Black Swan Event: Coronavirus (COVID-19)
A black swan event, a phrase commonly used in the world of finance, is an extremely negative event or occurrence that is impossibly difficult to predict. In other words, black swan events are events that are unexpected and unknowable. The term was popularized by former Wall Street trader Nassim Nicholas Taleb, who wrote about the concept in his 2001 book Fooled by Randomness.
Concerns of the coronavirus have led to global panic, resulting in select metropolitan areas on a complete lockdown, with factory closures and short-term layoffs. In recent days, news of mass cancellation of events from tech developers’ conferences to the Islamic Hajj pilgrimage to Mecca have been cancelled, while Disney shuts down it’s Tokyo theme park until Mid-March. The coronavirus-driven market sell-off has wiped out $6 trillion in value from the global markets in the past six days, according to S&P Dow Jones Indices. At Samra Wealth Management, we believe it will likely get worse, before it gets better, then slightly worse again. In this month’s issue of The Samra Report we focus on how to dampen the volatility in your portfolio and discuss what to expect in the coming months, addressing if investors should be concerned.
Most of the recent sell off is technical in nature, caused by trading volume, as markets appear to be pricing in future declines in sales, as opposed to fundamental analysis. In our December issue of The Samra Report, we highlighted the following:
“we believe there is heightened probability for a pull-back, a correction of 5% to 10% between December 12th to March 4th”
“we reaffirmed our risk-on consensus through year-end, however, our tax-loss harvesting strategies went into effect November 27th, reducing exposure to equities by 15% to 35% in client portfolios.”
At Samra Wealth Management, we reiterate our consensus in our sector rotational strategy, and believe mid-March through May could provide an entry point to invest in fundamentally strong companies with a history of paying a dividend. What has been a great decade for growth, is providing an opportunity to enter value stocks at prices discounted from recent highs. Although this correction has been the fastest in the history of the stock market, the road to recovery will be bumpy. As we head into the final stretch of Q1, we expect a late stage recovery in Q2, but warn investors that this recovery may be short-lived as Q1 earnings are released. At Samra Wealth Management, it is our belief that the transition from growth to value, will allow investors to position themselves into dividend paying equities, providing an opportunity for income and growth during the recovery.
In an effort to dampen volatility, our long-term view has been to steer clear of fixed-income in favor of real estate and pooled investment vehicles with high sharpe ratios (return earned in excess of the risk-free rate). With treasuries paying near record lows and talks of further interest rate cuts, we recommend investors look elsewhere for income. “Traders are pricing in a 72% chance of a quarter-point rate cut at the Fed's March meeting, according to CME Group's FedWatch.” With Goldman Sachs predicting the “Federal Reserve to cut U.S. interest rates by 75bps by June”, while expecting a lower GDP of 2%, missing President Trump’s 3% target. Although the 0.75% interest rate cut would stimulate domestic markets, the action would likely be seen as irresponsible, effective in the short-term however placing the United States economy at risk, with little tools left in the box as recessionary fears heighten. In the near term, these actions are more likely to have investors moving into cash than propping-up the equity markets.
At Samra Wealth Management, we understand many investors depend on the news media for information, as opposed to research. Investors should be concerned with the effects of the coronavirus on the global and domestic economy, although not correlated to the financial markets, the impact is likely to continue through Q2 2020. The charts below show: (1) The number of passengers carried after the Chinese New Year travel season remain a fraction of past years (Ministry of Transportation); (2) Daily coal consumption of major electricity producers remains well below normal (Goldman Sachs); (3) Daily Property sales volume in 30 major cities (Goldman Sachs); (4) China Steel Demand (Goldman Sachs).
Although sustained damage has been done, we expect the road to recovery to be swift but rough, suggesting investors are likely to see heightened volatility throughout the remainder of 2020. Novice investors would be wise to remember, risk is a measure of volatility, and as we see the coronavirus peak in mid-March as predicted by the World Health Organization and CDC, we expect much of the volatility to be on the positive side, returning markets to their recent highs. Furthermore, investors would be wise to be patient, and we recommend no additional exposure to equities until after Super Tuesday, March 3rd 2020. The World Health Organization has raised the Global Risk for coronavirus to very high, “as several countries are struggling with containment”. The WHO said this week, “it may be 18 months before a vaccine against the coronavirus is publicly available.” This should not be surprising, as vaccines “historically have taken two to five years to develop.”
