February 27, 2020
Re: Coronavirus outbreak (COVID-19)
Many are concerned about the impact of the coronavirus on their financial accounts. As of this morning the Dow Jones Industrial Average has fallen in to Correction territory meaning a 10% drop from the most recent high point. What has been alarming to many is the velocity of change in which this occurred, less than 2 weeks. In light of this and the concerns of many we wanted to take this opportunity to give input on this topic.
In our view we need to look at the virus and its impact in 3 separate and specific arenas. Health, Political and Financial.
On the health front the global spread of the coronavirus is certainly alarming and scary. Any new disease that can spread so easily can cause grave concerns for one’s own health but also that of their immediate family and friends. As of today (according to statistics from the World Health Organization*) there are 82,294 reported cases worldwide (in 47 countries) with 78,630 of those in China and 3,664 outside of China. Of those total cases 1,185 were reported new in the past 24 hours. It is significant that the number of newly reported cases for the rest of the world exceeded those reported in China. This is the first time more cases have been reported outside of China than within since the outbreak began December 8, 2019. Importantly the death toll from this virus is 2,805 individuals and while any death of any individual is very tragic for their family and friends the reality is that the rate of deaths from the coronavirus is only 3.4%.
One might take from the news reporting that every case if fatal but that simply is not the truth. In comparison the annual global severe influenza cases (influenza in general is over 1 billion cases worldwide) reported are between 3-5 million cases resulting in 250,000-500,000 deaths with a resulting death rate of 8-10%, for those with a severe case of Influenza A and B**. So, if we are just to look at the impact of one strain of virus versus another, severe influenza deaths occur over twice the rate of the current coronavirus. This difference can certainly change but given the current numbers the death rate is significant but lower than severe influenza. Again, this is not to minimize the impact of each and every death but merely to gain some prospective of the current risk level.
In the context of the current divided and heated political discourse, this topic is bound to create division and acrimony. Arguments will be made that not enough is being done to combat the danger and others will claim that all necessary protections have been made and that resources are ready for all that may come our way. Of course, more than likely neither side is totally true and facts will evolve on a daily basis which will guide response and movement of resources. Unfortunately (and this is just my opinion) some in a position of leadership are more interested in scoring “points” from this situation than in actually solving the problem. This malady knows no political boundaries and highlights these contentious times.
Of the 3 concerns this may very well be the one that impacts the most people. After all, how is this going to affect the investments within my 401 (k), IRA and any other account that I have? Will I lose all of my investments? Is there a huge stock market crash on the horizon? One, the probability of losing all of your money, in a diversified group of mutual funds, is all but nonexistent. Say you only own 1 mutual fund, the Standard & Poor’s 500 Index. The only way you would lose all of your money is if every one of the 500 stocks held by this fund went bankrupt. In order the 10 largest holdings in such a fund (as of today) are, Microsoft, Apple, Amazon, Facebook, Alphabet, Berkshire Hathaway, JP Morgan Chase, Johnson & Johnson, Visa, and Procter & Gamble. Think about it, if just these 10 companies went bankrupt, we would be in a world of hurt, not counting the other 490 companies that make up this index. If your account has a number of different funds your total holdings could be in the range of thousands of separate companies. Losing all of your money is therefore extremely unlikely. However, what is likely is there will continue to be volatility in the stock market just as we have seen for the past decades and will more than likely continue to see in future decades. Investments are ultimately purchased by people who have opinions and they represent buyers and sellers. If more people are positive at any moment in time stocks tend to rise, if people are negative/fearful at that moment stocks usually go down. That is the result of human nature.
