The market and the Corona virus effect

This week market action is certainly unsettling. The convergence of high valuation of most assets and the uncertainty of the corona virus was a perfect cocktail that sparked one of the fastest selloffs in market history.

While the correction did not come as an absolute surprise, the speed and indiscriminate selling (even gold did not hold up as it usually does in times of turmoil) was slightly puzzling.  The cross-sectional selling has much to do with the uncertainty of something relatively mysterious as a virus. While we have historical references such as the similar SARS virus in 2003, any possible pandemic can have very different trajectories of developments. In 2003, the equity slide was similar to the current correction, registering a 13% decrease in price albeit today, we seem to be moving with a faster pace. 

Undoubtedly, this situation will slowdown the economy for at least a couple of quarters (maybe 4), a factor that coupled with high valuations justifies partly the swift correction.  However, it is important to remember that much of this slowdown is delayed consumption and not all is going to be demand destruction. This means that as the world gets a better handle on the issue, the economic rebound could be just as violent.

Bonds have been the usual safe haven and stressed once more their importance in a proper asset allocation. The yield on the 10-year US Treasury hit an all-time low, making Uncle Sam’s bonds a tactical asset rather than a long-term income asset as it was intended in the past.

So, what is an investor to do now? The answer certainly depends on each individual situation but in general one should do very little. Assuming the asset allocation was built for the long term, volatile times such as these offer chances to rebalance or pick up additional yield.  It is unlikely that we will see a swift rebound like the one that followed the December 2018 correction; then the problem was mostly related to monetary policy while today we are dealing with a less predictable medical variable but it is reasonable to expect that only a minor contraction will affect the global economy before pent-up demand will resurface.

Individual investors have a great luxury that most professional traders do not have: patience.  As a professional, increases in volatility force selling because of leveraged positions and relative positioning. Relative performance on a short-term basis is what determines whether a portfolio manager will retain his/her job or bonus. One is forced to follow the market in order to limit tracking error and massive divergence from other managers competing for the same clients.

Properly allocated individual investors can be patient and use volatility to rebalance.

In an effort to contextualize today’s action, the following chart (courtesy of Schwab) shows epidemics and market performance going back to the 1970s: