What a week for world markets and coronavirus
What a week – global stock markets around the world tanked as fears and health concerns increased over the coronavirus – including both the spreading of the virus and preparedness for the virus. Pick a country – Germany, Japan, France, Canada, Mexico, England, China, United States – all the markets were down significantly, generally 10% or more.
The coronavirus has created great uncertainty – in terms of both healthcare and the economy. In the United States several companies, including Apple and Nike, have already expressed that their supply chains have been disrupted as factories in China were shutdown due to the virus. The coronavirus creates both supply and demand problems. On the supply side, supply chains have been disrupted. U.S. companies have not been able to source products – this affects costs, product availability, and ultimately increases prices. On the demand side, the coronavirus has the potential impact of reducing personal consumption – the driver of the U.S. economy. Spending on travel and leisure activities, higher prices resulting from supply chain interruptions, and the potential of rising unemployment resulting from reduced corporate profitability, all have the potential of derailing the driving force of economic growth – consumer spending. The big questions – how bad does the coronavirus get, and how negative will its impact be on the health and economies around the world?
The stock market is not the economy, but it reflects expectations of future corporate profitability. Much, much uncertainty remains over the health and economic impact of the coronavirus. However, stock markets around the world have tanked because of the expected impact on corporate earnings and the growing uncertainty over those earnings. There is also an impact on interest rates. In times of economic and financial market uncertainty, a “flight to quality” typically occurs. The “flight to quality” refers to selling risky assets, like stocks, and investing in relatively safe securities like Treasury bonds – debt of the United States government. The increased demand for Treasury securities pushes down yield (interest) rates. That occurred during the financial crisis of 2007-2009, and it has occurred again in 2020. The chart below shows how yield rates have changed since the start of the year across various maturities of Treasury securities. Except for the 3-month rate, yield rates across all maturities have decreased since the start of the year.
|Date||1 Mo||2 Mo||3 Mo||6 Mo||1 Yr||2 Yr||3 Yr||5 Yr||7 Yr||10 Yr||20 Yr||30 Yr|
The incredibly low level of interest rates creates another problem. The Federal Reserve, the central bank of the United States, strongly influences the overall level of interest rates in the economy. Central banks can ease credit conditions and increase the money supply – resulting in lower interest rates which may stimulate economic growth. Generally, lower interest rates can boost economic growth by encouraging spending through lower borrowing costs for both consumers and firms. However, if the Federal Reserve cuts interest rates in the current environment, the impact on the economy is highly questionable. The problem in the current economy is the uncertainty over the coronavirus – not the level of interest rates. If the Federal Reserve cuts interest rates further to try and offset the negative impacts of the coronavirus on the economy, it is highly questionable if consumer and business spending will react significantly.
During the recent financial crisis, after peaking in October 2007 the S&P 500 fell nearly 60% through March 2009. However, by April 2013, the stock market had fully recovered – reflecting the economic growth that had returned beginning in 2009. The market declines caused by the terrorist attacks (approximately 5%) in September 2001 were fully erased by the beginning of the next year. The ultimate impact of the coronavirus on the current economy, and financial markets, is yet to be determined. When those impacts can be quantified, market volatility will subside. Until those impacts can be quantified, the financial market ride will likely continue. For long-term investors, investing in the U.S. stock market is a bet on long-term economic growth and corporate profitability. Since 1926, the average annual return on large company stocks has been approximately 11%. However, that is the average return. Short-term, market volatility and stock market returns remain questionable as long as uncertainty remains over the outcome of the coronavirus on global health and economies.