This Is Going to Take Some Time to Play Out

I will start with the good news.

Just kidding. There is no good news.

Equity markets across the globe continued to slide as market participants react to the spread of the Covid-19 coronavirus. The S&P500 ended the day down just 0.38%, but realistically, further declines should be expected.Sadly, recent declines only take the S&P500 back down to average in my simple but so far fairly reliable tracking model:

In other words, it hasn’t really gotten interesting yet. The tape bombs are not going to stop anytime soon at this point. The virus looks like it is out in the wild in the U.S. now that we have a case in Northern California with no apparent direct connection to the outbreak. To be sure, this had already seemed inevitable earlier this week. The fact that many patients have no to mild symptoms means that it may have been circulating for many days yet been undetected. It seems likely that we will hear more such stories in the weeks ahead.

We are now heading into the unknown. Much now depends on how severe the outbreaks become and how much they disrupt the ordinary business of life. This in turn depends on the effectiveness of public health authorities to both manage the outbreak and maintain a sense of calm and normalcy.

Early signs are not good. Equity futures fell in the hours after President Donald Trump’s press conference today. Not exactly a vote of confidence. Market participants should recognize the danger of a government run by people who don’t believe in government. Such a government may do little short-run harm in the absence of a crisis. During a crisis, however, the incompetence of such a government becomes all too evident.

The best-case scenario is that a few hotspots of contagion appear, they are quickly isolated with minimal disruption and then warmer weather arrives and with it the natural dissipation of seasonally illnesses. On the other end of the spectrum is a more severe outbreak and the associated disruptions in activity as witnessed in China.

Hope for the best, plan for the worst. At the moment, market participants are beginning to plan for the worst.

U.S. treasury rates have descended as market participants prod the Fed to take action in the form of easier policy. The short end of the yield curve has inverted but the longer end has yet to follow suit:

My interpretation of this pattern is that market participants still believe the Fed can prevent a recession with two to three rate cuts. The Fed, however, is not inclined to move quickly. Nor are other central banks. The Bank of Korea, for instance, surprised by holding rates constant despite the growing number of cases in the nation. It seems that central banks are largely trying to treat the threat of the virus as if they would any other natural disaster. They may be able to do so if concerns soon ease. The longer the virus disrupts activity, however, the less tenable that position will be.

Bottom Line: For the time being, the Covid-19 virus will dominate headlines. It will depress activity in the short run. We don’t know how long the short-run will last, nor do we know what trip wires we may hit along the way.

P.S. New home sales climbed in January, reaching their highest level since 2007. There remains some fundamental momentum in this economy, but that momentum will remain hidden under the virus news in the near-term.