Monetary and fiscal authorities will likely respond with further stimulus, both to fund efforts to combat the virus and to bolster demand more broadly. Fiscal stimulus in the form of tax cuts outside the United States could soften the impact of the slowdown. Meanwhile, on Friday, Jay Powell released a very short statement noting that the Federal Reserve is “closely monitoring developments (related to the coronavirus) and their implications for the economic outlook” and that they will “…act as appropriate to support the economy.” This would seem to suggest high odds of a rate cut at their March 17-18th meeting, if not before. It should be noted that a rate cut would be very unlikely to bolster economic activity. However, it could further diminish the attractiveness of bonds and thus help support the stock market.
It is also not clear what any of this will mean for U.S. politics.
Following a big win in South Carolina, former Vice-President Joe Biden has momentum going into Super Tuesday when just over a third of the pledged delegates to the Democratic convention will be chosen in 14 states. A potentially big win in California should leave Bernie Sanders as the delegate leader. However, other contests are likely to be closer and, given the proportional allocation of delegates among candidates receiving over 15% of the vote (That is, 15% statewide for about a third of the delegates and 15% by congressional district or state senate district for the other two-thirds), the nomination race should still be very competitive following Tuesday, particularly if other moderate candidates drop out.
Who the Democrats choose as a standard-bearer in November will be important not just in winning the White House but in the potentially even more difficult task of holding onto the House of Representatives and regaining control of the Senate. Any sense that the Administration is bungling the response to the outbreak or an actual U.S. recession would likely reduce the President’s chances of being re-elected.
And so finally, what does all of this mean for investors?
It is important to acknowledge that both uncertainty and economic weakness are negatives for the stock market and positive for bonds. However, market movements in recent days have arguably priced much of this in. In particular, the P/E ratio on the S&P 500 has fallen sharply and is now just 16.6 times next year’s earnings compared to a 25-year average of 16.3 times while the yield on a 10-year Treasury bond has fallen to an all-time low of 1.13%.
While it is impossible at this time to judge the full extent of the damage that will be inflicted by the virus, it is more reasonable to consider how long that damage will last. Even if the virus were to spread much more generally, those who are either less nervous or less vulnerable to its effects would likely try to get back to normal. The distribution of an effective vaccine in the next year or 18 months would obviously help the world economy back on its feet, while even the news that such a vaccine was being produced should help global stock markets.
No doubt stock market valuations were on the high side before news of the virus worsened and this may have contributed to the size of last week’s selloff. But it is important to once again consider the meaning of valuations. The only thing that makes a stock valuable is future earnings. If the price on a stock is 16 times the earnings expected over the next year, then that means that next year’s earnings account for just 1/16th of the value of the stock. The other 15/16ths of the value does depend on earnings—but not next year’s earnings. Rather it depends on earnings in the following year and the year after that and years and decades into the future.
Looked at from this perspective, while 2020 is the year of the virus, the value of a portfolio will largely be determined by what comes next. For investors, this means looking at how well companies and sectors can weather what may be a difficult year but also how they can perform when the virus is no longer an important issue shaping the economic outlook.
David Kelly is chief global strategist for JPMorgan Funds.