After a strong calendar year 2019, the S&P 500 reached its most recent all-time high on February 19, up nearly 5 percent since the year began. Now, a week later, the global equity markets have fallen nearly 14 percent and yields on 10-year Treasuries are below 1.17 percent due to the growing and unpredictable threat of the Coronavirus (COVID-19). Although the market moves of the past week have put investors on edge, it is important to remember that corrections are a fundamental part of market cycles.
Indeed, periods of sudden and sharp volatility are not uncommon. Events such as the U.S. debt downgrade in 2011, the Eurozone sovereign debt crisis in 2010-12, China's sharp slowdown in 2015-16 and more recently, global trade wars in 2018 all caused investors to sell risk assets. Ultimately, however, these events did not end the longest equity bull market in history. And in each case, the most prudent response by investors was adherence to strategic policy. Today is somewhat unique, however, in that COVID-19 is a global challenge that is unfolding for reasons independent from financial markets and economics, making it more difficult to predict and to price. Nevertheless, given what we know right now, we see no reason to take drastic action. Rather, we believe staying disciplined with regard to investment policy and strategic asset allocation targets is the best course of action here, too.
As investors, we remain focused on what impact COVID-19 may have on the global economy over the short and the longer term, and how this could influence investment returns. Specifically, we are watching the following:
- global growth;
- central bank policy
We already know that the spread of COVID-19 will result in a reduction in global growth expectations in the near term. One of the data points we follow within our macro dashboard, the OECD Total Leading Indicator index, showed that growth had already begun to slow below long-term trend over the past year. If the virus continues to expand globally, we see slowing growth moving to flat to slightly negative growth in the U.S. vs. 0.8 percent growth globally.
Monetary policy could become more accommodative as the U.S. Federal Reserve and other global central banks are expected to cut interest rates to support economic growth. The market is now pricing one rate cut from the March Fed meeting, two cuts by June, and three cuts by the end of 2020. Whether stimulative monetary policy will be successful remains to be seen, however, as policy rates are already at very low levels across the developed world. In addition, lower interest rates are unlikely to spur economic activity if people are unable to report to work or are avoiding public places such as shopping centers. We believe accommodative monetary policy would be most effective once there are clear signs of virus containment and a return to normal daily routines.
Although the outlook for corporate earnings is more uncertain, fundamentals remain largely intact, particularly in the U.S., and we do not believe reducing equity allocations is warranted at this time. Currently, we remain benchmark neutral in our regional equity exposure. We recognize that non-U.S. equity valuations are much cheaper relative to the U.S., but we would first look to see a recovery in fundamentals and earnings growth internationally before contemplating a change to geographic weightings.
Turning to our private investments in China, we are happy to report that our Beijing staff remains healthy and unaffected as do the staff at the managers we invest with. As expected, the investment pace has slowed given travel and other restrictions. We are actively communicating with managers currently and will be closely monitoring the 4Q2019 and 1Q2020 financials for any sign of material impact to our private capital funds. Currently, our managers are focused on supporting their portfolio companies, while exploring new opportunities arising from the outbreak, such as online education, online medical counseling and healthcare services. Not surprisingly, the healthcare sector in venture capital has experienced a short-term boost and could benefit in the medium and longer term, particularly pharmaceutical companies and online diagnosis platforms.
We expect volatility to remain pronounced in the coming days and weeks as the market digests news flow on the virus and the global economy. It is too early to determine whether this will be a short-term market event or a longer-term global economic disruption. At the end of 2019, we made the decision to reduce a modest overweight position in hedge funds in order to increase optionality in advisory client portfolios and increase liquidity. Our intention at the time was to redeploy that capital opportunistically. We will continue to watch the economic data releases to better understand the depth and breadth of the impact the virus is having on global markets. Notwithstanding a new development that could impact the structure of the global economy for an extended period, our response is likely to be one of staying the course. Nonprofit investors with perpetual pools of capital should be able to weather challenging market events and their impact on returns over the short-to-intermediate term. We believe the focus should be on maintaining the flexibility to adjust portfolio positioning in response to new developments.