects are typically temporary.

As we entered into the first quarter of 2020, we expected continued growth in the global economy and presumed that the equity markets would follow suit. This seemed rational, as the outlook for growth in the major developed markets looked reasonable and central banks remained accommodative. This was especially the case in the United States. Geopolitics (i.e., China-U.S. trade wars, European anti-trust legislation) was seen as the most likely source of uncertainty and risk.

Then news of the outbreak of coronavirus in China hit. First and foremost, the outbreak and spread of COVID-19 is a tragic humanitarian event for all of those impacted. However, there are economic implications, given the importance of China to global growth and its integration into global supply chains and the subsequent spread of the contagion to other industrial countries, including Italy, Spain, the U.S., and Canada. We are very likely in the early stages of a global recession, that is, two consecutive quarters of negative growth.

There are natural comparisons to the Global Financial Crisis of 2008-09. However, the root cause is different and important. The crisis of 2008-09 was a global financial crisis stemming from deregulation and excessive subprime borrowing. This is a global health crisis that is causing financial market upheaval, given the uncertainty of its impact on our global economy. Nobody knows how long this global health crisis will last and exactly what the economic and financial-market implications are likely to be. There is the potential for lasting structural changes – for example, increased remote workforces, potential supply-chain migration, and long-term unemployment. There is also the possibility that the coronavirus will act as a catalyst to increase nationalism and geopolitical tensions (specifically the U.S. and China). (Cf., Stephen Chang, “Positioning Portfolios in Uncertain Markets: Global Health Crisis”, www.global.pimco.com, February 2020)

While the duration of the coronavirus pandemic is uncertain, its eventual end is certain. A virus is an organism, and an epidemic will inevitably have a lifecycle. The lifespan of that epidemic will depend on natural factors, like communicability and the availability of a host. Economic factors will determine the duration of an economic cycle, like the availability of credit and fiscal policy. While an epidemic might have economic implications (for example, by destroying market demand), its effects are typically temporary. To this point, Figure 1 shows how the S&P 500 performed over a 6-month period after other recent epidemics.

 

 

 

 

 

 

Fig. 1:  Performance of the S&P 500 Over a 6-Month Period After an Epidemic (Source: MarketWatch.com)

Now, these are all imperfect comparisons, as they dealt with different viruses, at different times, in different regions, in different contexts. The point is that the markets, while occasionally impacted in the short term by epidemics, are rarely impacted over the long term.

If we recognize that the present coronavirus pandemic will also pass, then we should also consider investments that would take advantage of this eventuality. Of course, it is possible to buy the market as a whole (SPDR S&P 500 ETF [SPY], iShares S&P/TSX 60 ETF [XIU]) or even to short the market as a whole (Proshares Short S&P 500 [SH]). We could also be non-committal and invest in the volatility of the market itself (iPath S&P 500 VIX Short-Term Futures ETN [VXX]). In the same way that the market dropped en masse, we would expect the recovery to be broad-based.

But after a market correction, stocks typically recover in a stratified way. First to enter into recovery are the defensive bond proxies. These are deemed to be a “proxy” for bonds because they offer income and relative security - they are typically issued by protected monopolies (e.g., banks, pipelines, telecoms, utilities) that can afford a stable income, that is, dividend payments. Often, traumatized investors prefer to return to the markets through dividend-bearing blue chip stocks where they are “paid to wait” for the eventual recovery.

But the biggest bang for your buck would come from buying cyclical stocks that have been deeply discounted by the recessionary pressures of the crisis. These are “value stocks” for a reason. Here, there is more timing risk because deteriorated market conditions have affected the viability of the company itself. Fundamental analysis is important - companies that are profitable and cash generative are likely to survive; weaker firms that are investing heavily and burning cash will struggle and often go bankrupt. (Cf., Daniel Rasmussen, “Crisis Investing: How to Maximize Return During Market Panics,” Verdad Advisers)

A market correction is a terrible thing to waste. For a few potentially profitable investment ideas, please contact me at dgraham@cgf.com or 780-408-1518.