Saturday, February 29, 2020

Update: The Uncertainty Surrounding the Coronavirus, the Economy, and Your Investment Portfolio

A Special Update from Scholar Financial
By Ron A. Rhoades, JD, CFP®
February 28, 2020 – 9:00 p.m. CT

COVID19, also known as the “Coronavirus,” has dominated the news over the past week. As have the news that stock prices are down substantially, many bond yields are at historic lows, and the global economy may be facing a recession. Permit me to provide some perspective on recent events, first addressing Coronavirus itself, then the effect of the virus on the economy, and then the impact on your investment portfolio.

(This is the newsletter sent to Ron's clients. It is reproduced here to provide other advisors with insights.)

PART ONE: ABOUT THE HEALTH RISKS POSED BY CORONAVIRUS.

This virus is highly transmissible.
This virus is unlike SARS, Ebola, and MERS. And it is unlike the seasonable flu virus, which there are four major types. Many people infected with the Coronavirus (COVID19) may show no symptoms. No fever. No respiratory distress. Yet, these people can still spread the virus to others. And any infected may be able to spread the virus for 14-21 days, whether they show symptoms or not.
Transmission of the Coronavirus is relatively easy, and is similar to the ease of transmitting the common cold. An infected person just breathing in and out will generate small infected droplets, which float through the air. So, those passing within several feet of an infected person, or touching a surface upon which those infected droplets have fallen, will be exposed to the virus. And, being a new virus, no population possesses a large percentage of people who have previously had the virus – thereby having developed antibodies to it within their systems.
Also, the Coronavirus does not kill its victims quickly. Ebola had a very quick and high death rate. In one sense (although it seems like it should not be stated) such a high quick death rate is a “positive.” Those infected with Ebola showed symptoms sooner and died quickly, thereby posing no risk to others to further transmit the disease. In contrast, a carrier of the Coronavirus can infect many people, and the mortality rate (i.e., rate of death) is far less.
Unfortunately, the characteristics of Coronavirus (easy transmission, few or no symptoms in some of those infected, and lower death rates) make this the “perfect” recipe for broad transmission of the disease.
Up to now the major way of stopping transmission has been the imposition of quarantines, often over large regions or entire countries. Sporting events, conferences, and other large public gatherings have been shuttered. In many instances, workplaces – including restaurants, offices, and manufacturing plants – have been temporarily closed. Restrictions on travel within and to affected the regions have been imposed. Despite this, Coronavirus has spread to over 50 countries as of the date of this writing. There is also talk of cancelling the 2020 Summer Olympics in japan due to the virus.

Mortality risk might be quite high – especially for older persons.
For those who are infected with Coronavirus, the rate of death (i.e., mortality rate) might range from 0.1% of those infected (1 out of a thousand) to 5% (1 out of every 20 infected). The likely actual figure is around 2%, but even that number will vary significantly depending upon the age and health condition of those who are infected, as well as the robustness of the health care system they belong to.
A recent study from the Chinese Center for Disease Control and Prevention analyzing 72,314 Coronavirus cases in mainland China found that while about 80 percent of cases are mild, the virus poses the greatest threat to elderly people with preexisting health issues. The study collected data from confirmed patients through Feb. 11 and is one of the largest such samples in a study of its kind. 
The research showed that patients older than the age of 80 had a 14.9 percent chance of dying after being infected, while those in their 70s were found to have an 8 percent chance of death. Patients in their 50s were about three times more likely to die than patients in their 40s, at a rate of 1.3 percent. 
Patients ages 10 to 19 were as likely to die as patients in their 30s, at just 0.2 percent. The study did not report any deaths in children younger than 10, who represented less than 1 percent of patients. 
The risk of dying dramatically increased among patients in their 70s and 80s as many in this age group are more likely to have preexisting health conditions. For example, Coronavirus patients with heart disease had a 10 percent mortality rate, while those with diabetes had around a 7 percent mortality rate. 
Men were also found to have a 2.8 percent fatality rate, versus 1.7 percent for women, according to the study. The overall fatality rate in China was 2.3 percent.

