Market Strategy 2/18/2020

Key Takeaways

• Although it appears too early to conclude that the coronavirus has peaked, the pace and momentum of new infections show signs of ebbing.
• Businesses shuttered earlier are beginning to reopen in China, and multinational corporations with significant exposure there are guiding investor expectations lower for the near term.
• Last week’s economic data showed a tepid gain in retail sales in January, while consumer prices edged higher—an uptick that’s likely temporary, given a decline in oil and gasoline prices since then.
• With 78% of S&P 500 firms having reported Q4 results, 74% have reported positive earnings surprises with earnings up 1.3% on the back of 3.6% revenue growth.

As we go to press with this week’s publication, we can’t help but feel a sense of déjà vu with coronavirus news prominent in the headlines for another week. This is notwithstanding some evidence during last week that progress is being made by health officials around the world even as the number of cases ticks higher along with the death toll.

As of Monday evening, stateside China had reported an additional 1,886 coronavirus cases along with 98 more deaths. The total number of infections in China was 72,436 with most of the occurrences (nearly 60,000) in Hubei Province, the epicenter of the outbreak. China’s National Health Commission reported that 12,552 patients have been discharged.

The World Health Organization said that it’s too early to tell if cases are declining.

Businesses in China which had been shut down in some locations are beginning to reopen— though at a relatively slow pace. Among those reopening this week are a number of key manufacturing facilities that had been closed in China as well as casinos in Macau.

Getting back to a normal pace of activity will likely remain in the distance until significant progress is made to stem the spread of the virus. For now, what progress is made will likely come at a labored pace until medical breakthroughs emerge.

The damage to the economy of China, the region surrounding it, and to its global trading partners will take some time to assess accurately. Investors can expect multinational corporations with significant exposure to China to begin guiding down expectations of revenue and earnings growth for the near term.

Our experience as professional investors who worked through the SARs epidemic from a stateside perspective and later traveled to China in Q1:04 (shortly after SARs had peaked) is that the resilience that economies and businesses show in coming back from health crisis such as this one is remarkable. Damage sustained is usually not permanent, and the process of recovery is often faster than expected.

With China’s authorities willing to provide stimulus as needed and with world interest rates low and plenty of cash likely still on the sidelines around the globe from Q4: 18, chances are there won’t be a dearth of investors to gather the opportunities that surface.

In the holiday-abridged week ahead, a brace of economic data will shed light on the health of the US economy from the perspective of housing, manufacturing, services, employment and producer prices.

So far this year, the message from the economic data crossing the transom stateside has been conducive for a continuation of an environment that typifies our mantra, “no boom, no bubble, no bust, we’ll take it.” Such an environment has served the bull market which emerged from the crisis of 2008 and early 2009 well, allowing stocks to grind higher and climb a “wall of worry,” notwithstanding occasional pullbacks and drawdowns along the way.

Many observers tend to focus on and blame monetary policy for a world in which interest rates remain at near record low levels 11 years into a recovery and expansionary period. However, we suggest that rates are as low as they are because of counter-inflationary secular trends embedded in globalization and technology—two genies that appear not about to go back into their respective bottles anytime soon.

In the world today, easy access to affordable technology on a global basis lowers barriers of entry to competition in business, thus heightening competition worldwide. Robotics on the factory floor and algorithms in the office lower the cost of production and keep wage inflation in check. Advances in technology deliver an abundance of most commodities worldwide, keeping those prices in check.

As a result, inflation over the last decade—and at least for now—remains low, making it hard to justify yields in fixed income securities that can stick at levels high enough to offer much competition to equities as they have in other cycles.

We continue to favor equities over fixed income at the present time. Within equities, we are overweight US equities while maintaining meaningful exposure to international developed and emerging markets. From a sector perspective, we favor cyclical sectors over defensive sectors with information technology, consumer discretionary, industrials, and financial sector stocks among our favorites. For investment income, we currently favor dividend paying stocks in cyclical sectors that offer potential for total return and allow us to avoid stretching for yield.

Although the number of coronavirus cases globally stood at 72,878 on Feb. 17, the number of new cases identified each day may have begun to show signs of tapering off as China’s and other national health authorities work to contain the virus’s spread. We would also note that nearly 97% of cases are in mainland China.