“The real key to making money in stocks is not to get scared out of them.”— Peter Lynch

When does this end? How bad can it get? The honest answer is nobody knows. Markets hate uncertainty so the drip feed of negative news only magnifies this. History suggests that disease outbreaks do cause short-lived sell-offs. Both Sars and the Zika virus saw drawdowns of about 13 per cent each in the S&P 500.

The coronavirus has already led to an intraday-day plunge of almost 16 per cent (as at last Friday. But markets do tend to recover.

In fact, after just six months after the outbreak of Sars, Zika and Mers the MSCI World Index was up 21.5 per cent, down 0.6 per cent, and up 8.6 per cent, respectively. There is, of course, no guarantee this plays out the same. It’s worth noting that the Chinese market is recovering rapidly — the Shanghai Shenzhen CSI 300 is down only 1.8 per cent from its recent peak as of last Friday.

Diversification

First, the good news. Diversification is working. Bond portfolios are rallying — especially treasuries. It seemed silly to own bonds a few weeks ago when the equity rally was outstripping the bond rally. I think we can now agree, however, that the bond market was right, and the equity market was wrong when it comes to Covid-19, at least in the short-term.

Although balanced accounts are still likely to see some pain, this has been mitigated with diversification. Bonds at some point can also be sold and become a funding source for rebalancing.

Central banks can’t save us

The recent Fed cut was a form of insurance designed to convince market participants that it is willing to do whatever it takes to support the economy in the face of the virus. Lowering rates, however, does not provide a vaccine.

Low interest rates tend to help when tight credit conditions are constraining demand. With interest rates virtually zero everywhere, this is not really the case. Lowering rates is not likely to help boost demand when it is collapsing from lower economic activity and the shuttering of production.

A big concern is that the Federal Reserve and most central banks have used up most, if not all, of their monetary ammunition fighting small and insignificant downturns over the last ten years. We could look back and regret how aggressive they have already been.

Fiscal policy may be the most effective weapon to combat a potentially deflationary environment. China is rolling out some as we speak, and I think other major countries should do so as well.

Demand and supply shock

Covid-19 does present a material economic threat that will test confidence in the near term. It may also push economies into recession. One of the big reasons a viral outbreak is so dangerous economically is that it can affect demand and supply at the same time.

From the demand side, the fear and caution that it spreads curtail consumption. Nowhere is this more evident than in the travel sector where we see flight cancellations, conference closures, and events being postponed daily. If people are quarantined or simply hesitant, they will spend less or not be able to spend.

The supply side is also affected by the collapse of global supply chains in production brought about by manufacturing shuttering. The knock-on effect can ironically turn into a demand reduction feedback loop as closed manufacturing operations, for example, do not pay wages, which in turn does not allow workers to spend.

It may get even worse if companies with high fixed costs and debt suddenly reach the point where cashflow is insufficient to maintain operations leading to bankruptcies.

Although no one indeed knows how long this will last or how much damage to the economy this virus will do, I am confident the world will go on. If history is any guide, there will be a point that the market dispassionately ignores the virus-related headlines and looks towards the future.

Nobody knows when sentiment like this will shift, but it is important to try and ascertain the real change in value versus the change in price. This is difficult, especially when the situation is fluid, but chaos and uncertainty offer opportunities brought about by fear.

Remember some things I think I know:

5, great investors move ahead when petrified. Great investors also are terrified about markets that have moved way ahead.

13, there will always be compelling reasons to sell and tentative reasons to buy.

16, “The markets rise over time because a vast majority of people wake up every morning to do good things … not destroy the world. Betting against the market is betting against human ingenuity, grit, perseverance, and advancement.”

• Nathan Kowalski CPA, CA, CFA, CIM, FCSI is the chief financial officer of Anchor Investment Management Ltd and can be contacted at nkowalski@anchor.bm

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