What is the danger in the United States?
This is the great unknown. As of the time that I write this, there were only 16 confirmed cases in the United States (not counting the 44 cases resulting from those repatriated from a cruise ship that was docked in Japan). As I was writing this, a second case in northern California was confirmed, and this case appears to be a second “community transmission” – i.e., transmission from someone who did not travel nor knowingly came into contact with a traveler. (UPDATE: Another case of unknown origin – indicating “community transmission” – has occurred in Washington State, and a fourth case is believed to exist in Oregon, as of Saturday morning, Feb. 29th.)
At the time I am writing this, across the United States there have also been 445 people who were “Persons Under Investigation” (“PUI”) but also tested negative for Coronavirus. Hundreds more persons remain “PUI.”
U.S. health officials expect more cases of the Coronavirus in the coming days and weeks. The key question is … will a “break-out” occur, in which many new cases appear in a town, city, or region? And, if such a break-out occurs in the United States, will quarantines and travel bans be imposed, enforced, and effective?
There is hope. Better tests for Coronavirus have been developed, and these tests are being made available to more health care centers around the U.S. But, these tests take time – often about 10 hours after the sample is delivered to the lab for the test results to be obtained. The supply of tests is limited now, although the number available to health care centers and hospitals is rapidly increasing.
Also, the U.S. doesn’t have a “test on the fly” – wherein people arriving at a particular destination could be tested before being admitted. With the “quarantine period” necessary to ensure that a person who may have been exposed ranging from 14-21 days, it is likely that anyone who may have been exposed will need to “self-quarantine” for an extended period of time in their home. Fortunately, and unlike many countries in the world, we do have market-based solutions already in place for the home delivery of groceries and, to a limited extent, certain medicines.
The World Health Organization (WHO) just upgraded its risk assessment for Coronavirus to “very high at a global level.” This is the WHO’s highest risk level, although the WHO has not declared Coronavirus to yet be a “pandemic.” A pandemic is essentially a conclusion that most of the world’s populations will be exposed to the disease.
Another uncertainty about Coronavirus is whether new cases will substantially decrease by April, May, or June, as the weather gets warmer. As more people spend time outside in spring and summer, and schools let out for summer, we often see cases of seasonable flu decline greatly by April of each year. Will this occur for Coronavirus? We simply don’t yet know.
Another question is when a vaccine may be ready for the Coronovirus. Will it be ready by next Fall? Unlikely, say the experts. A year to a year-and-a-half may be necessary for a vaccine to be developed, tested, produced, and ready for dissemination. This means that even if the Coronovirus is “seasonal” (i.e., far less cases in late Spring through early Fall), it may return next winter.
In summary, the risk in the U.S. is – as of the date I write this – simply unknown. A great deal of uncertainty exists. 
On the one hand, it is plausible that travel restrictions, increased testing, the high caliber of the U.S. health care system (relative to other countries), and the likely imposition of government-imposed quarantines, may work to stem any regional outbreak.
On the other hand, it is also plausible that, given the limited resources of our  health care system, and the high degree of transmissibility, that a regional outbreak will occur and will then spread through most of the United States. Some health officials have called the spread of Coronavirus in the United States “inevitable,” while others have not yet reached that conclusion.


