Investors experienced another volatile week on Wall Street as it has become more common to witness days where the market has been up or down by 3% or more. The above average daily swings are a function of the market reacting to an evolving risk in the Coronavirus. Essentially this is just a function of the market repricing this risk and trying to find the appropriate equilibrium in share prices. Volatility, such as this, is common after unexpected events. This was similar following 9/11 and when Lehman Brothers filed for bankruptcy. Since all the facts are not immediately known, the market can oscillate around as participants digest incremental pieces of data and reflect those in prices. As everyone interprets information slightly differently and at different speeds, this leads to the consequence of volatility.
The U.S. is clearly bracing for the impact of the coronavirus. This week we saw airlines suspend and cancel routes and heard of many conventions being cancelled. Regardless of how significant the spread of the virus becomes, the incremental news flow from the week indicated that it was going to have some impact on the U.S. economy. As we assess this information, we acknowledge there could be added downside risk to equity markets if the economic impact magnifies.
This past week we have also seen an acceleration in the downside potential of other assets. High yield bonds and crude oil are two of those. Crude oil fell -9.4% on Friday, presumably on the back of OPEC and Russia failing to come to an agreement on production cuts. High yield bonds saw their interest rate differential compared to Treasury bonds widen from roughly 3.5 percentage points (350 basis points) to just over 5 percentage points (500 basis points) at Friday’s close. This wider differential is due to investors assigning greater risk to these securities.
As riskier assets are being sold, investors are flocking to Treasury bonds. The interest rate on the 10-year Treasury finished the week at a stunning 0.76%. When 2020 began, the 10-year Treasury yielded 1.92%.
There is clearly an element of fear selling across markets as investors react to uncertainty. Each market is adjusting to new information differently. Eventually this will even out and find an equilibrium. Its all too easy to get caught up in fear by turning on the television or looking up what the market may be doing on any given day. Challenging down days, such as Thursday and Friday, may cause one to wonder when it may be over. However, keep in mind the S&P 500 finished the week up +0.6%. As hard as it is, looking past the short-term noise on any given day and keeping the long game in mind is what’s important during market downdrafts such as this.
Market corrections such as what we are going through are where compelling long-term investment opportunities can be presented. Moreover, having a more active investment approach can add incremental value as not all securities get repriced equally during quick downturns. We continue to believe the coronavirus impact on the economy will be transitory. Under this expectation, the quick retrenchment of stock, bond and commodity prices will provide attractive long-term opportunities in these markets. Diversification is important and we continue to believe our asset allocation ranges remain appropriate. We plan to act on investment opportunities that present attractive return potential as they present themselves.