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Concerns about the coronavirus have triggered extreme market volatility in recent weeks. While concerns over health and safety are of paramount importance, investors are also challenged by the uncertainty surrounding the economic impact of the virus and how — or whether — they should adjust their portfolios. With that in mind, here are three things to consider going forward.

Although this is a unique event, history can be a guide.

This is officially a bear market with S&P 500 down -30% from peak-to-trough, as of March 16, 2020, according to Bloomberg (see Figure 1). It has been one of the fastest bear markets ever based on ratio of drawdown-to-duration (see Figure 2). Throughout this period, exchange traded funds have provided investors with an effective tool to allocate capital, trade positions and help manage risk.

However, investors should consider remaining patient and constructive. Historically, forward returns after a market bottom have been very strong, with a +22% average return in the next six months (see Figure 3). This underscores the importance of staying invested even during market drawdowns.

Figure 1: S&P 500 Index sell offs

Figure 1: S&P 500 Index sell offs

Source: Bloomberg, as of March 16, 2020.

Figure 2: COVID-19 is one of the fastest bear markets we’ve seen (speed = peak to trough decline/duration)

Figure 2: COVID-19 is one of the fastest bear markets we’ve seen (speed = peak to trough decline/duration)

Source: Bloomberg as of March 16, 2020.

Figure 3: History of S&P 500 drawdowns

Forward returns
1962: Flash crash -28% 12/12/1961 6/26/1962 196 8.1% 23.7% 40.0%
1966: Fed tightens credit -22% 2/9/1966 10/7/1966 240 19.5% 26.4% 24.2%
1968: Recession -36% 11/29/1968 5/26/1970 543 21.7% 39.2% 43.7%
1973: Oil embargo -48% 1/11/1973 10/3/1974 630 26.1% 44.6% 62.8%
1980: Volcker hikes fed funds -27% 11/28/1980 8/12/1982 622 32.1% 56.3% 61.0%
1987: Black Monday -34% 8/25/1987 12/4/1987 101 20.3% 17.3% 38.3%
2001: Dotcom Bubble -48% 9/1/2000 7/23/2002 690 14.5% 7.6% 32.9%
2008: Global Financial Crisis -57% 10/9/2007 3/9/2009 517 33.2% 64.0% 64.8%
2020: COVID-19 -30% 2/19/2020 - 29 - - -
Average -37% 396 22% 35% 46%

Source: Bloomberg. As of March 16, 2020. Note: Drawdowns are calculated over a rolling 2 year period. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

A large economic impact, but not expansion ending.

We expect a large and sharp economic impact from the Coronavirus outbreak, but don’t see this as an expansion-ending event, as long as a pre-emptive and coordinated policy response is delivered (see Market plunge: This is not 2008). We recently moved back to neutral across equities, credit, government bonds and cash.

The Federal Reserve delivered a historic 100 basis point (bps or 1.00 percentage point) rate cut on March 15th, alongside $500 billion of Treasury purchases, $200 billion of agency mortgage backed security purchases, and open market operations (OMO) conducting repo at 0% to support the functioning of markets after liquidity concerns contributed to risk-off sentiment last week. We think that a coordination between monetary and fiscal policy is required to navigate out of this market shock effectively (see Time for policy to go direct). Absent this policy response, there is a risk that balance sheets will not recover — especially for small and medium-sized companies — and this could have a sustained impact on the global economy.

Our view is also based on an expectation that the coronavirus outbreak will reduce in severity, with effective containment measures helping to limit transmission and economic disruption. If the virus proves to be a more persistent global health issue, adding strain to healthcare resources and having long-lasting material impacts on supply chains and consumer demand, we would see a heightened risk of a global recession.

Consider focusing on four areas:

Consider adding defensive exposure. We prefer building portfolio resilience through the quality and minimum volatility factors, U.S. Treasuries and gold. With Treasury yields hitting all-time lows, long duration fixed income exposures have acted as a solid hedge for portfolios to help offset equity market volatility.

Large caps have outperformed small caps during recent market selloffs as they are less sensitive to sudden changes in domestic economic activities and small caps typically have inflexible cost structures. The Russell 1000 index has outperformed the Russell 2000 by more than 1200 bps.1

In the factor space, the MSCI USA Minimum Volatility Index has outperformed the broader S&P 500 index by more than 400 bps YTD. Interestingly, momentum has been the best performing factor this year.2

Don’t forget International investing. The China A Shares index has held up relatively well this month despite the global equity selloff and is the best performing major equity benchmark year-to-date, down -12.2% while the broader MSCI EM Index benchmarks have fallen -31.3%.3

Two factors have been supporting Chinese equities: strong monetary and fiscal easing measures, and data suggesting that coronavirus cases may have peaked in China. The People’s Bank of China (PBOC) has also continued to support liquidity in markets, with a further 100B yuan injected ($14.3 billion) via the one-year medium-term lending facility, following the March 13th announcement of a Reserve Requirement Ratio (RRR) cut of 50-150 bps.

Economic data is beginning to show the first quarter impact of the coronavirus outbreak, but we see monetary and fiscal policy supporting a growth rebound and remain positive on Chinese assets in the long term.

Look below the index level to Industries. The coronavirus outbreak appears some way from peaking in the U.S. and we therefore remain cautious on U.S. assets in the near term. Easing measures and reduced political risk could prove supportive for U.S. industry exposures on a relative basis.

Sectors and industries with strong fundamentals and secular trend support performed better in this round of selloffs. For example, large cap technology is still one of the best performing sectors YTD despite supply chain disruptions, outperforming the broader S&P 500 by nearly 500 bps this year.4

In past U.S. election cycles, markets have tended to react most strongly towards the end of the campaign. Consider health care industries that have benefited from reduced regulatory risks, government funding and rising demand for medical supplies.

Consider environmental, sustainable and governance (ESG) investing. Investors looking to re-enter markets may want to consider ESG vehicles to rebuild strategic equity and fixed income exposures. ESG strategies broadly tilt towards companies with high profitability and low levels of leverage; more profitable companies with solid balance sheets may be better positioned to focus on mitigating ethical issues and introducing sustainable practices than their less profitable peers.