What is causing the current negative impact on global stocks? Health and/or political concerns or something else? We believe the biggest concern and therefore largest effect brought about by the coronavirus is the impact on the global supply chain. Over the past 30-40 years the U.S. consumer has demanded more products at lower prices. Whether it be electronics, clothing, furniture, toys, airplane parts, auto parts or pretty much any consumer product, we have wanted lower and lower prices. We all know the result; manufacturing has gone to countries that can produce the most products at the lowest price and for many years this place was China. We wound up getting cheaper consumer goods but the consequence of this is that we lost our “quality control” to another country and its laws/regulations and in this case a growing health crisis. This outbreak of the coronavirus has caused a severe break in the global supply chain. Meaning that the production of so many products are dependent upon a chain of suppliers so that if one part of that chain is weak the entire process can come to a complete halt.
A health scare that we had no control over the initial response/diagnosis/containment now has a direct and potentially significant impact on our economic lives. With the closure of so many Chinese factories, parts for so many of our consumer products have become momentarily unavailable. This is not a permanent problem. Factories will re-open and goods will again flow. We know that. We just do not know how long it will take for that to happen and if the delay is too long (not sure what too long is) will that push the world to a global recession? That is the question that has the financial markets so worried and driving prices down. For example, Apple makes or depends upon Chinese factories for the production of iPhones. So, if a factory is shut down in China due to the coronavirus the supply chain for Apple is disrupted up and down the line. Less iPhones will be manufactured and shipped resulting in lower quarterly profits and a downward move in their stock price. Will this impact Apple forever? Certainly not. At some point these factories will re-open, phones will be shipped and more than likely Apple’s sales will surge in a future quarter to make up for the momentary shortage of phones.
On the other hand, service industries do not have the luxury of multiplying product in future quarters to make up for a poor quarter. Look at it this way, a restaurant has so many tables and on any given night all of those tables are full. If due to the coronavirus concern people stay home for dinner those tables that are typically occupied are empty and therefore the restaurant suffers that day and every day following that people stay home. Even if a month later every table is full it does not make up for those nights the restaurant was empty. Those are the companies that will be most severely impacted by this crisis and the question is whether they have enough in reserves to make it through until either a virus is developed or the coronavirus runs its course and dies out on its own. I am no scientist but I am confident that those at the World Health Organization (WHO) and Centers for Disease Control (CDC) are working night and day to come up with a solution.
Over my career I have often been in discussions over whether it is better to be a manufacturer or distributor. In other words, do you make your own products or are you reliant upon others to build the product and make those available to you for distribution. I have always been on the side of manufacturing are own products. This has always cost more, i.e., manufacturing your own versus distribution but we have always accepted that higher cost so that we were not beholden to some other organization to manufacture a product for us to distribute. For example, we (Cashman Consulting) create our own content (this newsletter) and asset allocation models. It would be far easier to subscribe to a newsletter, put our logo on it and distribute that to our clients. We choose to create our own. Asset allocation models can be purchased and subscribed to; we have chosen to create our own. In our view being a manufacturer is a far better route to travel as opposed to distribution.
Another example is how the United States reacted at the beginning of World War II. In reaction to our entry in to this conflict the U.S. military needed tanks, airplanes, trucks, munitions, uniforms and many other items. What did we do at that moment? United States factories started turning out airplanes, tanks, munitions and all that was needed in record numbers. We had the manufacturing capability at that time to make that change. Assembly lines at Ford and GM were converted from producing cars to making necessary military vehicles. Boeing and other airplane manufacturers began producing, in large numbers, military equipment. At the time we had the capacity to be our own manufacturers.
In 2020 so much of manufacturing is done outside our borders and we have become distributors. Yes, this allows for less expensive goods but at what price? I am not arguing that we shut ourselves off from the rest of the world as in fact this expansion of the supply chain has benefited many around the world including companies right here at home. However, we cannot avoid the consequences or our actions and we (United States) need to have plans to meet unexpected events.
On March 9, 2009 the Dow Jones Industrial Average hit 6600. It closed yesterday at 26,957. By any measurement a dramatic move from what seemed to be such a dire time. Just goes to show that when times may seem the worst or scary there is the probability that the financial markets will right themselves and economies around the world will continue to grow.