Fears surrounding the coronavirus have rattled financial markets after a surge of cases outside of China were reported over the weekend, prompting concerns about new pockets of infection in Italy, Iran, and South Korea. Volatility spiked while stocks and other risk asset categories declined. The broad global equity market (MSCI All Country World Index) fell almost -3.5% on Monday and is down about -2.0% today (as of this writing). “Safe haven” assets, such as investment grade bonds and gold, moved higher. The yield on the 10-year Treasury hit an all-time low of 1.31%.
First, we must acknowledge that no one knows with certainty how the coronavirus outbreak will play out or how bad it will eventually get. But it’s clear that there will at least be a large negative short-term impact on China’s economy and spillover effects on other countries with closer economic and trade ties to China.
We assume that there will be a material negative impact on corporate profits in the near-term as businesses deal with supply and demand disruptions resulting from this health scare. Yet, this is likely a one-time impact over the next couple of quarters and should not have a permanent effect on future earnings potential.
Over the intermediate term (next 3-5 years), our expectation has been for lower-than-average positive returns from most asset categories along with higher volatility. Acknowledging that there is a great deal of uncertainty, this remains our base case view.
Therefore, we continue to advocate a slight defensive posture with an elevated cash/short-term fixed income position as “dry powder.” We recommend maintaining a slight underweight to global equities overall, with a modest tilt towards more reasonably priced international and emerging markets stocks.
Click here to read our market commentary regarding the coronavirus outbreak.