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Stay disciplined when outside events drive volatility

MAR. 10, 2020

As recently as three weeks ago, I was perplexed about the financial market’s split personality. On one side, stocks had been resilient. On the other, bonds had reflected underlying pessimism.

The events of the last three weeks have emphatically shifted this view. The disorganized nature of the stock and bond markets devolved into panic, with the major equity benchmarks skidding toward bear market territory and, even more remarkable, interest rates on long-term U.S. Treasury debt falling below 1% for the first time ever.

Rather than rehash the market’s reaction to the global spread of the coronavirus or COVID-19, I want to look ahead to the intermediate term to offer my perspective on where we may be headed, with the caveat that the current situation is rapidly developing and still mostly unclear.

My goal is to provide investors and their financial advisors with some cogent information to take into account as they consider how recent events may affect their financial plans.

First, the current downdraft in the S&P 500® is the sixth correction (a loss of 10% or more) since the end of the previous recession and global financial crisis. Plenty of uncertainty accompanied each of those earlier corrections, and investors found it difficult to see any light at the end of those dark tunnels. Markets were concerned then as they are now about the strength of the global economic expansion and the health of certain segments of the credit market.

Second, external events like the current coronavirus outbreak tend to feed investor anxiety and cause overall market weakness. While I am loath to compare the current outbreak to others in the past, the spread of COVID-19 is similar to SARS, MERS and others because of the inability to measure the scope and duration of the outbreak. This uncertainty has contributed greatly to higher levels of investor anxiety. However, previous viral outbreaks have shown the effects are neither permanent nor lasting.

Third, fear and panic have gripped the markets over the last three weeks against a backdrop of strong economic fundamentals. The current disruption is likely to hit corporate earnings for Q1, with some industries such as energy, transportation and hospitality suffering more than others. Still, outlooks for Q1 Gross Domestic Product (GDP) growth remain mostly favorable; as recently as March 6, the Atlanta Fed’s GDP Now forecasting model estimated a 3.1% annual pace of growth for the 1st Quarter.

Moreover, stocks seemed fairly priced as recently as Monday morning, with the S&P 500®
price/earnings ratio at around 16-times forward earnings. That was before Monday’s massive selloff, which saw prices for most U.S. equities drop during the trading session. At current levels, it appears stock investors have mostly repriced the risk of the uncertain outlook for earnings and GDP growth. That being said, the previous five corrections in this bull market cycle turned out to be buying opportunities for savvy investors. Those downturns, like the current one, were driven more by elevated fears than by worsening fundamentals.

Finally, it’s acceptable to question whether the stress and uncertainty of the COVID-19 outbreak will tip the U.S. economy into recession. The odds of a recession in 2020 are rising as the coronavirus impacts businesses and consumers while the oil price war adds to the market uncertainty. The Nationwide Economics team at present sees economic growth slowing sharply in mid-2020 with a strong chance of a short recession if consumer activity slumps in response to the virus contagion.

Whether you’re an investor, a financial advisor or a seasoned market watcher like me, it’s always stressful to be active in the markets through these times of heightened anxiety and volatility. Over my 23 years in the financial industry, I’ve been through roughly ten similar periods of market stress. The instinct during each instance of powerlessness is to act. However, it’s almost always wise to be disciplined with your investments.

Emotional reactions to news headlines and external events can undermine any investment strategy or philosophy, no matter how prudent. Even if the coronavirus outbreak ends up limited and temporary, it’s likely that elevated market volatility will be a fact of life for the rest of 2020. We still have a presidential election to contend with, and uncertainty about the path of the U.S. economy in the late phase of the current cycle.

For an individual investor, I always believe it is best to follow a disciplined, long-term approach to your financial goals. I typically find confidence in watching business fundamentals to see if this external event has a substantial and prolonged effect on corporate earnings or growth. This is particularly true given the quick progression of this outbreak and the inability to predict how bad or long it may persist or what impact it may have on the economy or the financial markets.

Disclaimers

  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition or particular needs of any specific person. Investors should discuss their specific situation with their financial professional.

    Except where otherwise indicated, the views and opinions expressed are those of Nationwide as of the date noted, are subject to change at any time and may not come to pass.

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