Market Selloff Goes Viral, Injecting More Value into Prices
Coronavirus-induced market volatility is another in a long string of blows to the global economic recovery. But investors should look through the disruptions for free-cash-flow generative companies with healthy balance sheets and resilient, if not robust earnings.
The selloff in risk assets and flows into safe-havens have accelerated as the coronavirus’ spread internationally reached previously unaffected parts of the globe, or rather, its detection in several countries previously classified as “COVID-19”-free increased. Sharp rises in confirmed cases and deaths outside the virus’ epicenter in China include Korea, Japan, Italy and Iran.
As with previous coronaviral outbreaks, warmer weather with the advent of spring should slow its spread, while a rising number of pharma companies are pushing hard to develop vaccines. But we may still be weeks away from the global peak in the epidemic’s geographic transmission, even as the number of new cases in China is apparently falling. That suggests the hit to global economic growth may be sizable and downward revisions to broad-index earnings are now being priced into first- and perhaps even second-quarter estimates. Long-term investors shouldn’t lose sight of the types of stocks that can weather the storm and come out better positioned when it passes.
That may sound like cold comfort when investors are scrambling into U.S. Treasuries, the dollar and gold. The 10-year Treasury hit a record low of 1.33%, while the DXY dollar index climbed above 99, up about 3% from the start of the year. Spot gold traded higher at $1,659 per ounce, a gain of more than 9% so far in 2020 and its highest level in seven years.
On the flip side, benchmark crude grades were down 5%, bringing their year-to-date losses to some 16% while most base metals were off mid- to upper-single-digit percentages in the period. Most blue-chip stock indices globally have given up their major gains from a month ago, when a pro-cyclical rebound seemed to be in the cards following the “Phase-1” U.S.-China trade deal, greater Brexit clarity and renewed major central bank monetary accommodation.
Global Cyclical Recovery Deferred Again
“Economic green shoots have been constantly cut low for a decade,” says Josh Rubin, who works on Thornburg’s emerging markets strategies. In 2010, he recalls, the Arab Spring broke out and the European debt crisis erupted, as Portugal, Ireland, Spain and especially Greece strained to refinance their sovereign debt. That endangered their countries’ financial systems, hurt banks across Europe and even threatened the viability of the euro currency. All that delayed the global recovery from the 2008 Financial Crisis.
Then there were the U.S. debt ceiling disputes in 2011 and 2013, when the U.S. Federal Reserve also sparked the “Taper Tantrum.” That signaled the eventual, albeit gradual, end of its quantitative easing and ZIRP (zero-interest-rate policy) stimulus strategy, knocking the wind out of the global recovery. The Ebola virus outbreak in 2014 and the oil price collapse that same year, from which the energy sector is still struggling to emerge, dealt further blows. The Fed’s rate “normalization” from late 2015 through mid-2019, alongside U.S. President Donald Trump’s trade wars, delivered still more shocks, Rubin notes.
Now in 2020 it’s coronavirus. While it’s no doubt impacting global growth near-term and to varying degrees earnings, depending on sectors and individual companies, as Global Perspectives recently pointed out, it’s important to recognize the bigger picture. The global economy was already on its knees and just starting to get back on its feet when COVID19 knocked its legs out from under it. “Being closer to the ground means the fall isn’t going to hurt nearly as much as when you were standing,” Rubin says. “As investors, we’ve been conditioned to keep looking through disruptions because there’s always a work-around—companies and markets adapt—and central banks and governments are also doing their parts to cushion the blows.”
The market is already pricing in a couple quarter-point interest rate cuts from the Fed this year, though it’s unclear just how much monetary policy can compensate for supply-chain disruptions. China, where capacity utilization was running at an estimated 40% to 50% in mid-February, has already signaled significant monetary and fiscal stimulus, which should fast-track recovery in the world’s second-largest economy once the virus has been subdued. Other central banks are likely to follow suit, given the knocks on economic activity.
Investors should remember that risk asset prices at the beginning of 2020 were quite frothy, particularly in the U.S., given renewed central bank liquidity late last year and expectations for the long-awaited global economic reacceleration this year. The February selloff has restored some value to previously pricey stocks and bonds with tightly compressed yields.
A U.S. sovereign 10-year yield of less than 1.4% isn’t attractive for those who don’t think the sky will continue falling for the next decade. Investors should focus on those positive free-cash-flow companies that can reasonably offer a sustainably attractive spread to that 10-year yield, Rubin says.
“Growth companies with the right profit fundamentals can fit that. Value companies with the right business strength can fit that,” Rubin adds. “Both cases need to be combined with the right starting valuations. Otherwise, multiple quarters of surprisingly disappointing global economic growth will hurt, but less so for investors who can perceive normalized earnings through the disruptions by focusing on their visibility and stability in generating free cash flow. That should enable firms to fund their investments internally, get through the disruptions relatively unscathed and potentially expand their market shares.”