The outbreak of the coronavirus (COVID-19) continues to shake the financial markets, with major stock indices dropping into correction territory. (As of Thursday’s close, the S&P 500 was off 12% from its Feb. 19 peak.) While some observers want to chalk it up to “uncertainty” I beg to differ. This problem has more to do with “visibility” than “uncertainty.”
As I’ve written in the past, uncertainty is, well, uncertain. You don’t know what’s going to happen—if, when, where, how, and by whom. The more uncertain things are, the more fear, anxiety and aversion there is to taking risk.
Visibility is a different animal. With visibility you know the problem, which means resources can be allocated in the right direction to address it. As an investor you can “handicap” the risk. Price discovery is a wonderful mechanism to discover a fair price and with visibility that can be evaluated. With uncertainty, it’s much harder to make decisions as things often change quickly. What we have now is an issue with “visibility.” For example, government resources, global health agencies, the best and brightest in healthcare, and all-around smart people are being mobilized to come up with a solution to COVID-19. What that will look like remains to be seen, but without question, we have enough visibility into the coronavirus problem to have reasonable assurance, in my opinion, that the outbreak will be addressed and solved.
That visibility also helps us gain clarity into the likely impact. We are already seeing some economic damage in the interim, but I believe the virus and its economic disruption will not produce a long-term impact. In my opinion, the virus will not be the biggest economic issue in the next 6 to 24 months.
The other visibility we have is in the rearview mirror, which gives us perspective into the current market “correction” and why it should not be surprising.
As we discussed late last year, the Federal Reserve pumped significant liquidity in response to a shortage of overnight funds in the repo market (the balances that banks trade with each other to square up their balance sheets). I believe the increased liquidity was a major force propelling the markets higher in Q4 2019. As I wrote in my 2020 Outlook, I would not be surprised if much of those gains were taken back. Lastly, as I am not a market timer, it is difficult to forecast if this correction marks the beginning of the end of the expansion or just a nice resting spot before the economy accelerates again. As of this writing, the Astor Economic Index® (“AEI”) is at average reading which we believe argues for the “correction” being a resting spot.
Two things happened that formed our view about the current market conditions. First, our Astor Economic Index® (AEI) indicated to us that, although the economy was still growing, the pace had slowed during 2019. For that reason, we decreased exposure to risk assets over the course of the year. The move to reduce risk across our strategies, in our opinion, was based on fundamental analysis and prudent, regardless of the Q4 2019 rally that continued into the New Year.
Second, we believed if an unforeseen event were to happen, the impact on the market would likely be more significant than it would be if the economy were growing at a stronger pace. Certainly, no one could have predicted the coronavirus, but we believed the current status of the economy, compared to 12-18 months ago would make it more difficult to just shrug off an unforeseen event quickly.
To be clear, we are not saying the coronavirus is going to cause a recession. To repeat, it is an unforeseen event occurring during a period of weaker economic growth that creates problems. What happens next will be revealed in the economic data in real time. Our analysis always involves now-casting, not forecasting.
Where to from here, though, is not yet visible. It is—you guessed it—uncertain. Until we know more, stay tuned.
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The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points, including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. There is no guarantee the Index will produce the same results in the future. All conclusions are those of Astor and are subject to change.