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Dow drops 2.5% as fears rise over spread of coronavirus

A market downturn doesn’t bother us. It is an opportunity to increase our ownership of great companies with great management at good prices. – Warren Buffett

Investors succumbed to fears over the spread of the coronavirus in China last week and the major stock averages all closed lower, with losses ranging from 2.5% for the Dow Jones Industrial Average to 1.8% for the Nasdaq Composite Index. Most of the damage occurred on Friday as investors did not want to be long the market over the weekend. China’s stock market has been closed for Lunar New Year but is scheduled to reopen on Monday, probably with a significant decline. While there have been less than ten confirmed cases of the virus in the U.S., the number in China has risen to over 10,000 with over 200 fatalities. The World Health Organization (WHO) declared a global health emergency and out of an abundance of caution, the U.S. declared the coronavirus to be a public health emergency and implemented tighter travel restrictions to China. The virus has created a lot of uncertainty as no one knows what impact it will have on the global economy. This fear overshadowed an otherwise stellar week for fourth quarter earnings as we approach the halfway mark in the corporate earnings season. Roughly 70% of S&P 500 companies have topped expectations with results last week from Apple and Amazon being particularly impressive. Apple handily beat revenue and earnings estimates as iPhone sales increased 8% while Amazon reported blowout results that beat on both the top and bottom lines, sending its stock up nearly 10%. Other blue chip companies that announced better than expected earnings included McDonald’s, General Electric, Microsoft and Caterpillar. The Federal Open Market Committee (FOMC) also met last week and, as expected, decided to keep the federal funds rate unchanged at between 1.50% and 1.75%. In a statement, the Fed stated that its objective is still 2% inflation and reiterated that the labor market remains strong with the economy growing at a moderate rate. The only change from the prior meeting was a downgrade in their assessment of consumer spending from “strong” to “moderate”. This coming week brings another slew of earnings reports as well as the January employment report, but all eyes will be on China and the status of the spreading coronavirus.

Last Week

Durable goods orders rose modestly in December after falling in November but non-defense capital goods excluding aircraft, a good proxy for business spending plans, registered its largest decline since April. Gross domestic product (GDP) in the fourth quarter was unchanged at 2.1% and pending home sales fell in December as the supply of homes remains low. Both the consumer confidence index and the University of Michigan consumer sentiment index rose more than expected in January as consumers remain upbeat about the labor market and the economy.

The United Kingdom officially left the European Union (EU) on Friday and will begin new trade talks with the U.S. and the EU.

For the week, the Dow Jones Industrial Average dropped 2.5% to close at 28,256 while the S&P 500 Index declined 2.1% to close at 3,225. The Nasdaq Composite Index fell 1.8% to close at 9,150.

This Week

The January employment report is expected to show that about 158,000 new jobs were created and that the unemployment rate was unchanged at 3.5%. December factory orders and construction spending are expected to post modest increases. The ISM manufacturing index is forecast to be higher in January but still under 50, which signals contraction, while the ISM non-manufacturing or services sector index is forecast to be about the same as in December but comfortably in expansion territory.

The most prominent companies scheduled to report fourth quarter earnings this week include Sysco, Clorox, Kellogg, Walt Disney, Alphabet (Google), Qualcomm, Ford Motor, General Motors, Merck, Bristol Myers Squibb, Abbvie, Cigna, MetLife and ConocoPhilips.

Portfolio Strategy

The market sell-off on Friday assured that the S&P 500 would end the month of January with a slight loss of 0.2% and negate the positive predictability of the so-called January barometer, which says that so goes January, so goes the year. The Dow Jones Industrial Average also ended the month lower while the Nasdaq Composite Index ended higher by nearly 2%. Since 1950, when the S&P 500 is positive in January, 86% of the time this benchmark winds up positive for the full year. The fear and uncertainty of the impact of the coronavirus on the global economy caused investors to flee stocks in favor of the safety of bonds, sending bond yields plunging. (Bonds prices and yields move in opposite directions). The yield on the 10-year Treasury plunged to 1.51% while the 2-year Treasury yield dropped to 1.33%, a difference of only 18 basis points. (A basis point is one hundredth of one percent). Even more worrisome was the fact that the 3-month Treasury yield (1.55%) exceeded the 10-year Treasury yield, an inversion of the yield curve that can portend a recession. The presence of the coronavirus has caused investors to reassess their economic growth outlook and the Federal Reserve’s desire for at least a 2% inflation rate. Falling bond yields may lead to an additional interest rate cut by the Fed in order to help spur growth and increase inflation. A dovish Fed is in direct contrast to the neutral stance the Federal Reserve adopted to start the year, suggesting that there would be no change in interest rates. It was thought at that time that the trade deal signed between the U.S. and China would boost growth and lead to rising bond yields. Unfortunately, the coronavirus has changed all of that as first quarter GDP is likely to be less than originally expected.