By Arthur G. Swalley, CIMA®, founding partner and Director of Investments
Over the past 10 days, US markets have come to the realization that COVID-19 is going to have substantial negative economic impact, resulting in a 13% decline in the S&P 500 index from the market peak, and a 4.6% rebound on March 2. Volatility is likely to remain high as headlines flash the progress of the spread of the virus, and high volatility will most likely continue until the virus’ spread is confidently contained. Adding to the uncertainty is the difficulty in testing for, and diagnosing, the presence of the virus. Longer time frames of the virus spreading will lengthen the period of reduced travel, affecting economic activity.
The course of the spread of COVID-19 is inherently unpredictable, rendering short term market predictions even less useful than usual. What we can say with certainty is that the Federal Reserve today reduced short term interest rates to a 1% target in response to the sudden slowdown in global growth. Additionally, the 10 year US Treasury bond yield is now 1.00%, by far the lowest rate in history. Money is cheap to counter the short-term economic slowdown, both here and around the globe. Even though central banks can’t develop a vaccine or cure for COVID-19, as of this writing they are showing all signs of continuing fiscal policy stimulus for as long as they deem necessary to keep markets and economies as stable as possible.
Additional risks adding to the short-term volatility of the markets include the inversion of the yield curve (short term interest rates higher than long term interest rates) for the second time in the past year, and the polarized political environment with an election looming. Yield curve inversions historically precede recessions, as do, though less frequently, stock market declines. High levels of uncertainty about future economic policy also tend to mute capital allocation decisions, which generally contribute to slower economic activity.
While there is no reliable way to predict the long term economic and market impact of COVID-19, we at Arlington continue to favor owning equity in well run businesses over being lenders at extremely low rates of interest. This philosophy is volatile in the short run and rewarding over the long run, as businesses by nature adapt and shift quickly to new economic environments, rewarding patient investors.