We will admit a secret to you, dear reader.
You should know this is a secret we don't share with many of our closest friends and family.
We hate needles, shots, injections, whatever you want to call them. We freak out. We get scared. We carry on like babies anytime we have to get a blood test or flu shot. We hate them. Of course, there are many incredibly funny and embarrassing stories about the experience of getting shots. It’s not at all uncommon.
Upon a deeper analysis, it is really the anticipation of the shot that gets to us. It is everything prior to the actual injection. It's the buildup and the worry about the unknown which, weirdly, we know is coming. How bad is the pain going to be, what if something goes wrong, what if the wrong stuff is accidently injected, what if the vein explodes (is that even possible?), etc. Immediately after the deed is done, we feel foolish, it’s never as bad, or as dire, as our imagination. What was all the fuss about?
It was about the fear of the unknown.
That is what investors are dealing with today in response to the global threat of the coronavirus.
Of course, we are not virologists (though there seems to be a lot of them around today), and we will not offer an opinion on the future of the disease (though there seems to be a lot of those around, as well). We have no idea what will happen.
From an investment perspective, we are primarily concerned about the impact this disease outbreak may have on economic activity and ultimately corporate earnings. Earnings drive equity prices. When negative news like this first breaks, the market generally reacts to fear and goes down first i.e., it shoots first and asks questions much later. Again, it is the fear of the unknown…the unknown impact on earnings in the future.
Broad macroeconomic things that are minor but have a very certain impact on earnings - think tax cuts - can get incorporated into economic and earnings outlooks quickly. However, big stuff with an unknown impact on economic and earnings activity, like the coronavirus, are tough to accurately estimate, so investors expect the worst and (maybe) irrationally send equity prices down. The fact that equities were more expensive (relative to historical pricing) from a valuation perspective when the coronavirus news hit was a further complication. Expectations now seem to suggest the impact of the virus will be severe and prolonged.
Maybe it will or maybe it will not, no one knows. It is possible that the coronavirus will, not have a big macroeconomic impact over the long-term or even a year from now, or even six months from now. Note – none of the previous global virus contagions (bird flu, SARS, MERS, Ebola, etc.) resulted in big, long-term macroeconomic impacts, including the H1N1 global flu pandemic 10 years ago. Do you even remember that one?
Back to the future of earnings. Though we cannot/will not know with certainty what will happen in the future, we can look to other key market price signals, outside of equities, when they are behaving irrationally in the short-term, as a rough but helpful guide to the future. For us, watching the price of copper and gold can help us figure out how the market is interpreting the impact of the coronavirus on corporate earnings.
Copper is an industrial metal, and when the spot price of copper is rising, investors believe industrial activity will improve in the future; when the price is falling, the opposite. Gold is a precious metal and "haven" asset: when things get crazy, investors flee to gold for security and vice versa. Looking at the prices of both and the ratio of copper-to-gold is a helpful exercise in times of uncertainty:
In the chart above, the blue line represents an approximate spot price for copper since the beginning of the year, the gold line represents gold, and the green line represent the ratio of copper to gold.
What is interesting to us is that the price of copper peaked in middle of January and then started to go down as coronavirus worries picked up steam, but - and this is very important - it has NOT gone to a new low price (vs. the lowest price set in the beginning of February) recently as the coronavirus pandemonium broke out in full force over the last two weeks. That is, as the news media and probably everyone around you freaked out, the rational price of copper did not. Similarly, the price of gold peaked on February 24th, and - again this is very important - it has declined lower since then as the coronavirus pandemonium broke out. The ratio of two metals has also started to move higher since February 24th indicating that investors today believe the future impact of the coronavirus is not getting any worse.
For now, this is good news for economic activity, corporate earnings, and, ultimately, helping equities find a bottom. If copper breaks down to a price lower than the recent low in the beginning of February and similarly if gold breaks higher than the recent high on February 24th, that might signal trouble brewing. Your Sequoia team is remaining vigilant and keeping a watchful eye on the markets. We’ll keep you informed and up to date as changes occur.
For more information on this topic, please contact your advisor directly or reach out to us by emailing email@example.com.