Thoughts on a Rocky Monday

US and global stocks started this week on a sour note, as fears over the coronavirus’s spread into South Korea and Italy shook sentiment. The S&P 500 finished Monday down -3.4%, with most overseas markets similarly weak.^[i] Coverage of the disease leads virtually every financial news website, which are also teeming with analyses from economists, politicians, analysts and pundits. Generally, their take is negative, operating on the assumption markets are just now catching on to the coronavirus’s potential fallout—and arguing more downside lies ahead. But this rocky Monday doesn’t change our view: Sentiment swings can always hit stocks short term, but the coronavirus is highly unlikely to upend this bull market.

First, some perspective seems in order. While Monday’s swings were large, it is worth remembering that the S&P 500 stood at all-time highs last Wednesday.^[ii] Global stocks? Eight trading days ago (February 12).^[iii] Since their respective high-water marks, US and world stocks are down a little over -4% each. That is the definition of a short-term dip—of which there have been dozens during the nearly 11-year old bull market that began in March 2009. For example: Last year had two nearly -6% downdrafts (April 30 – June 3 and July 24 – August 15) and one very similar to today’s size in September.^[iv] We aren’t suggesting you should anticipate 2019’s hugely positive returns this year, just that even in great years, short-term volatility is normal.

As we often write, bull markets end one of two ways: Atop the wall of worry when widespread euphoria makes expectations impossible to meet; or when walloped by a huge, unseen negative. Neither of these seems likely today, in our view.

The notion markets were blissfully ignoring the virus until Monday implies markets were complacent or euphoric. But if either were true today, we would expect investors to be broadly dismissing coronavirus—and poking fun at the bearish narratives dotting media. Instead, it seems to us most are reacting fearfully. The financial press aren’t poking fun at bears these days—our review of media from Hong Kong to Houston is littered with worried coronavirus coverage.

While few sentiment measures covering February are out yet, January data don’t hint at broad euphoria entering the month. Margin debt wasn’t spiking—it has actually declined recently. The University of Michigan’s Index of Consumer Sentiment has been more or less flat for over three years.^[v] About the only sentiment gauge covering February, the American Association of Individual Investors’ sentiment survey, revealed 40.6% of respondents said they were bullish in last week’s tally.^[vi] That is a hair above the 38.1% average since this survey began in 1987—reflecting optimism, but far from euphoria, in our view. It is also down from 45.6% the week coronavirus became a global news fixation, hinting the disease has dinged sentiment some.

As for a wallop, we stand by our commentary from late January, when the illness first made waves. While they may ding short-term sentiment, there is no history of even far-larger illnesses than this coronavirus hitting markets longer term. Market theory suggests this one isn’t likely to prove different. Neither SARS, MERS nor Swine Flu caused material downside. While data from the early 20^th century are dodgy, the Dow Jones Industrial Average rose in both 1918 and 1919, while the Spanish flu—which killed 50 – 100 million people globally—raged. Global Financial Data’s historical reconstruction of the S&P 500 suggests US stocks rose 25.5% and 20.7% those years.^[vii]

This isn’t to say there is no economic impact from pandemics. But stocks are efficient discounters of widely known information. They see and adjust to information and opinions about the effect of the illness near-immediately. They also realize any interruption is very likely to prove temporary—and they move on. None of that means there won’t be short-term swings as headlines evolve. As we often say, volatility can happen for any reason or no reason at all. But negativity doesn’t seem likely to prove lasting, in our view.

Ultimately, we are a handful of days removed from record highs and have seen a not-uncommon level of negativity since. Even if the cause was something we thought more likely to drive a bear, we would still argue it is far too soon to take action. This close to a high, there is too much risk of getting fooled out of stocks by a correction or just near-term wobbles—only to watch markets bounce back right past you. A humble investor, in our view, exercises patience at a time like this.

So yes, recent weakness is sharp. It is uncomfortable for many, no doubt. It is accompanied by fearful headlines. But all these traits accompanied many of the fears rotating through media over the past decade-plus of overall rising stocks—and they are common features of corrections and sentiment-driven moves that typically pass fast.