A Message From RS Crum

March 9, 2020

To our Friends and Family,
As we enter our fourth day in a row of the stock market sell-off, we thought we would share some of our thoughts on the effects of the Coronavirus, the upcoming election, and overall market conditions. And, most importantly, how they may affect your investment portfolios.

Let’s start with the Coronavirus because it is on everyone’s mind. There are two concerns, first the actual affect of the virus on our health and the health of others, and second, the economic impact from a significant disruption of business and economic activity as a result of factories being closed or workers not being available due to illness.

I read a thoughtful piece on Bloomberg (I wish I could remember the author) this morning about the potential effects of the Coronavirus. The author said three main scenarios could play out.

The first scenario is that the virus is contained and eliminated, much like the SARS virus. Under this situation, the economic impact would be minor, perhaps one bad quarter of corporate earnings.

The second scenario is that the virus is not contained and continues to spread, but remains rather benign, affecting most people with symptoms like the common cold or standard flu. The economic impact could be over a more extended period (more than one quarter), but would still not have a significant economic impact, but the global economy would feel a mild slowing effect.

The third scenario is that the Coronavirus grows into a global pandemic with millions and millions of deaths, just like the 1918 Spanish influenza outbreak that killed between 20 – 50 million people, which by the way also originated in China. This is the scenario that everyone fears. However, the reality of this occurring is very small.

The World Health Organization (WHO) developed a model in 2017 about the possible effects of pandemics. In their model, they put the odds of the worst-case scenario (1918 influenza) at 1 in 2000. If this scenario were to play out, there is no way to project or quantify the social and economic effects.

With this as a background, let’s focus on the most likely outcome, which would be the first two scenarios. During the SARS outbreak in 2003, the S&P 500 fell 12.8% and with the Zika virus in 2015/2016 the S&P 500 dropped 12.9%. There have been other recent outbreaks (ex. Ebola) that caused some fear but never spread to any great extent. The long-term economic effect of these viruses was negligible, which could be the case here as well.

As of right now (9 am on Thursday, February 27th), the market has dropped 10% for the week, which is now officially considered “a correction”. I believe that you will likely see some buyers come in soon, and most, if not all of the declines will be quickly erased. However, the market often goes back to test the lows before making it’s next move up. This is to say that no new dramatic news stories hit the airwaves. If the Coronavirus accelerates, then the stock markets will certainly see more volatility.

Switching to politics, some say that the emergence of the progressive Democratic candidates, primarily Bernie Sanders is also contributing to the sell-off. This may be contributing to the uncertainty, but I don’t think this is a primary cause of the stock market weakness.

What should we expect now? I have been telling clients that when stock prices get stretched and more expensive on a relative basis, the more susceptible they are to sell-offs if an unexpected event occurs. The Coronavirus being a perfect example. The failure of Bear Stearns and Lehman Brothers is another example from the 2007/2008 Great Recession.

The more expensive the stock market becomes, the more significant the declines can be. Today, the stock market is certainly not cheap, but it is also not grossly over-valued like previous markets. So, if this is the start of a larger decline, we don’t expect it to resemble that of the Great Recession. Most bear markets are accompanied by a recession, which is not currently on the horizon.

However, there are some areas of the stock market that are showing signs of over-valuation and are expensive on a relative basis. This is primarily with large-cap growth and technology stocks which have had incredible returns over the last 5-10 years.

If we strip out the extreme fear and worst-case scenarios of the Coronavirus, we still find a strong US economy which is much stronger than most economies throughout the world. We also have, for better or worse, a Federal Reserve that is committed to keeping interest rates low and providing other ammunition to avoid a dramatic sell-off in the markets and help prevent the US from falling into a recession.

In closing, please know that we will be active on the investment front, taking advantage of opportunities when and where they appear. We also have plenty of safe hedges to counteract a declining stock market.

Although we would love to call every one of our clients today to talk through this, unfortunately there just aren’t enough hours in one day. If you are feeling uneasy and would like to talk, please don’t hesitate to call, we would love to hear from you. We know these can be scary times, but please know they are completely normal and part of the process.

– RS Crum