Dalton — The physical impact of the coronavirus (a.k.a. COVID-19) is immense. And I don’t mean just the symptoms or the death toll of the virus. Businesses in China are struggling, with many workers unable to reach their factories and offices, disrupting global supply chains. The boost we were hoping to get from the signing of Phase I of the U.S.-China trade pact has all but evaporated.
Listen, I am no infectious disease doctor. I won’t even try to suggest that I know anything about the likelihood of the coronavirus going global and becoming a pandemic. Currently I am investing as if the coronavirus is going to be contained and treated. If I am wrong, and Manhattan becomes the next Wuhan, China (the epicenter of the virus), then I can easily imagine a scenario where major U.S. stock indices get cut in half. But we’re not there yet. I am not dismissive of the possibility, and I will remain alert. But that is not the scenario for which I am currently investing.
As big as the physical impact is, the psychological problem of the coronavirus may have an even larger impact. That’s true for both businesses, which may be either unable or reluctant to, engage in planned activity, as well as investors, who decide to sell stocks out of fear of a greater contagion. However, so long as my baseline scenario of containment and treatment is correct, I don’t think any correction we may (or may not) experience should be blamed on the coronavirus. I’m not saying the market won’t go down, or even that the coronavirus doesn’t make stocks more vulnerable to short term shocks. I am saying if the stock market does correct significantly, the culprit, as purported by the media, could be the coronavirus, or it could be any “reason” that is good at catching headlines, as I opined Jan. 29. Given the information we currently have, I would not sell stocks based on the fear of coronavirus having a lasting impact on stocks.
Bespoke recently made the interesting comparison of Google searches of coronavirus versus the 2014 Ebola outbreak. As Bespoke point out, if people are Googling it, “it’s obviously on their minds.” It used Google Trends to track searches of the two outbreaks and make comparisons to the S&P 500.
Bespoke noted that the peak for searching “coronavirus” was Jan. 30, which was the day prior to the market’s low for the year. Since then, the number of searches has been trending lower. This is similar to 2014, when searches for the Ebola virus peaked, then the stock market began to recover.
I run a small money management business — just 14 of us. I have no infection-disease doctors on staff, nor have I spoken with any. However, I probably account for nearly half of those Google searches on the coronavirus, so I’ve got wildly accurate “but I read it on the Internet” information. With that, I’ll give you my baseline scenario of how I anticipate this playing out. China is already getting hit hard. It’s expected that the country’s gross domestic product for this quarter will be negative. GDP growth for China will be bad for the first half of the year but rebound in the second half. Significant Chinese government stimulus will cushion the fallout (last week the People’s Bank of China cut the one- and five-year loan prime rates by 10 and five basis points respectively), but the global economy will still feel it. The International Monetary Fund lowered its global growth forecast for 2020 by 0.1 percentage point to 3.3% in response to the coronavirus. I believe the IMF’s forecast for global growth is too high, and I also I think that it’s optimistic of them to believe that the coronavirus will only reduce global growth by one-tenth of 1%. I am sure they built much more sophisticated mathematical models than what I’ve got scribbled on the back on this napkin, but a drop of three- or four-tenths of a percentage point feels much more realistic. On the back of my napkin, I note that China’s GDP is about a 19% share of global GDP. If China’s GDP grinds to a halt this quarter and is more than halved next quarter, then struggles to get back to a more normal number in the second half (which would be about a 6% growth rate for China), I see a drop four-tenths of a percentage point in global GDP.
My back-of-the envelope calculation makes mathematical sense as well as intuitive sense. After all, Chinese tourism and business travel has come to a virtual halt. Supply chains are disrupting manufacturers and will continue to do so. Fortunately, the U.S. economy is somewhat insulated from the impact of the virus effect on China, but we’re not immune. Not only do many U.S. multinational corporations have distribution and operations in China, but about 3 million Chinese tourists travel to the U.S. each year, and each of them spend nearly 50% more than the average foreign visitor. I’d expect the coronavirus to cut U.S. 2020 GDP by a few percentage points, but not be the cause, by itself, to push the U.S. into a recession.
If you already took my Jan. 29 advice to properly rebalance your portfolio, I wouldn’t advise making any further changes just yet to your portfolio based on the coronavirus.
This previous Monday, the 24th, the S&P 500 fell over 3%. The Dow Jones Industrial Average was down over 1,000 points. Is that the begging of the end? Not necessarily. Since March 2009 there have been 18 prior 2%-plus Monday drops. As you’ll see in the chart below, there have been positive returns for the S&P 500 17 out of 18 times in the next week and month, with average gains of 3.16% and 6.08% respectively.
Monday felt sucky. But at Berkshire Money Management, we were busy getting excess cash invested.
The Oracle of Omaha
Warren Buffett, head honcho at Berkshire Hathaway, is often considered to be one of the best investors alive. One of the reasons for his success? Discipline. Berkshire Hathaway recently released its annual letter and I thought I’d share a couple favorite excerpts of mine:
“Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater. But the combination of The American Tailwind, about which I wrote last year, and the compounding wonders described by Mr. Smith [economist and financial advisor Edgar Lawrence Smith, writing in a 1924 book], will make equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!”
“If something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments.”
This article originally appeared in The Berkshire Eagle on February 26, 2020