What Should I Do Now?
Should you be concerned? Yes. You should monitor the news. While there is no need to cancel travel plans within the United States at this time, you should be prepared to do so in quick order. There is no need to panic. And it is prudent to undertake some actions.
1) Seriously, wash your hands
Some of the most impactful steps to stop a Coronavirus outbreak are ones we are all aware of, but often find it hard to put into practice.
Wash your hands much more than you think you need to wash your hands, and try not to touch your face. According to the CDC, you should “wash your hands often with soap and water for at least 20 seconds, especially after going to the bathroom; before eating; and after blowing your nose, coughing, or sneezing.” If soap and water isn’t readily available and your hands are not visibly dirty, you can also use hand sanitizer.
2) Avoid shaking hands.
You should also avoid shaking hands. You should use a tissue when you blow your nose, and put the tissue in the trash. And you should avoid touching your eyes, nose, and mouth – keep your own hands below your neck, when possible.
3) Wipe down surfaces.
If you think a surface, such as a table, might be infected, wipe it down. There is evidence that coronaviruses can live on inanimate surfaces for up to nine days, but it’s not yet clear how likely humans are to be infected by touching these surfaces.
A solution that is 75% alcohol, 25% water might be best. Certain cleaning products may be effective, but there is uncertainty about the effectiveness of some of them. If you don’t have a cleaning product or an alcohol-based solution, using warm soapy water might be just as effective.
4) You don’t need to wear a face mask if you’re well, but you should if you are sick
In pictures from cities in China, South Korea, Singapore, and Japan, all of which have experienced significant coronavirus outbreaks, almost everyone is wearing face masks. That prompted many Americans to wonder — should we be doing that too? The answer is that unless you are sick, it’s not a particularly good idea. (People in Asia tend to wear face masks to avoid pollution in their cities.)
The CDC “does not recommend that people who are well wear a facemask to protect themselves from respiratory illnesses, including Coronavirus. You should only wear a mask if you are sick and a healthcare professional recommends it.”
The fact is that there is a shortage of face masks – especially of the kind that actually protect against the transmission of this virus. We need to make sure that we have enough for our front-line health care workers.
5) Get the things you’d need to manage for a long period of time – a few weeks.
Purchasing a couple of weeks supply of food you would want while home, either due to a quarantine, or being sick, is important. Don’t forget other essentials: toilet paper, cleaning supplies, laundry detergent.
We know that many stores are now delivering groceries, as well as online retailers such as Amazon. What we don’t know is whether such delivery services will continue to function should a very large outbreak occur within any specific community.
Think about what you might need to buy in the next month, and try to buy as much as possible of it now. If you are somebody who takes daily medication, you may want to have more than a month’s supply, and really, you want to have as much of that on hand as your insurance will allow you to have. Consult with your pharmacist as you may have to get your doctor to write a new script to get more than a 30-day supply.


PART TWO: EFFECT ON THE ECONOMY.
Without a doubt, Coronavirus has already impacted the world economy. Many products have components that are manufactured in China. China’s economic growth, previously projected at above 6% in 2020, will likely be quite modest instead.
The impact on the U.S. economy is … U N C E R T A I N.
I know you would like to know what will happen in the economy. But the fact of the matter is, at this point, we don’t know if the Coronavirus virus will spread widely within the United States.
If Coronavirus does not spread widely in the U.S., the growth of the U.S. economy in 2020, previously projected at about 2%, will likely be about 0.5% less. Due to supply chain disruptions, and restrictions on worldwide trade to and from countries with large outbreaks, the U.S. economy may only grow about 1.5% this year. (Of course, any economic projection – even when there is not a global health crisis – has a great deal of uncertainty – even without the uncertainty surrounding the spread of Coronavirus in the U.S.)
If Coronavirus does spread widely in the U.S., then the United States would likely possess negative economic growth for several months – enough to call the result a “recession.” However, the vast majority of the U.S. economy is not manufacturing, but services. And for many (but certainly not all), "working from home" is a solution should the coronavirus break out in that person's community.
Even if Coronavirus does not spread widely in the U.S., it might spread in other regions of the world – Japan (which has already imposed quarantines, to a degree), China (quarantines still largely in place), Indonesia, Europe, Brazil, and many other countries. As a result, global economic growth is expected to stall – although (again) there is a great deal of uncertainty as of this time.
Regardless, certain products will likely become more expensive. In particular, supplies of Apple products, some brands of computers, televisions, and other electronic products, may become quite limited. Sales of such products, often undertaken at various parts of the year, might not occur due to reduced supplies.
At the same time, other products and services might become less expensive. Gasoline prices are already falling, although OPEC could (and likely will) reduce production next week to partially counter the fall of oil prices. The cost of traveling (via airplane, and hotel stays) in many parts of the U.S. may be substantially less … for those who are willing to take on the risk of travel in these times.
I now expect the Federal Reserve to cut its target for short-term interest rates, by at least 0.50%, by July 2020. And I anticipate that the White House and the U.S. Congress may, if the Coronavirus breakout becomes severe, will try to stimulate the economy through temporary tax cuts and/or greater government spending.

