Coronavirus, Reader Questions, and Weekly Updates February 10, 2020

The coronavirus showed some signs of slowing the pace of its expansion even as the number of fatalities surpassed the SARS crisis. Efforts to contain the virus are shrinking consumption in China and affecting diverse industries, such as auto manufacturing, oil, and luxury goods.

This commentary originated on Carson Wealth here.

Key Points for the Week 

• Stocks rallied as data indicated the coronavirus’s expansion has slowed even as the number infected and the number of fatalities continues to rise.
• The S&P 500 reached a new high as markets reacted to optimistic economic data in addition to news on the coronavirus.
• The U.S. economy produced a staggering 225,000 new jobs last month as more people returned to the workforce.

U.S. employment data showed the economy continues to bound forward. Employers hired 225,000 new employees last month, as shown in chart one. Earlier in the week, manufacturing data showed signs of recovery from the U.S.-China trade war.

Investors switched last week’s focus and emphasized the economic data over concerns about the coronavirus. The S&P 500 soared 3.2%. The MSCI ACWI climbed 2.7%. The Bloomberg BarCap Aggregate Bond Index gave back a mere 0.1% to last week’s gains.

The coming week includes the New Hampshire primary, which may provide some clarity to the Democratic presidential race. If it doesn’t, hopefully final results will be tabulated prior to Friday’s U.S. retail sales and industrial production data. Those data points will provide additional glimpses into the health of the consumer and manufacturing.

I Was Starting to Feel Better

The global economy seems to be shaking of the effects of a cold, but just as it is rallying, it will be faced with the aftereffects of a nasty virus.

Manufacturing, and other parts of the global economy most affected by the trade war, is showing signs of improving. As chart two shows, the Global Purchasing Managers Index (PMI) for manufacturing inched its way above the 50 line. Any number above 50 indicates expansion, and the indicator has stayed above 50 for three months after dipping below the second quarter of 2019. The improved data reflects our hypothesis that manufacturing would start to heal as companies reworked supply chains to lessen the damage from tariffs. The Phase One deal with China removed some pressure as tariffs are more likely to decline than increase in 2020.

Some parts of the global economy have remained strong the entire time. Chart one shows the resilient U.S. labor market. U.S. employers continue to expand the ranks of the employed by steadily increasing wages and expanding their workforces. The 225,000 jobs created last month was the second highest in the last 12 months. Wages expanded 3.1%, and more potential employees were drawn into the labor force. Enough people are optimistic about finding work that unemployment actually rose 0.1% to 3.6%. In order to collect unemployment, the recipient has to be actively seeking employment. Much of the credit for the strong employment growth goes to service industries, which continue to hire new workers and expand.

The next big challenge to the global economy appears to be the fallout from the coronavirus. There are some indications the spread of the virus is slowing even though it continues to reach more victims. As we discussed last week, a number of economic activities will be delayed or not occur because the virus is shutting businesses, postponing travel, and reducing other activities.

Additional challenges to global growth were announced this week. A notable car manufacturer shut down some of its production lines in Korea because it lacked parts that were produced in China. Like an airplane manufacturer’s decision to slow production of the 737 MAX, the shutdown of a final assembly line reverberates through the entire supply chain.

Many retailers in China have closed some or all of their locations in order to help contain the virus and not expose their workers needlessly, as many people are staying inside. The lack of activity has cut off more than trips to the shopping centers. Chinese cancelled travel plans around the Chinese New Year, and they aren’t travelling much within the country or abroad. According to the Wall Street Journal, Chinese tourists are key purchasers of luxury goods at shops in Paris, New York, and Rome.

Another casualty has been oil prices. All the trips being cancelled and goods not being produced and shipped have reduced the demand for energy. West Texas Intermediate Crude has dropped more than 20% from its January peak. This puts pressure on oil-producing states, such as Iran, as well as shale producers in the U.S. hoping for higher prices.

Investors should expect a slowdown in the first quarter from the coronavirus. Even as markets rallied again this week, the question we will be watching is how many industries and companies will be affected. Some of the companies are well-positioned to weather a decline and benefit as trips delayed are taken in coming quarters. Others may face challenges as they hadn’t fully recovered from the slow growth following the financial crisis or have been challenged by strong competitors disrupting their industry.

The length of the coronavirus crisis and the severe measures taken to contain it will lengthen the negative consequences. Expect the shocking health crisis in China to affect portfolios longer and more broadly than first anticipated.

Reader Questions

[The first quarter provides us a number of opportunities to interact with some of our readers. For the next month, we’ll share some of the questions we get from readers.]

U.S. stock markets have historically gone up around 10% per year over the long run. Should we anticipate similar returns in the future?

The long-term expected returns for stocks will likely be lower than the historical nominal level, while still providing a meaningful return for taking risk. Using 10% as a rough estimation for the long-term return of global stocks and 4% for long-term inflation, the return above inflation was about 6%. Currently, inflation is below 2%. Assuming inflation reaches 2% in the future, a consistent real return of 6% would pull estimates down to 8%.

Valuations are also pushing our expectations for future returns lower. At 21x earnings over the past 12 months, the S&P 500 looks a bit more expensive than normal. Valuations can act as a restrictor on the pace of returns. If you think markets are going to rally more than 30% again this year, you may be right, but we suggest you curb your enthusiasm.

Disclosures:

This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.