LIM's Perspective on Coronavirus

Turmoil may not be a strong enough word to describe this past week in the financial markets. U.S. equities have fallen at an unprecedented rate, resulting in a loss of over $5 trillion of value from its peak (14% of market value). Safe haven assets, first among them U.S Treasuries, have rallied dramatically. Ten-year Treasury yields (yields move inversely to prices) have fallen to record lows and are now at 1.17%, compared to 1.52% a week ago. Corporate bond credit spreads have widened moderately but importantly have not indicated distress and the market remains liquid and orderly. As one would expect, high yield bond returns have been thrown into negative territory.

All of this is the result of the spread of the coronavirus and its potential – and as yet unknown – impact on the global economy. While the virus appears not to be as deadly as some initially feared, the need to contain its spread will likely cause decreased economic activity. Global interconnectivity increases the odds that the virus will reach nearly every country on the planet, and globalized supply chains mean that supply shocks could be felt in many industries. Despite these factors, we expect the panicked response by markets to subside based on the following:

  • Epidemics have been dealt with before. In fact, following most outbreaks markets have tended to recover in short order. Of recent epidemics, equity markets had more than fully recovered within months of the outbreak.
  • Equity valuations were, arguably, stretched. While growth – and profits – will undeniably be hurt by the economic impact of the virus, the extent of the decline in equity prices reflects high relative levels at the start of the period.
  • The response from the medical/pharmaceutical industry has been aggressive. While development, testing, and implementation of a vaccine is a painstaking process, a number of companies have already made progress on this front.
  • The Federal Reserve is likely to lower interest rates. While the short-run impact of a Fed Funds cut on economic output due to supply disruptions may be negligible, it will be important symbolically and indicate to markets that the Fed will do its part to underwrite a recovery.

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