The steady rally in equity markets that we have enjoyed for over 12 months may have come to an end. Our current rally began in January 2019 after our last correction that occurred in October 2018.  The S&P 500 has declined approximately 11% from its all-time high achieved just a few weeks ago.  Volatility has risen to the highest level in several years over the last two weeks.

 

Has the rally just paused or is this the beginning of a more significant correction as investors discount the likelihood of the growth phase of this economic cycle ending because of the impact of the coronavirus.  We highly suspect that this is not the case! However, we cannot ignore the unknowns that exist with this highly infectious virus that has not proven to be very deadly, but is a threat to people who already have respiratory distress. The last time we had a coronavirus in the globe was in 2003 with SARS. It began in China as well and mutated from animals very similar to this virus. The SARS virus caused little if any damage to the global economy or the American economy and burned itself out within six months. SARS had a much higher death rate and was also very infectious but never spread to a vast part of the globe.  We have had other viruses over the years that were deadly but have never shut down or changed course of the global economy. SARS, MERS, Swine Flu, the list goes on…Hopefully this will just be another one that is added to the list of viruses that burned himself out before they ever damaged the US economy.

 

COVID19 mostly threatens to infect a lot of people and keep them out of work for several weeks.  How damaging is this current virus to our economy and the global economy?  This all hinges upon the globe’s ability to contain the virus and keep it from spreading in a highly significant manner to the other economic engines of consumption and growth for the global economy. Is the American economy at risk as we wait for the virus to burn itself out? Could this be the catalyst that ends this great growth phase of this economic cycle?

 

We have closely examined the historical characteristics that exist in the US economy at or near a recession.  The most common characteristics that exist just before a recession begins involves rising interest rates, restrictive Fed policy, and heightened energy prices.  These factors generally result in a loss of consumer confidence that then causes a significant decline in consumption leading to recession. Other factors would include problems with employment and wages.   None of these are present in our economy today.  Employment, consumption and retail sales are all at all-time highs. Interest rates are low and Fed policy is accommodative.  Energy prices are at 20 year lows.  This is not the recipe for a recession. Our fed stands ready to lower interest rates further if necessary.

 

It is very difficult to quantify the impact of the coronavirus on our economy.  It would seem that the virus would have to infect an extremely large percentage of the population of the US for an extended period of time for confidence and consumption to change enough to throw our economy into recession.

 

Will the coronavirus somehow change the almost nirvana scenario that we have in our economy today that has produced an economic cycle that seems recession-less.  Our economy has ebbed and flowed for 10 years now without producing any type of excess or irrational exuberance that typically ends the growth phase of the cycle. It would seem that if this cycle is going to end here from the impact of the coronavirus employment will need to falter as a result of this virus.  Are there enough industries and companies highly affected by this virus that will result in widespread significant layoffs. If so rising unemployment will affect consumer confidence and consumption and bring on a recession. Currently employment is very tight and companies have been desperate to find quality employees. As a result I think they will be reluctant to let go of employees because of a virus that is likely to burn out within six months. Further the industries directly affected by this virus (airlines, cruise lines, restaurants, casinos, entertainment parks, etc) are relatively small part of the US economy and the impact from layoffs of these few industries would not seem to be that meaningful to the overall economy.

 

Thus far only 60 people in the US have been infected with the virus that we are aware of currently.  There are approximately 82,500 reported cases of the coronavirus globally of which 78,500 are within mainland China. The majority are in the Wuhan area of China.  The infection rate within China has decelerated and total people with the virus is now in decline.  People are starting to go back to work in the Wuhan area.  The virus has not spread to other areas within China in any measurable manner and we have not seen the infection rate accelerate in these other areas of China.  China seems to have done a relatively good job of containing the virus within the Wuhan area. China’s population is over 1.4 billion and 78,500 is a small part of their population. This is .005% of China’s population. This relative success in containment bodes well for predicting that other areas of the world will be able to contain the virus and keep it from spreading to the large populations of those countries.

 

Outside of China is a different story entirely.  Infections although quite small in number are starting to accelerate and the overall number of people infected is under 4000.  Regardless this spread of the virus outside of China has brought fear to the financial markets.  It would seem that the equity markets will remain highly discounted until it is clear that this virus is being contained globally. Fear begets more fear and it is hard to anticipate how much the markets will sell off as it reasonably discounts the probability of this virus becoming uncontrollable. The majority of people who get this virus recover within a few weeks and are able to return to work.  There are lots of reasons to be optimistic that this virus is not a threat to the global economy or the US economy.  This Virus will likely burn out in six months as did SARS.

 

We have decided that the gains in our portfolio must be preserved.  We have had significant gains over the last several years and cannot allow the portfolio to meltdown because of fear or a real economic collapse.  As a result we have decided to move to a 20% cash position tomorrow.  If the selloff continues we will move to a 50% position in cash within the next week.

 

We are optimistic that the market may bounce tomorrow and our need to move to cash may not happen but we are ready with our guns loaded to make significant change tomorrow.

 

We believe that this will be looked back upon no differently than the corrections that we had in late 2018 as well as mid to early 2015 and 2016.  In each of those three periods the S&P 500 declined by more than 12% sparking a move to cash by our team but ultimately not turning into a full-blown correction or change in the direction of the economy.

 

We are cautiously watching the markets and will do whatever is necessary to protect your portfolio.