Waking Up to the Coronavirus

Market Reaction: February 24, 2020


With the coronavirus spreading beyond the borders of China and into South Korea, and Italy (and potentially others), financial markets are being forced to consider the increasing odds that the virus goes from a regional epidemic to a global pandemic. We are not experts in virology, but here are some our takeaways:

Think delay, not derail. Epidemics (and pandemics) are similar to natural disasters when it comes to the economic impact. The hit is often swift and immediate, but so is the rebound. In the case of SARS in 2003, a sharp economic recovery occurred in China the following quarter….massive hit in 2Q, massive boost in 3Q. There is no guarantee that this occurs in the same fashion this time around and the recovery could be more “U-shaped” than “V-shaped, ” but there will likely be a sharp recovery eventually. It is more a question of when, not if.

The U.S. stock market had been showing little concern regarding the virus with the S&P 500 near all-time highs. With valuations somewhat stretched and investor enthusiasm quite high, markets were vulnerable to a pullback. This is not an uncommon phenomenon in financial markets. Intra-year corrections are common in any given year and often tell us very little about what the annual return will be. Outside of periods of recession, pullbacks usually provide longer-term opportunity.

We do not know how widespread or deadly the coronavirus will prove to be, but the impact on financial markets of past epidemics has often been temporary. As figure 1 shows below, the S&P 500 has experienced 6%-13% declines during past virus emergencies, but returns were often positive six months later.

Figure 1: S&P 500 Performance During and After Epidemics
Epidemic / Pandemic S&P 500
Peak-to-Trough Dates During Emergency
S&P 500 Return
(% Change from Peak-to-Trough)
S&P 500 Return
(6-Months After Outbreak)
SARS January 15, 2003 - March 11, 2003 -12.80% 8.95%
Avian Influenza January 23, 2004 - August 12, 2004 -6.90% -4.85%
MERS September 1, 2012 - November 15, 2012 -7.30% 7.69%
Ebola December 31, 2013 - February 3, 2014 -5.80% 6.05%
Zika November 6, 2015 - November 11, 2016 -12.90% -1.93%
Average: -9.14% 3.18%
This table shows S&P performance during and after past health epidemics.
Sources: Citi Investment Research and Analysis – U.S. Equity Strategy, Haver Analytics, and Citi Personal Wealth Management as of January 30, 2020. Note: Exact dates of an outbreak and containment are hard to assess. The dates used above are estimates. Past performance does not guarantee future results.

A hit to economic growth seems likely, but away from the virus, the economy does not appear to be at risk of a recession near-term. One of the best indicators of this is weekly jobless claims with the four-week moving average still well below the five-year moving average. In the past, when the four-week average moved above the five-year average, it was a pretty reliable sign that we may be near a recession. That is not the case now (see figure 2). The labor market could weaken in response to the coronavirus, but why reduce workers only to rehire them once activity picks up again after the virus stabilizes?

Figure 2: U.S. Initial Jobless Claims vs. Periods of U.S. Recession
Figure 2: U.S. Initial Jobless Claims vs. Periods of U.S. Recession
This chart shows the four-week moving average compared with the five-year moving average, highlighting their values during periods of recession. The data shows the four-year average moved above the five-year average before each period of recession. The four-week moving average is currently below the five-year average and has been for over 8 years.
Sources: Haver Analytics, and Citi Personal Wealth Management as of February 15, 2020.

Global central banks have signaled intentions to act if warranted. While several Fed speakers have recently mentioned their desire to hold policy steady, we only have to look back to the fourth quarter of 2018 when Fed speakers were also on a “set course” and then “righted the ship” very quickly. Citi’s base case remains that the Fed will not cut this year, but the recent past has shown that policy can change quickly if financial markets deteriorate sufficiently. As such, market timing is extremely difficult with rebounds often occurring as quickly as the sell-offs.

Moving forward, we expect to see weakness in U.S. economic data due to the coronavirus and would not be surprised to see markets on edge for the next several weeks (or longer). Particularly with developments on the U.S. election also rolling in. That said, we continue to see “remaining calm” as the best strategy for clients.

While Citi’s 2020 year-end target for the S&P 500 remains unchanged for the time being at 3,375, Citi Private Bank’s Global Investment Committee has decided to reduce its exposure to global equities by moving from an +3.0% overweight position to a neutral position. Those reductions in equity exposures are being offset by a reduced underweight (essentially adding to the position) in U.S. Treasuries (from -4.0% to -2.0%) and an increase in its gold position (from +1.5% to 2.5%).