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With the threat of additional cases of coronavirus globally, and investors adopting a risk-off mentality over the past week, it is important to take a step back and put these recent events in context. The equity markets have enjoyed strong, above average gains over the last several years, supported by both monetary and fiscal stimulus on a global scale. U.S. consumers have fueled services and consumer goods companies to grow and thrive, allowing for hiring that has pushed the unemployment rate to historic lows. While the trade tensions with China weighed on the global manufacturing economy, it was not enough to derail positive GDP growth, and optimism was rising coming into 2020 that manufacturing would be back on track, providing a boost as we moved through the year. We are now grappling with a sharp deceleration in output, particularly from China, as global supply chains are disrupted by production halts, and the threat of greater disruption resulting from broadened travel restrictions and wider containment measures. Couple this with uncertainty around the means of transmission and the timing of a vaccine, and one can understand the sell-off we have experienced over the last several days.
Putting the magnitude of the declines in perspective, the S&P 500 index now sits -12% from its most recent (all-time) high, with the losses experienced in the last week wiping out what had been a positive start to the year; the index as of Thursday’s close was down almost -8% in 2020. Stocks outside of the U.S. have performed modestly better in the recent decline, with developed international equities, as represented by the MSCI EAFE index, down -6.3% year-to-date, and the MSCI Emerging Markets index down -6.4%. For their part, high quality bonds have experienced meaningful inflows as investors have fled into safe haven assets; this has resulted in a 10 year Treasury yield which fell from 1.88% to 1.16% over the course of the first part of 2020. High yield issues, not surprisingly, have fallen, but while spreads have widened, we have not experienced the forced selling which created historically wide spreads during the financial crisis. And the U.S. dollar, expected to weaken over the course of this year, is up +2% versus a basket of global currencies.
So where do we go from here? As mentioned above, we do not yet know what the magnitude of the economic impact on the U.S. economy will be, with estimates ranging anywhere from a minimal impact of 25 basis points to over -1% in negative GDP impact in the first and second quarters of 2020. Companies have been hesitant to quantify the potential impact to their earnings, instead acknowledging only that guidance is difficult to deliver given the evolving situation. Response to a slowdown could come in the form of an interest rate cut (or cuts) by the Federal Reserve, although the relative effectiveness of a rate cut to remedy a drop in global demand is questionable. And fiscal stimulus in China is almost certain, and Germany and the United Kingdom could follow suit, particularly if the virus spreads to those countries in a meaningful way.
As for how we are allocating our portfolios, we have not deviated from our positioning coming into the year. Based on our economic assessment, and the relative valuations available across the major asset classes, we are slightly underweight to our long term target in equities, preferring large cap companies both here and abroad over small cap companies. We increased our allocation to fixed income last year, and remain at a neutral weight at this juncture, although we acknowledge that adding to bonds at these levels will be done thoughtfully as we expect yields to move higher from these levels over the next several months. Finally, we increased our allocation to differentiated strategies such as preferred stocks, real assets, and alternative strategies over the back half of 2019, and we believe that these allocations will help to provide some insulation amidst continued equity volatility.
As your trusted advisor, we understand that you may have questions or concerns that go beyond what we have discussed in this note. We welcome the opportunity to review your financial plan, in order to ensure that it is still aligned with your long term goals, and your risk tolerance, as volatility in markets can allow for a level of introspection that goes beyond the academic exercise which underlies the planning process. As always, we encourage you to reach out to your Wealth Advisor with any questions you may have in these turbulent times.