After setting new record highs on February 19, U.S. equity markets experienced a rapid and sharp decline through the end of February. The major stock indices entered correction territory last week, which means a decline of over 10% but less than 20% from a recent peak. As of February 28, the S&P 500 index was down 13% from its peak. Global equity markets also had sharp declines. Commodity markets sold-off as well. For example, West Texas Intermediate (WTI) crude oil fell 16% between February 19 and 28. As so often happens during risk asset sell-offs, safe haven assets such as government bonds have rallied. The benchmark 10-year U.S. Treasury bond yield dropped (and price rose) to an all-time low of 1.13% on February 28. The 30-year Treasury bond yield dropped below 2% for the first time on record last week and ended February at 1.65%. With this type of volatility and the significant negative returns in a short time period, investors are understandably anxious about the outlook for financial markets.
Fears about the Coronavirus (COVID-19) and its potential economic impact shocked investor sentiment and drove the global sell-off. In attempts to contain the virus, travel and trade throughout China has been restricted leading to permanent loss of business for certain companies, temporarily loss of business that could be recouped later in the year for other companies, and disruptions to the supply chain for business around the world. As reports came out of new cases people infected with the virus in the Middle East, Europe, South America, and the U.S., worries about the negative economic impact spreading beyond China increased. As a result, market participants increasingly moved out of risk assets, such as equities, and into safe haven assets such as government bonds and cash. The heightened demand for government bonds drove yields lower, which triggered program trading selling, which drove equity prices even lower.
It is too early to tell what the ultimate economic impact of COVID-19 will be as the situation is changing daily. While, the number of new cases outside of China is likely to continue to increase in the coming days, the economic disruption is expected to be a short-term event since governments and medical professionals are working diligently to contain the spread of the virus. In a bit of good news, in China where the outbreak began in December, the number of new cases has been declining for days and stores and factories are reopening. Financial markets do not like uncertainty, which is leading to heightened volatility. Even though monetary authorities around the world have announced they stand ready to take measures necessary to support their economies, it is likely that the high level of market volatility will continue until there is evidence the spread of the virus is stabilizing.
Vogel Consulting continues to remind you that it is best to avoid emotional reactions during times of extreme volatility and to rather focus on long-term investment objectives. We continue to monitor events and speak to various money managers about their assessment of market events and investment opportunities. We have been recommending for quite some time that families keep at least a year of cash on hand to be in a position to ride out market volatility. Our asset allocation recommendations have not changed. They are constructed with a long-term focus. We will notify promptly if there is a change to our recommendations.