Global spread of coronavirus brought a swift and sudden reversal of the positive momentum that was driving equity markets at the start of 2020. The volatility is likely to persist as investors weigh the impact on corporate earnings and global supply chains. While we expect earnings will be hard hit this year, we see coronavirus as a transitory event (perhaps three to six months) that does not permanently impair the world economy and company earnings power. The recent fall in U.S. stocks has been particularly pronounced, but history suggests investor patience has been rewarded as markets regain stability.
This is not 2008
Volatility never feels good, but the foundation underlying it is important. Daily market moves in response to the COVID-19 outbreak have matched the scale of those seen during the global financial crisis. But this is not 2008. The coronavirus shock is not one caused by a crisis in the core of the financial system and spreading to the rest of the economy. The economy is on much stronger footing and the financial system is much more robust. In fact, policy measures and safeguards put in place since 2008 have only strengthened the financial system.
What to do? The bad news: Few investors are good at trading around extreme market volatility. The good news Decades of stock market history tell us “this too shall pass.” This, and our own experience, suggests that the most prudent tack for a long-term investor is to stay the course ― and to prepare for the opportunities that may arise as markets emerge from the turmoil.
Prepare now for opportunities ahead
Our teams are working to assemble “shopping lists” to position their portfolios for eventual market stability and recovery. Some of the best places to look, in our view, are those that have experienced out-sized dislocations or those that tend to be all-weather and proved their mettle during the downturn. These include:
- Quality cyclical stocks. Stocks with large market exposure (or “beta”) have under-performed our expectations. We see potential for these high-beta cyclicals to lead on the way back up. We would be discerning here and focus on those companies with high-quality balance sheets and the free cash flow to allow operational flexibility in market downturns.
- Value. Stocks of all stripes have declined, but value has been particularly hard hit. It has been the worst performing style factor year-to-date, lagging momentum, min vol and quality in both the early-year rally and in the subsequent sell-off. We see a short-term performance gap to be made up after a particularly sharp fall. History has taught us that value’s best times are generally rising out of a recession.
- Health care. The sector has held up better than the broad market since the downturn began on Feb. 19. The MSCI Health Care Index was down nearly 22% through March 16 versus an S&P 500 decline of roughly 29%. This is what we would have expected given the sector’s defensive characteristics and limited reliance on the economic cycle. We continue to like health care for its history of resilience, and see election-related fears subsiding as the Democratic nomination nears closure.
- U.S. stocks. No region has been spared amid the recent rout. Yet we see several reasons to stick with U.S. stocks over other developed markets: The U.S. has a diverse economy, as well as the nimbleness and tools to deploy further monetary and new fiscal stimulus. We also see a particularly good mix of valuation and quality among U.S. companies.
- One to avoid: leverage. Stocks with high debt ratios have under-performed in the downturn. While we would expect levered stocks to lead in a recovery, we would steer clear. If the slump is longer and more persistent than we expect, companies like these could suffer bankruptcy, resulting in a significant impairment to investor capital.