Stocks drop as coronavirus fears reignite global growth worries

Index funds have a large following among institutional investors such as pension funds and insurance companies. Ironically, one of the most vocal advocates of index funds for individual investors is Warren Buffett, self-made billionaire and chairman of Berkshire Hathaway Inc., who made his fortune through individual stock selection. – Richard A. Ferri, CFA and author of All About Asset Allocation

The spread of the coronavirus reignited global growth worries and ended the stock market’s two-week winning streak as all three major averages fell more than 1%. On Friday, China’s National Health Commission confirmed a spike of 800 new cases of the illness, bringing the total cases of the virus to more than 75,000 with over 2,000 deaths, most of which are still in China. However, news that there were deaths in Japan and South Korea also sent shockwaves through the financial markets as both countries are key players in the world’s technology and industrial supply chain. There were tangible signs that the impact of the coronavirus is being felt by companies, too, as Apple warned that it will not meet its quarterly revenue forecast, citing disruptions in production and weaker demand. Procter & Gamble also warned that the virus will have a material impact on its sales and earnings for the current quarter. Fears that the spread of the virus will reduce global economic growth and negatively affect corporate profits not only caused stocks to decline but sent bond yields tumbling as well. (Bond yields move inversely to prices). The yield on the 30-year Treasury bond fell to 1.92%, its lowest level ever, while the 10-year Treasury yield ended the week at just 1.47%. The uncertainty over the potential impact of the coronavirus also caused the price of gold to surge to its highest level in seven years. With the stock market trading near all-time highs, investors had been hoping that central banks in the U.S. and China would be very aggressive with monetary stimulus to help offset the negative effects on the economy from the virus. Minutes from the Federal Reserve meeting in late January, however, indicated last week that officials believe that current monetary policy is appropriate and that interest rates are likely to remain unchanged. Trade uncertainties with China have now been replaced with uncertainties involving the effects of the coronavirus, leaving the market vulnerable to a correction unless it is contained soon.

Last Week

The producer price index (PPI) in January rose by its highest level since October 2018 but the jump is likely to be temporary. In the twelve months through January, the PPI has risen 2.1% as wholesale inflation remains relatively low. Both the IHS Markit Purchasing Manager’s Index (PMI) for the manufacturing and services sectors released last week were disappointing as the former recorded its lowest level since August and the latter fell to its lowest level since October 2013, raising concerns about growth.

For the week, the Dow Jones Industrial Average dropped 1.4% to close at 28,992 while the S&P 500 Index fell 1.2% to close at 3,337. The Nasdaq Composite Index declined 1.6% to close at 9,576.

This Week

The revised fourth quarter gross domestic product (GDP) is expected to be slightly higher at 2.2% while January durable goods orders are expected to drop slightly after a modest increase in December. Consumer confidence in February is forecast to remain high and January new home sales should top the previous month’s total as mortgage rates remain low and the labor market remains strong.

The most notable companies scheduled to report fourth quarter earnings this week include HP Inc., Home Depot, Macy’s, Lowe’s, Marriott International, TJX Cos., Anheuser-Busch InBev, Autodesk, Best Buy, Dell Technologies and Chesapeake Energy.

Portfolio Strategy

Fears that the coronavirus could severely impact the world’s second-largest economy and affect the rest of the world renewed talk about a possible recession in the U.S. Even though fourth quarter GDP topped 2% and the stock market is trading near all-time highs despite the plunge on Friday, investors have been spooked by the rapid spread of the virus and its potentially devastating consequences. Action in the bond market last week indicated that investors were fearful as the yield on the 30-year Treasury bond plummeted to its lowest level ever and yields across the board also dropped. Part of the concern is the flattening of the so-called yield curve, which shows the difference between the yield on short-term bonds and longer-term bonds. With a flat yield curve, there is a higher likelihood that the curve could invert with yields on short-term bonds higher than yields on long-term bonds. As of Friday, the difference between the yield on the 2-year Treasury (1.35%) and the yield on the 10-year Treasury (1.47%) was only 12 basis points. (A basis point is one hundredth of one percent). In the past, yield curve inversions have been a reliable predictor of recessions or downturns in the economy. While the flattening of the yield curve is certainly a worrisome sign, the Federal Reserve seemed sanguine about the U.S. economy in its minutes from the previous meeting and confident enough to leave interest rates unchanged. Corporate profits in the fourth quarter have also been solid, although estimates for earnings in 2020 have been lowered with profit growth forecast to be about 6% now compared to roughly 8% when the year began. Markets do not like uncertainty, though, and the coronavirus has introduced an element of uncertainty that could lead to a global growth slowdown and increased market volatility.