The coronavirus continued to wreak havoc on markets in the month of February. Many—if not most—investors are likely to be best served by sitting on their hands, as historically equity markets have recovered reasonably quickly from previous global health concerns. Still, many can’t help but contemplate how far markets could fall.
So why do events like these often have significant impacts? One reason could be that stocks could have been overvalued at the outset. We’ve previously suggested that stocks had been more or less fairly valued, but we’ll get back to that discussion next month. It is the possibility of lingering damage to the companies and the broader economy that provokes the larger hit to markets.
Still, if history is a guide, drawdowns from recent global health issues have been similarly sized, recoveries were reasonably quick, and returns just six and 12 months hence were meaningfully positive.
Sources: Bloomberg and Morningstar. Morningstar data used for pre-2012 epidemic data. “Drawdown to Recovery (Days)” represents the number of days from the start date of the S&P 500’s drawdown to the date the index returned to pre-drawdown levels. Returns "from start" represent returns from the date of the start of the drawdown.
Only U.S. bonds managed to deliver a positive return in February.
Source: Bloomberg, as of 02/28/20.
The havoc in risk assets in the latter half of February resulting from concerns over the spread of COVID-19 drove down yields for safe-haven assets as yields reached an all-time low on both 10-year and 30-year U.S. Treasury bonds. The 10-year Treasury yield declined 36 basis points in February to end at 1.15%, while the 30-year fell 32 basis points to close at 1.68%. These declines re-inverted certain portions of the yield curve. Futures markets are now pricing in reductions on the Fed funds rates, and the Fed reacted with a surprise inter-meeting rate cut of 50 basis points.
Corporate bond yields have risen—but perhaps not as much as one might expect. Widening corporate credit spreads—500 basis points on high yield, and 116 basis points on investment grade as of the end of February—have been offset by falling Treasury rates. The fact that Treasury rates and credit spreads frequently move in opposite directions often limits the downside of corporate bonds but presents an obstacle to profiting from a tightening in spreads, if, say, virus fears wane. Focusing on high yield, the fact that energy exposure has declined from nearly 20% of the Bloomberg Barclays High Yield Index just a few years ago to around 10% today, mitigates a key obstacle to spreads tightening. Even if oil weakness continues post-virus, the spillover effect in the credit markets is likely to be less this time around.
The more substantive obstacle is Treasury rates. Just as falling Treasury rates just muted the impact of widening spreads, rising Treasury yields could mute the impact of tightening credit spreads. And with the 10-year Treasury at all-time lows, it is quite likely that any relaxing of virus concerns would drive Treasury rates higher. Investors may be beginning to see opportunity in corporate bonds—and seeking to profit from potential tightening spreads—and are also likely considering ways to hedge their Treasury rate risk.
The coronavirus has hit equities hard and fast, overwhelming any positive indicators. Perhaps entirely forgotten, the S&P 500 Index has recorded year-over-year earnings growth for the first time since the fourth quarter of 2018. Current numbers reveal that the index was able to eke out positive earnings growth of 0.9% in the fourth quarter of 2019, which exceeded estimates at the end of last year that called for a contraction of -1.7%.1 But coronavirus concerns are not about what happened last quarter…
One thing that is certain is that timing the market is a skill that is extremely rare to possess. To do so, you must be correct not once but twice—when to get out and when to get back in. Is it too late? Will you miss the potential rally following the recent correction? History tells us that dividend growth stocks have been able to stomach reactions to epidemics a bit better than their peers.
As a group, the S&P 500® Dividend Aristocrats®—U.S. large cap stocks with a minimum of 25 consecutive years of dividend growth—have proven to be high-quality companies with durable business models, stable earnings, solid fundamentals, and strong histories of profit and growth. Upon reviewing the S&P 500 Dividend Aristocrats’ performance during recent epidemics including avian (bird) flu, Ebola, and Zika, we note that the Aristocrats have experienced smaller drawdowns and shorter recovery periods than the broader S&P 500.
Sources: Bloomberg and Morningstar. Morningstar data used for pre-2012 epidemic data. “Drawdown to Recovery (Days)” represents the number of days from the first day of drawdown for the S&P 500 and S&P 500 Dividend Aristocrats indexes to their return to pre-drawdown levels.
Keep in mind that inclusion in the S&P 500 Dividend Aristocrats requires 25 consecutive years of dividend increase. These are companies that increased their dividends even in the Great Recession, which is worth noting in the event the impact of the coronavirus drives lingering economic weakness.
Source for data and statistics: Bloomberg, FactSet
1 Source: FactSet as of 02/28/20 with 95% of companies reporting
The different market segments represented in the chart use the following indexes: US Large Cap: S&P 500 TR; US Large Cap Growth: S&P 500 Growth TR; U.S. Large Cap Value: S&P 500 Value TR; U.S. Mid Cap: S&P Mid Cap TR; U.S. Small Cap: S&P U.S. 600 SC TR; International Developed Stocks: MSCI Daily TR NET EAFE; Emerging Markets Stocks: MSCI Daily TR Net Emerging Markets; Global Infrastructure: Dow Jones Brookfield Global Infrastructure Composite; Commodities: Bloomberg Commodity TR; U.S. Bonds: Bloomberg Barclays U.S. Aggregate; U.S. High Yield: Bloomberg Barclays Corporate High Yield; International Developed Bonds: Bloomberg Barclays Global Agg ex-USD; Emerging Market Bonds: DBIQ Emerging Markets USD Liquid Balanced.
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