Monthly Letter February 2020

As stocks plummeted, investors flocked into U.S. Treasury bonds as a safe haven (see Figure 2 below).  The yield on the benchmark 10-year Treasury bond fell from 1.52% at the end of January to a record low of 1.13% at the end of February.  The 30-year Treasury bond yield fell to an all-time low of 1.67%.  Oil prices dropped sharply to $45 a barrel, and airline stocks plunged, amid forecasts of a major reduction in global travel and a slower economy.

Economic and Political Developments

Economic reports were generally strong in February, enabling the market to climb higher for the first three weeks of the month.  The ISM manufacturing report was above estimates and the monthly employment report showed a strong gain of 225,000 jobs.  Building permits and housing starts were very strong, reflecting a booming housing market, and consumer sentiment also had a good reading. 

Political news was also favorable for the market.  In general, many investors believe that a continuation of the current administration’s policies would be good for the economy and the market, whereas any move toward socialism would be very negative.  Therefore the market was encouraged in early February by the President’s State of the Union address and the fact that he was acquitted by the Senate in his impeachment trial.  In addition, Gallup polls showed that large majorities of the population are happy with the state of the economy and are satisfied with their own personal economic situations. 

Thus, in mid-February, investors were becoming increasingly confident that the economic outlook was bright and that the President would be re-elected, and the stock market climbed to record highs.

Coronavirus Situation Becomes a Crisis

News of the virus outbreak in China first began to affect the markets in late January.  The Dow dropped by 600 points on January 31^st, as the virus started to spread beyond China, and the U.S. Secretary of Health and Human Services declared that the situation presents a public health emergency in the U.S. 

In the first three weeks of February, the number of cases increased each day, and the disease gradually spread to various countries around the world.  However, investors were essentially “looking through” the issue, assuming that it would be brought under control within a month or two, and that it would be mostly contained within Asia.  Market analysts commented that similar public health crises in the past, such as the SARS virus, did not cause any major economic damage, and noted that the stock market was usually higher six months after these other virus outbreaks. 

However on Monday, February 24^th, news emerged that the coronavirus had now spread to several additional countries, including Iran and Italy.  In Italy over 150 people were already infected and six dead, raising the prospect that the virus would soon spread throughout Europe.  This news proved to be the tipping point, as investors could no longer ignore the issue and had to acknowledge that the situation was a major problem which could affect the entire global economy.  The stock market plunged, with the Dow down over 1,000 points that day.

The market continued to plunge throughout the last week of February as the virus news took center stage.  The Centers for Disease Control stated that the American public should be prepared for a possible sustained outbreak of the virus, and public health officials briefed Congress on the situation.  A new case of the virus was identified in California, with no known cause, raising the issue of “community spread,” or general transmission of the virus with no clear explanation of the source. 

Schools were closed in Japan and France’s President Macron warned of an epidemic in that country.  Major investment firms such as Goldman Sachs lowered their forecasts for GDP growth, and large multinational corporations such as Microsoft (MSFT) and Apple (AAPL) began to warn that their earnings would be reduced because of the virus. 

Thus by late February, the spread of the coronavirus had created massive uncertainty about the outlook for the global economy.  The situation has thrown a monkey wrench into all economic forecasts and earnings projections for the year ahead.  Travel and tourism will be the areas hit hardest initially, but in general, many people may be more likely to stay at home, and may refrain from going shopping, going to restaurants or attending large public gatherings. 

Disruptions to global supply chains, most notably from China, are likely to impact supplies of parts and components in many industries.  Depending on how long the virus lasts, many more companies may need to cut their guidance, and earnings expectations for the next few quarters may need to be revised down.

Government Policy Response 

The U.S. government has taken various actions to address the situation.  Administration officials have tried to reassure the public that the overall risk is low and there is no reason to panic.  Vice President Mike Pence is leading a task force to deal with the virus outbreak and coordinate the actions of various government agencies.  Several companies report that they have already made progress toward finding a vaccine.

In addition many governments are planning to provide fiscal and monetary stimulus to address the economic slowdown.  China and Hong Kong have already taken measures to stimulate their economies.  In the U.S., Federal Reserve Chairman Powell stated in late February that the Fed will act as appropriate to support the economy, and investors now fully expect that the Fed will cut interest rates at its next meeting later in March.  In fact this action by the Fed is expected to be part of a coordinated global stimulus effort in conjunction with other central banks.

Two other factors should also be supportive of the U.S. economy.  The bond market rally has led to very low interest rates in the U.S., which could lead to a wave of mortgage refinancing activity, and lower oil prices mean lower gasoline prices, a factor which puts extra spending money into the pockets of consumers. 

Figure 2    Long-term bond prices have risen sharply