Resumption of economic activity in China an important signpost
Global equity markets have declined sharply the past two weeks as investor anxiety has spiked over the COVID-19 outbreak across the world. As of this writing, both the S&P 500 Index and the S&P/TSX Composite Index are down more than 17% from the recent high reached on February 19, 2020. We’re also seeing extreme dislocations in other asset classes like the oil market where the price opened down -30% in overnight trading. In the bond market, government bond yields have retrenched significantly across the entire term structure.
The catalyst for the severe sell-off in risk assets like stocks and the oil price is certainly the worry over the adverse economic impact from the COVID-19 spread. Markets dislike uncertainty above all else, and there’s much uncertainty right now about how to contain the COVID-19 from spreading and what the economic fallout will be from the COVID-19. During volatile periods like this, it’s important that investors remain calm and don’t sell in a panic. Over the short term, markets tend to over-react to the upside and to the downside. Over the long term, however, empirical evidence shows that stocks go up two-thirds of the time and earn a return above cash, bonds and inflation.
Global central banks stand ready to ease financial conditions and ensure that financial markets remain liquid and functional. To that end, both the Bank of Canada and the U.S. Federal Reserve have made emergency rates cuts of 50 basis points or 0.50% and I expect that we’ll see more rate cuts in the next few months. Data also show that new COVID-19 infections in China have been steadily declining, and workers are starting to go back to work. As China is the world’s second largest economy and accounts for 19% of global GDP, a resumption in economic activity in China is an important signpost for the global economy.
In the past few weeks, it‘s been easy to forget that stock markets had an exceptional year last year with most markets delivering returns of 25-30%. Coupled with the fact that we’re in the 11th year of this bull market for stocks, a correction in stock prices was perhaps overdue. Stretched valuations for stocks have now been reset lower and bonds have once again shown to be a valuable asset in terms of providing effective diversification in a client’s asset mix and in providing downside protection during equity sell-offs.
Lastly, it’s premature to call a bottom in the equity markets or an end to the extreme period of volatility that we’re in. However, this bout of volatility is not new and will not last forever. In fact, we experienced a similar environment as recently as the 4th quarter of 2018, and during 2010, 2011, and 2015-2016. During those market declines, investors were similarly worried about economic growth stalling and the possibility of a recession. In each of those previous instances, equities fell 14-20% before recovering. We don’t know when a recovery in stocks will occur this time and when the volatility will subside, but investors will be rewarded for remaining calm with an eye on the long term.
Lieh Wang, CFA
Chief Investment Officer
iA Investment Counsel Inc.
This article is meant for general informational purposes only. Please obtain professional investment advice before making any investment decisions. LFA is a trademark and business name of iA Investment Counsel Inc.
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