Heading for the Entrances?

by Justin Lowry, CIO, Global Beta Advisors

The past week between 02/21/20 and 02/27/20 has officially become the worst week for stocks since the financial crisis.  In fact, it is the most the S&P 500 index has been down in that span of time.  The easiest solution for investors is to liquidate their positions, stuff their cash underneath their mattresses, lock themselves in their house, and wait for a vaccine.  However, is that the most prudent thing to do?  The fact of the matter is that this is neither the first global health concern or the first stock market correction resulting from it.  For context for what we are dealing with, it is best to view the most comparable health scare and its resulting market correction.  A market correction is defined as any one of the major U.S. indexes (i.e.:  Dow Jones Industrial Average, S&P 500, or Nasdaq 100) declining by 10% or more from its most recent closing 52-week high price.

Severe Acute Respiratory Syndrome (SARS)
SARS is probably the best comparison to the current coronavirus as their origins are from the same family of viruses.  In March 2003, the SARS virus was identified as global epidemic (Center for Disease Control), however, the first cases of the disease arose in November 2002 from Guangdong, China (Center for Disease Control); which is also the origin of cases from the current coronavirus.  In humans, the disease primarily impairs the lungs, and as such, presents itself as an upper-respiratory infection.  The incubation period for SARS, which is the period from when you are first infected to when you begin to demonstrate symptoms, was about 2-10 days (Center for Disease Control), which is not too dissimilar from the current coronavirus’ incubation period of 2-14 days (Center for Disease Control).  Both SARS and the current coronavirus spread similarly, which is through contact with an infected person.  There resulted in over 8,000 cases with 774 deaths (representing a nearly 10% death rate) among 26 countries of SARS from November 2002 through July 2003 (World Health Organization).  Although no vaccine was ever developed, the virus was ultimately contained and there have been no cases reported since 2004 (World Health Organization).  In contrast, the current coronavirus has over 80,000 cases with about 2800 deaths over 50+ countries, representing a death rate of around 3%, or 1/3 of that of the SARS virus (World Health Organization).  Below is a chart showing the S&P 500 total return performance from November 2002 through July 2003:

Total Return: October 31, 2002 – July 31, 2003

Source:  S&P 500 data from Factset Research Systems.  Events documented by CDC and WHO.

The above chart chronicles the headline events of SARS and the performance of the S&P 500 throughout the time horizon.  While the index technically bottomed on March 11th at a cumulative return of -8.72% from the beginning of November 2002, much of the damage took place in the 15 trading days between 1/24/03 and 2/13/03, amidst growing cases in China and concern the disease was becoming a global threat.  A vaccine was never developed for the disease.  Once the disease was contained, cases of new instances began to drop.  Part of the reason seemed to be due to proper protocols being developed globally and the other part seemed to be the changing of seasons eradicating the life of the virus.  In the end, the market ended up 13.35% from the beginning of November 2002 when the first report of someone containing the virus was identified through July 2003, once no new cases emerged globally and all travel restrictions were lifted worldwide.  So, what kind of overlaps do we see to date with the current coronavirus compared to SARS?  Below is a chart of the S&P 500 index chronicling similar events and showing where we stand now versus the point at which we stood then:

Total Return: December 31, 2019 – February 27, 2020

Source: S&P 500 data from Factset Research Systems. Events recorded by CDC and WHO.

While there was a drawback from the initial news, the veracity of selling was not as immediate this time as it was with SARS.  That can be partly to blame for why there has been more selling in a shorter period of time now than there was then.  Unlike the 15 trading days it took for the S&P 500 to drop -8.72%, the S&P 500 has dropped -13.05% in six trading days from 2/21/20 to 2/28/20.  I’ve included today’s drop of -0.82% in the S&P 500 index, which is not included in the above chart illustrating a cumulative drop of -7.52% from the time of the first case.  If you add in today’s -0.82% drop, we now have a cumulative drop of -8.34% in the S&P 500 from the first case to now, which now puts the index only 38 basis points from the bottom of the drop that occurred during the SARS epidemic.  The market believed it had a lot of ground to make up when dealing with a virus of epidemic proportion, and it has done so at a record pace.  This is the most the S&P 500 index has been down in the shortest span.

This is not to say that the worst is here, but if history is an indication, we are very close, although even when we do bottom, it may take some time for a full recovery.  Like any large market pullback, there are buying opportunities that present themselves.  I am not talking about the day traders that are taking advantage of the current wild intraday price swings.  I am talking about the average investor looking for an entry point into a market that was quite frothy at the end of December.  From our view, it’s hard to find a better time to make that entry.  Global Beta Advisors suggests investors seek high quality companies with strong cash flows and lower price-to-sales multiples.  We believe companies such as those provide the highest probability of long-term return, while earning yield from those strong cash flow companies in an environment that has now seen record low treasury yields.  So, while everyone else is heading for the exits, it might be time to start looking for the entrances.  We encourage investors to reach out to our team for guidance and assistance in what has become a very unique period for investing.