It’s getting harder and harder to ignore the potential financial fallout from the novel coronavirus (nCoV-2019) outbreak underway. Some of this fallout was evidenced in the global stock selloff on Friday and futures (as of this writing) point to a weaker start at Monday’s open. Indeed, the concerns surrounding the ongoing spread of nCoV is likely to weigh on market sentiment for weeks. But why is nCoV relevant from a financial perspective?
Well, in our opinion, the quickening spread of the coronavirus illustrates how fast unexpected events can alter near term economic assumptions and upend best laid financial plans, notably at a time when the U.S. economy is primed for a recession. Amidst the potential for outbreak-related market and economic volatility, we provide a few recommendations that households can use to increase their financial preparedness as Wall Street and Main Street worries potentially intensify in the weeks ahead.
It’s going to get worse before it gets better
Coming into the year we expected several key events (like geopolitics, central bank policies and elections) to raise uncertainties and simply make getting ahead in life financially harder for some households in 2020. In last week’s post, we wrote about one strategy investors can use to increase portfolio returns as economic growth falls and market volatility picks up.
We’ll talk about some additional financial strategies that can be used to help mitigate uncertainties later, but before we do that we need to highlight two key reasons why we think the coronavirus is important to consider from a financial perspective.
First, reports on the spread of nCoV and the subsequent global response suggest that the outbreak is likely to get worse before it gets better. While Beijing has stepped up its efforts to quarantine suspected infected zones, other governments, like Russia and Singapore have sealed their borders with China while countries like the U.S. have put up their own restrictions on travel to-and-from China amidst the outbreak.
This comes as the World Health Organization (WHO) declared a “public health emergency of international concern” last week. To be sure, the rapid spread of nCoV compared to other coronaviruses like SARS suggests that the current outbreak has the potential to only get worse before it gets better. Barring a rapid de-escalation of current events, what this likely means is that discretionary international travel is poised to slow in the coming weeks not just into and out of China, but potentially among countries that are seeing infections rise and more importantly as deaths outside of China begin to increase in number as well. This brings us to our second point.
Figure 1: U.S. recession risks are elevated in 2020
U.S. economy primed for a slowdown
The restriction on travel and closing of borders could very well aggravate a downturn in a U.S. economy already primed to slow this year. As we’ve written about in past posts, we believe that the risks related to a U.S. recession remains elevated this year as business spending and hiring activity declines. And while discretionary household spending supported the U.S. economy in 2019, last week’s fourth quarter GDP print remained soft even as the Fed primed its quantitative easing pump during the last three months of the year.
And from this perspective, we expect corporate earnings growth to remain subdued in 2020, challenging already stretched financial valuations. In other words, risky assets have broadly had a strong run in recent months, but now appear expensive on historical basis. And this fact increases the chances that already expensive risky assets could come under increased selling pressure as some sudden shock causes the recent bullish euphoria in the markets to fade. Today, the economic implications of nCoV are only likely to complicate the current market backdrop.
Assuming the uncertainty surrounding nCoV is not reversed quickly, there is a potential that growth in the world’s second largest economy (China) could slow to a rate below current year estimates, contributing to broadly weaker global growth in 2020. This could happen if a further spread of the nCoV outbreak expands quarantine zones and halts economic activity across Chinese provinces as the movement of people and goods grinds to a halt.
What’s more, demand for goods and services globally are likely to fall as people stay home and consume less, impacting exports of goods and services in affected regions and slowing commerce between China and its key trade partners. For the U.S., such uncertainties are likely to only galvanize the willingness of business leaders to postpone discretionary hiring and spending this year. While it is still too soon to tell how the U.S. economy would be affected, the risks related to a U.S. recession are likely to increase in a scenario where global trade declines, business hiring and spending falls and consumers stay home. This leads us to our point about financial preparation.
Coronavirus: how to prepare financially
Without being overly alarmist, we believe that it is important for households to use current events surrounding the novel coronavirus as a reason to take a few steps to ensure financial preparedness as economic and market volatility rise in the coming weeks. This is important because as the economy slows, plentiful jobs may become harder to find when unemployment rises and the ability to borrow money becomes harder as banks tighten lending conditions. So, what steps can households take to increase their financial preparedness?
First, we recommend households look for ways to increase net cash flows. This includes reducing discretionary (or non-essential) spending and finding ways to advantageously use today’s low interest rate environment to refinance high-cost debts. We also suggest maxing out employer-matching retirement savings contributions, putting off big-ticket spending and using excess cash flows to build up emergency savings. We believe that these steps can better prepare households for unexpected life events, particularly as labor market conditions show signs of weakening in the coming months.
Figure 2: Strategies to help financially prepare for the unexpected
Second, for investors oriented towards asset growth, we recommend trimming exposure to higher-beta, lower quality investments and broadly ensuring that aggregate portfolio holdings across all investment accounts reflect long-term goals. While volatility exposes risks in the markets, it is also likely to present opportunities. And this is one reason why we believe that investors should rebalance portfolios, not only to align allocations with long-term goals, but also to generate cash that can be deployed opportunistically as market volatility creates favorable buying prospects.
Finally, for households preparing to take distributions from their investment, we recommend rebalancing accounts to long-term investment objectives and reduce unnecessary risk taking. As we pointed out last week, we investors can increase overall returns (without increasing risks) by trimming unnecessary expenses in their portfolios. Further, we recommend ensuring that cash positions are adequate to meet 6-12 months of living expenses. This is intended to avoid forced selling at depressed prices when market volatility increases.