What to expect from ­coronavirus-related market swings

The coronavirus (COVID-19) outbreak in China and passage to multiple locations across six continents has captured everyone's attention, and rightfully so as white-coated scientists proclaim a probable "global pandemic" and tell us to prepare for major disruptions in our lives. Investors are reacting to the news flow as it portends a slowing of economic activity. Equity markets and commodity prices declined in January on the initial reports. Then, a perceived improvement in the rate of new cases in China in early February brought a bounce. However, news of the virus spreading into other countries re-ignited fears of a pandemic-caused economic slowdown and the selloff intensified - the decline in recent weeks has been dramatic. Once again, a good old fashion stock market correction has arrived. One thing that the current environment illustrates well is that market-moving events are usually unpredictable and unexpected. That's to say that what we expect is usually already discounted in the market. However, a viral outbreak is not something you'll see in most economist models for the future. Now that it's here, assuming an imminent economic decline is quite reasonable in light of the travel bans, economic disruptions and publicity around the outbreak of COVID-19. Given the generous valuations in several leading sectors of the stock market, the recent declines are similarly logical due to declining earnings expectations. ----- How should we think about these market moves? Historically, corrections (declines) in the stock market of 10 percent or more happen about once every year. As we entered 2020, there had been six 10+ percent corrections since the market advance began in 2009. The 19.9 percent decline in the fourth quarter of 2018 was the worst. Over the past 70 years, there have been nine periods when the market declined by 20 percent or more (with the average decline being 33 percent). These declines tend to be steep and quick, on average 14 months from the market peak to the subsequent trough. Trying to time the beginning and end of such movements is a fool's game. However, understanding how they unfold historically can help with perspective on an appropriate long-term asset allocation and strategy. We should expect corrections and bear markets will be a part of the experience. What we also observe is that the stock market typically begins to rise powerfully even while economic data is still negative. In fact, there is never a time when the economy and investment markets are free of worry. If you wait until corporate earnings are back on the upswing, you will have missed much of the move. Simple observation of history tells us that "bad stuff happens" to the economy and corporate earnings periodically, but corporations are adaptive entities, able to adjust and change in ways that have produced economic gain over time. With this understanding, the ability to withstand the periods of "bad stuff" is strengthened and allows us to be patient through the difficult times. In the current difficulties, some silver linings are visible. Oil and gas prices have declined dramatically as a result of lower demand estimates. Declining energy prices are a powerful boost to consumer pocketbooks. In addition, interest rates have declined - another boost to consumers and corporations. Finally, China and other governments have proposed economic incentive programs designed to support their home economies. These benefits are likely to enhance economic activity once COVID-19 outbreaks begin to moderate. ----- What next? I don't want to minimize the potential challenges that COVID-19 presents to our health, the economy and investment markets. They are real. However, I'll also note this is not a brand-new phenomenon; we've seen and dealt with epidemics like this before. In recent cases of viral outbreak, the stock market recovered and posted good gains as the episodes evolved. Their depressant effect on economies was transitory; eventually, demand for goods and services reset to normal levels. This can be seen as we look at S&P 500 returns in the calendar years following other viral outbreaks: +28.7 percent in 2003 following the SARS outbreak, +15.6 percent in 2010 following the H1-N1 outbreak, and +32.9 percent in 2013 following the MERS outbreak. Will COVID-19 be the same? Or better? Or worse? Most of us are currently experiencing what behaviorists call the "recency bias" or "anchoring," where we believe that the most recent episode is more important (or worse) than the parade of past data. This bias crept into our thinking as 9/11/2001 evolved; similar thoughts arose in the depths of the 2008-09 financial crisis. For investors, responding to these feelings is at the root of the most damaging behavior - selling low and sitting on the sidelines waiting for the "all clear" signal. History has shown that an "all clear signal" never comes. In good times, and particularly in difficult times, adhering to a rational, long-term asset allocation plan is essential to long term success. For COVID-19, holding fast to your plan is the best medicine. ----- Michael Jones is Chief Investment Strategist at High Probability Advisors. Published: Thu, Mar 12, 2020