Is There a Buying Opportunity?
The fear over the spread of coronavirus and the spike in market volatility this past week are capturing headlines. One question we are being asked by clients is if the current decline in the markets is a “buying opportunity.” To help answer this question, we looked at the performance of the markets after various pandemics.
The two tables below show five recent pandemics, and the performance of the S&P 500 and intermediate-term Treasury bond returns during these outbreaks. Note how stocks in all but one pandemic performed quite well after a period of decline. Note also, that Treasury bonds generally rallied initially—as they have done recently—only to perform poorly during the subsequent stock rallies.
From a historical perspective, the data would suggest the current market decline is a buying opportunity. For example, might the coronavirus outbreak behave similarly to the SARS pandemic of 2003? Then the markets experienced a V-shaped recovery after the Chinese containment measures proved effective. Similarly, economic-based market declines over the past few years have also provided good returns for buyers “on the dip.”
But will the effect of the coronavirus be different this time? That really depends on how extensive the “pandemic” becomes, and how impactful it might be on the global supply chain.
Dun and Bradstreet has estimated that of the U.S. Fortune 1000 companies, 163 have China-based Tier 1 suppliers, meaning they rely heavily on these suppliers’ parts for manufacturing. Another D&B estimate is that Fortune 1000 companies have 938 China-based Tier 2 suppliers which supply parts to Tier 1 firms. In other words, the China global supply chain is extensive.
The Chinese government has initiated widespread containment efforts and longer quarantine periods—measures we hope will be effective to stop the spread of the virus. However, these measures are proving exceedingly disruptive to economic activity, bringing Chinese communities and businesses to a standstill. With a disruption in the supply chain, manufacturers can’t make product. Revenues decline. Workers get laid off. Consumer buying drops. The market is attempting to assess the negative impact a coronavirus pandemic might have on the economy. The last time the market wrestled with the increasing possibility of a recession was in Q4 2018. We had a bear market that, fortunately, lasted a very short time before buyers stepped in after the Federal Reserve became dovish on interest rates.
It’s critical to US manufacturers that any disruption the coronavirus might have is short-lived. The risk to global economies slowing down from a lack of parts is very real. Could U.S. companies switch from China-based suppliers? A difficult challenge. If they could, would they not already have done so given the tariff war?
The fact that the stock market is declining should not be a surprise to an equity investor. Such declines are “the stuff” of financial markets—as are rallies. The surprise is when the market declines or rallies, and the extent of those price movements.
Before asking if this is an opportunity to buy or sell, investors should first ask themselves, from the perspective of their investment objectives and risk tolerance, “Is my allocation among stocks, bonds and cash appropriate?”
If your allocation is good, sit tight. We would expect financial markets to find a “floor” when the disruption from the virus begins to fade. Markets historically do recover.
If your allocation is off or inconsistent with your risk tolerance, then ask the question: “Should I be buying or selling?” Please call us if you need help answering this question.