PART THREE: ABOUT YOUR INVESTMENT PORTFOLIO
You are invested in the global economy, with a “tilt” in favor of U.S. stocks. You are also invested in U.S. bonds and/or certificates of deposit. 
Price Changes Year-to-Date (through February 28, 2020).
Most bond funds saw modest increases in prices since the beginning of this year, from 1% (for short-term corporate bond funds) to about 10% (for long-term U.S. Treasury bonds). In fact, over the last few days U.S. Treasury bond yields have plummeted, to record low levels. (As bond prices rise, yields fall.)
Already we have seen a dramatic fall in stock prices, around the world. Large company U.S. stocks have fallen in price about 8% since the beginning of the year, while small company U.S. stocks have fallen by about 11%.
In the U.S., value stocks have fallen more than growth stocks, making an even stronger case that growth stocks remain substantially overvalued, while U.S. value stocks are close to the mean of valuation – or in the case of U.S. small cap value stocks perhaps even somewhat undervalued.
Foreign developed markets stocks and foreign emerging markets stocks are down about 10%-13% year-to-date.
The Market Does Not Always Go Up.
As I’ve often stated, investments don’t always go up in value. There can be abrupt changes in valuations, as has been seen this past week. Such changes are unpredictable.
What will occur next week? Or next month? Or  during the rest of this year? If the news is positive about the containment of the Coronavirus (worldwide, and within the U.S.), stock prices could rebound. Some market commentators have stated that stocks have fallen further than they should have, given the small dispersion of the Coronavirus virus in developed market countries.
However, if the news suggests a greater outbreak will occur (especially in developed markets, such as Japan, Australia, Europe, and the United States), then stock prices could fall further.
Unfortunately, no one has a crystal ball. We don’t know what will occur next week. We don’t know what the news will bring. 
BUT … We Have a PLAN.
It is called your Investment Policy Statement.
Following this plan, by rebalancing your portfolio at the appropriate times, is one proven way to take advantage of the inherent volatility in the markets.
And your plan suggests these four words to follow: BUY LOW. SELL HIGH.
Keep in mind that if stock prices fall, then (generally) the expected long-term returns of stocks go up. For example, an 11% fall in stock prices implies that future average annualized returns will be 1% higher, per year, over the next 10 years.
However, economic recessions can and do affect expected returns of stocks. Not to the degree stock prices fall, but rather in more subtle ways. We all prefer a robust global economy, with steady economic growth. But economic surprises, such as the impact of Coronavirus, can and do occur from time to time. Let’s hope for some positive economic surprises in the months ahead.
Most of my clients were with me during the 2007-2009 Global Financial Crisis (also called the “Great Recession” – when stocks worldwide fell by over 50% (and in some instances more than 60%). What did we do then? As stocks fell in value, we rebalanced the portfolios, by selling fixed income investments (usually, bond funds) and purchasing additional stock funds. Then, when stocks fell further in value, we rebalanced the portfolio again (and again).
The result paid off, in the long term. By taking advantage of a substantially undervalued stock market (as of late 2008 and early 2009), my clients saw exceptional returns in subsequent years.
I suggest to you the same strategy be utilized today. I will monitor your portfolio and let you know when I believe trades should be undertaken. Each day trades are undertaken, we won’t know if the stock market will go up, or go down, subsequent to the trades. Be we do know that this strategy – following a strategic asset allocation, with targeted rebalancing, works over the very long term. It adds value to the portfolio via a “rebalancing bonus” over the very long term. 
I Am Undertaking More Frequent Reviews of Your Investment Portfolio.
I will continue to monitor and review your portfolio, and I will contact you when actions might be taken to rebalance.
I will continue to update you, periodically, about major economic developments – if and when they occur.
In the interim, always feel free to contact Cathy and myself. We are here to answer your questions, and to address any concerns you may possess, and to provide guidance.

Thank you,
Ron
Ron A. Rhoades, JD, CFP®
Financial Advisor
Scholar Financial

Client Services Director: Cathy Rhoades
    Ph: ‭(270) 904-2728
    Email: cathy@scholarfinancial.com