As the novel coronavirus, COVID-19, evolves into a global pandemic, the capital markets continue to react dramatically. The major indexes have been wildly volatile, dipping into correction territory as elevated
uncertainty over the threat the outbreak poses to the global economy and oil prices has rattled investors. The
health impact of COVID-19 and its potential economic implications are extremely fluid, as are the market reactions
to those two drivers. Given elevated market volatility and still unfolding developments, we are maintaining a
proactive and analytical approach — placing greater emphasis on the fundamentals and quality of asset classes
and sectors — rather than taking a reactive and emotional stance.
COVID-19 IMPACT ON KEY MARKETS
Source: Ivy Investments and FactSet. Year-to-date performance of the S&P 500 Index, 10-Year U.S. Treasury yield index and West Texas Intermediate (WTI) crude oil price index; Jan. 1 – March 9, 2020. Past performance is not a guarantee of future results.
Rippling effect of economic weakness?
We believe global economic growth will be weaker
in the first quarter, which could carry over into
second quarter as COVID-19 spreads throughout
the U.S. and Europe. Looking at specific economies,
growth on a quarter-to-quarter basis could be
negative in China, South Korea and Japan, as well
as countries in Europe like Italy, which has issued
quarantine measures across the country.
However, the situation in China appears to be
improving as government officials and businesses
work to balance containing the virus with
preventing further weakness in economic growth.
We think the Chinese economy will likely continue
to improve from here, albeit from very weak levels.
Global economic growth will likely be weak in the
second quarter as the number of confirmed COVID-19
cases of rise in the U.S. and Europe, with a high
likelihood that much of the western world sees negative
growth on a quarter-to-quarter basis. Magnifying the
economic impact of the virus outbreak is the supply
chain disruption. We already are seeing massive delays
in the delivery times on materials.
SUPPLY CHAIN DISRUPTION — WORLD, MARKET PURCHASING MANAGERS’ INDEX (PMI)
Source: Macrobond. Data show the measure times for suppliers to deliver goods to end users and the month-to-month disparity in deliveries. Past performance is not a guarantee of future results.
A drain on the supply portion of the equation could lead to
shocks to the demand side. Social distancing actions taken
by public health officials and businesses, coupled with
likelihood that people may want to avoid high traffic
locations — travel destinations, stadiums, theaters and
restaurants — could shrink consumer consumption, further
weakening gross domestic product (GDP) growth.
Oil prices recently plummeted following a breakdown of
an alliance between the Organization of the Petroleum
Exporting Countries (OPEC) and Russia after failing to
agree to additional production cuts. We believe that this
fracture will put downward pressure on oil prices for the
foreseeable future, which should increase the purchasing
power of consumers but should also hit capital spending
on oil infrastructure. In general, recent weakness in oil
prices could act as an additional drag on oil-producing
economies, including the U.S.
Further price deflation is likely to occur as the oil cost
curve is pushed lower. Lower cost production from OPEC
and Russia is likely to push out higher cost production,
effectively lowering the marginal cost of production. The
need to lower cost structures may force some energy
companies to consolidate in order to remain competitive.
This action by OPEC and Russia could also have severe
repercussions for many U.S. exploration and production
firms, as well as oil service companies. We believe
bankruptcies are likely. This event could also affect other
industries due to the severity of cuts to spending, higher
unemployment and negative impact economic growth.
We anticipate other sectors to feel pain.
We have revised our 2020 global outlook due to the
economic and market impact of COVID-19. We now
believe the global growth rate for 2020 will be around 3%,
down from our initial forecast of 3.4% coming into year.
However, we think this disruption is temporary and
growth in the second half of 2020 could be closer to our
original forecast, even surprising to the upside.
This is due in part to improvement in the underlying
fundamentals, such as a better inventory situation and the
reduced overhang of higher tariffs as a result in the cease
fire in the U.S.–China trade war. These conditions could be
amplified by the crisis as inventories are drawn down
further as a result of supply-chain disruptions.
In addition, we are likely to see a considerable amount of
stimulus added into the system. The Federal Reserve (Fed)
enacted an emergency interest rate cut of 0.5%, and will
likely cut rates another 0.5% or more in the next couple of
months. Policymakers in Canada and Australia have also
reduced interest rates. Several emerging markets central
banks actually led the current rates reduction trend, and
could possibly continue to make cuts.
Coronavirus: Market impact and macro view
We’ve also started to see fiscal stimulus in Italy, France and
a number of Asian countries. We believe the U.S. could also
introduce some form of fiscal stimulus, including a possible
reduction in tariffs. Anything is possible in an election year.
If this slowdown is temporary as we believe, we could see
a scenario where the combination of fundamentals and
stimulus could further fuel a possible snapback.
Downside credit risk in the short term
The moves in the rate markets must be put into perspective
in order to understand their magnitude. The chart below
(Exhibit 1) shows the historical returns of the 2-year U.S.
Treasury note — it is a distribution curve illustrating the
standard deviation of returns. Looking at the far left side
of the chart, a tiny green bar shows the intraday move
after the Fed’s March rate cut of 0.5%. The move broke the
distribution chart, as the other side of the bell curve doesn’t
even appear. In essence, this was an unprecedented move
on the 2-year U.S. Treasury note.
