Spring 2020
The world is watching with concern the spread of the new coronavirus. The uncertainty is being felt around the globe, and it is unsettling on a human level as well as from the perspective of how markets respond.
It is a fundamental principle that markets are designed to handle uncertainty, processing information in real time as it becomes available. We see this happening when markets decline sharply, as they have recently, as well as when they rise. Such declines can be distressing to any investor, but they also demonstrate that the market is functioning as we would expect.
Market declines can occur when investors are forced to reassess expectations for the future. The insidious proliferation of the outbreak is causing worry among governments, companies, and individuals about the impact on the global economy. As the stock market started its deep dive in late February, Apple announced that it expected revenue to take a hit from problems making and selling products in China.1 Australia’s prime minister predicted that the virus will likely become a global pandemic,2 and other officials there warned of a serious blow to the country’s economy.3 Airlines prepared for a sharp drop in travel.4 And these are just a few examples of the coronavirus’ economic impact.
The market is clearly responding to new information as it becomes known, but the market is pricing in unknowns, too. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower. Our investing approach is based on the principle that prices are set to deliver positive future expected returns for holding risky assets.
We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been a lesson of past health crises, such as the Ebola and swine flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008–2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire. Moreover, with the Treasury Department and the Federal Reserve working together to do whatever it takes to bring the economy back on its feet, it’s possible the economy will begin to recover later this year. But it is by no means certain.
Now, as in less-dramatic times, a personal CFO plays an important role, helping clients develop a long-term plan they can stick with in a variety of conditions. Financial professionals are trained to consider a wide range of possible outcomes, both good and bad, when helping a client establish an asset allocation and plan. Those preparations include the possibility, even the inevitability, of a downturn. Amid the anxiety that accompanies developments surrounding the coronavirus, decades of financial science and long-term investing principles remain a strong guide.
With thanks to Dimensional.
Footnotes
- Apple, February 17 press release. https://www.apple.com/newsroom/2020/02/investor-update-on-quarterly-guidance/
- Ben Doherty and Katharine Murphy, “Australia Declares Coronavirus Will Become a Pandemic as It Extends China Travel Ban,” The Guardian, February 27, 2020. https://www.theguardian.com/world/2020/feb/27/australia-declares-coronavirus-will-become-a-pandemic-as-it-extends-china-travel-ban
- Ben Butler, “Coronavirus Threatens Australian Economy Reeling from Drought and Fires,” The Guardian, February 5, 2020. https://www.theguardian.com/business/2020/feb/05/coronavirus-threatens-australian-economy-reeling-from-drought-and-fires; Ed Johnson, “Australia Says Economy to Take ‘Significant’ Hit from Virus,” Bloomberg, February 5, 2020. https://www.bloomberg.com/news/articles/2020-02-05/australia-says-economy-to-take-significant-hit-from-virus
- Alistair MacDonald and William Boston, “Global Airlines Brace for Coronavirus Impact,” Wall Street Journal, February 26, 2020. https://www.wsj.com/articles/germanys-lufthansa-makes-cuts-as-it-braces-for-coronavirus-impact-11582712819