At Samra Wealth Management, it is our consensus that investors should be concerned, especially those investors with conservative, or moderately conservative portfolio’s. These portfolios typically have greater exposure to fixed-income and energy. Energy has been the poorest performing sector of the S&P 500 over the last decade, and research shows energy could take a further hit, should oil drop closer to $41/barrel. Furthermore, with financial markets in their current status in an election year, could result in an unexpected outcome in the general election this November. Concerned investors should consider increased exposure to cash and understand they may not be reallocating at recent highs, however, 2019 was a great year for global markets.
Do not be mistaken, the United States is not prepared to deal with the coronavirus. “Dr. Barry Bloom is the Joan L. and Julius H. Jacobson Research Professor of Public Health at the Harvard T.H. Chan School of Public Health.” When Dr. Bloom was asked if the United States was prepared to deal with the coronavirus he responded with the response:
During the Obama Administration, all 17 agencies involved in emergency preparedness, including the White House’s Office of Emergency Preparedness and the Department of Homeland Security, had regular conference calls to discuss how to tackle scenarios such as a viral outbreak or a bioterrorism attack. There were plans in cities to prepare for either of those eventualities, and there was a legislative fund created for emergency preparedness that could be released by CDC very rapidly if need be. Such emergency preparedness offices do not exist today, and the emergency fund has disappeared.
Dr. Bloom went on to praise China, stating “China’s success has taught us that stringent control measures like restricting mobility, prohibiting large gatherings, closing schools etc., can reduce the spread of a major localized outbreak. These measures won’t stop an epidemic, but they will slow it down and can ultimately reduce the total number of cases.”
Disclosure: All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. The information contained here does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor. Investing involves risk including loss of principal.
The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index.
Adinarayan, T. (2020). Goldman expects 75 bps of Fed rate cuts by June | MarketScreener. [online] Marketscreener.com. Available at: https://www.marketscreener.com/GOLDMAN-SACHS-GROUP-INC-12831/news/Goldman-expects-75-bps-of-Fed-rate-cuts-by-June-30083384/ [Accessed 28 Feb. 2020].
Grenfell, R. and Drew, T. (2020). Here's Why It's Taking So Long to Develop a Vaccine For The New Coronavirus. [online] ScienceAlert. Available at: https://www.sciencealert.com/who-says-a-coronavirus-vaccine-is-18-months-away [Accessed 28 Feb. 2020].
Haefele, M. (2020). Opportunities amid COVID-19 sell-off. [online] Coronavirus and market volatility. Available at: https://www.ubs.com/global/en/wealth-management/marketnews/home/article.1482041.html [Accessed 28 Feb. 2020].
Mulier, T. (2020). WHO Raises Global Risk for Coronavirus to Very High. [online] Bloomberg.com. Available at: https://www.bloomberg.com/news/articles/2020-02-28/who-raises-global-risk-for-coronavirus-to-very-high-from-high [Accessed 28 Feb. 2020].
Mutikani, L. (2020). U.S. economy misses Trump's 3% target in 2018. [online] Reuters.com. Available at: https://www.reuters.com/article/us-usa-economy-growth/u-s-economy-misses-trumps-3-target-in-2018-idUSKCN1UL1KP [Accessed 28 Feb. 2020].
Nathan, A., Lipton Galbraith, G. and Grimberg, J. (2020). Top of Mind: 2020’S BLACK SWAN: CORONAVIRUS. 86th ed. Goldman Sachs: Global Macro Research, pp.1-25.
Samra, I. (2020). The Samra Report: That Time of Year.... [online] https://www.samrawealthmanagement.com/post/that-time-of-year. Available at: https://www.samrawealthmanagement.com/post/that-time-of-year [Accessed 28 Feb. 2020].
Woordard, J. and Deverey, J. (2020). THE RIC REPORT: What to expect when you’re expecting a rebound. [online] ml.com. Available at: https://olui2.fs.ml.com/MDWSODUtility/PdfLoader.aspx?src=%2Fnet%2Futil%2FGetPdfFile%3Fdockey%3D6208-12091449-1%26segment%3DDIRECT [Accessed 28 Feb. 2020].