EXTREME VOLATILITY IN THE FIXED INCOME MARKET (EXHIBIT 1)Historical returns in the 2-Year Treasury Note
Source: Bloomberg. Data show the six-month returns of the 2-Year Treasury note from Sept. 3, 2019 - March 3, 2020. Past performance is not a guarantee of future results.
Additionally, the 10- year U.S. Treasury yield fell to
historic lows. The root cause is inflation expectations
are collapsing and, in an environment of falling
demand, the chance of having an inflationary scare
is minimal. So, while absolute rate levels are
dramatically low, in the context of the current
environment and its economic risks, we don’t
view current rate levels as overly irrational.
Yield curve remains encouraging
When looking at a period of yield curve of U.S. Treasuries, most moves in the curve are
typically do not have meaningful deviation. However,
the extent of the recent moves in rates is massive. The
following chart (Exhibit 2) illustrates the downward
shift in the yield curve of U.S. Treasuries from one month
ago to early March.
YIELD CURVE REMAINS POSITIVELY SLOPED (EXHIBIT 2)
Source: Ivy Investments, Bloomberg. Data show change a 30-day comparison of the yield curves of select U.S. Treasuries as of March 09, 2020. Past performance is not a guarantee of future results.
While the magnitude of the moves is significant, the signal
from the shape of the curve is critically important. With the
parallel shift down in yields, we’ve seen a slight steepening
on the curve. From a longer term economic perspective,
this is how investors want to see the curve move down in
environments like this. Worry creeps in when the curve
flattens massively, as that tends to be a troubling sign. We
believe the steepness in the curve two years and beyond
demonstrates the market thinks a recovery will occur and
return to normal at some point in time.
In credit, investment grade spreads have widened.
Whenever markets come down, companies come to
market with new issues, trying to take advantage of lower
interest rates. High yield credits have seen spreads widen
due to increased economic uncertainty. The rise in
spreads is even greater following the oil price decline as
energy-related issuers come under pressure.
In terms of overseas credit, in Europe, the German
sovereign curve, which is the best gauge of yields in
Europe, had a similar shift to the U.S. Treasury curve.
In contrast to the U.S., the absolute changes haven’t
been as big given rates in Europe are in negative territory.
While we are seeing big moves in rates, we’re not seeing
things that we deem irrational or concern us materially.
Every market challenge is an opportunity
In our view, the coronavirus outbreak is likely to be a
transitory event. While tragic, we believe such passing
events lead to risk-off market environments, providing us
opportunities to seek to take advantage of near-term stock
price dislocations to invest in long-term advantaged
business models. Looking ahead, we continue to put
greater emphasis on the fundamentals and quality of
asset classes and sectors.
We believe it is important to stay focused on the merits
of individual market sectors, industries and companies
when making investment decisions. Historically, those
fundamentals have tended to outweigh external factors
such as the coronavirus outbreak. While these factors
can certainly impact markets and economic growth
over the shorter term, we think the innovation and
management skill within individual companies can
drive stock selection opportunities.
The epidemiology of COVID-19
After its initial detection in the Hubei province of China
last December, cases of COVID-19 were confirmed in
South Korea, Italy and Iran within weeks. By late January,
the World Health Organization (WHO) issued a warning to
take precautions for a possible pandemic. This alert was
followed by a similar action from the Centers for Disease
Control and Prevention. On Feb. 26, the first confirmed
U.S. case of COVID-19 was identified in a patient with no
known risk factors, suggesting the virus is now circulating
in our community.
As of early March, Covid-19 had spread to 104 countries
with nearly 110,000 confirmed cases and had claimed at
least 3,800 lives.
Two characteristics of the virus that are worrisome are its
person-to-person transmissibility and its mortality rate.
At the current time, the transmissibility is felt to be similar
to influenza virus while the mortality rate is believed to
exceed influenza virus (influenza morality rate overall <
0.1%.) The mortality rate for COVID-19 is difficult to predict
due to incomplete data, particularly in asymptomatic and
mildly symptomatic individuals. However, advancing age
seems to be a clear risk factor, with mortality rates in
confirmed cases in excess of 8% for people age 70 and
older. In addition, the mortality rate among confirmed
cases for people with chronic diseases, such as diabetes
and cardiovascular disease, is greater than 5%.
HISTORY OF PANDEMICS
SARS (Coronavirus beta)
2003–2004 (15 months)
2009–2010 (14 months)
Spanish Flu (H1N1 virus)
1918–1919 (12 months)
SOURCE: Centers for Disease Control and Prevention.
The opinions expressed in this article are those of Ivy Investment Management Company and are not meant to predict or project the future performance of any investment product. The opinions are subject
to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a
recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs,
risk tolerance and time horizon.
The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. It is not possible to invest directly in an index. Standard deviation is a quantity
calculated to indicate the extent of deviation for a group as a whole which can be used as a measure of how volatile a fund’s returns are. The US Treasury yield curve is a graphical representation of the yields available
for bonds of equal credit quality and different maturity dates.
Risk factors: Investment return and principal value will fluctuate and it is possible to lose money by investing. International investing involves additional risks, including currency fluctuations, political or economic
conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Fixed income securities are subject to interest rate risk and,
as such, the value of such securities may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds.