Global stock markets fell sharply yesterday (Monday 24 February) as reports from Japan, South Korea, Iran and Italy stoked fears over the global spread of the coronavirus. Among the notable falls, FTSE MIB index of Italian shares ended the day 5.4% lower after authorities moved to lock down ten towns in the country’s north to prevent the virus spreading. Meanwhile, the S&P 500 index of US shares fell 3.4%, erasing its year-to-date gains. While stock markets dropped, safe haven assets which investors typically turn to in times of market turbulence, such as high quality government bonds, rallied. The extent of concern among investors was clearly signalled by a sharp rise in the Vix index which is commonly known as “Wall Street’s fear gauge”.

Figure 1: The Vix index: Wall Street’s fear gauge

Source: Bloomberg

While the coronavirus poses obvious healthcare threats, the threat to investors might be less clear. In short, efforts to limit the spread of the virus – particularly in China – have caused factories to shut their doors and encouraged consumers to stay at home. This has disrupted global supply chains, leading to a shortage of some key components, and undermined retail sales. Against this backdrop, companies have begun to reduce their profit forecasts for the first quarter of the year. The impact has been most pronounced among airlines, cruise ship operators and commodity (e.g. oil and precious metal) producers. However, as illustrated by Mastercard’s recent profit warning, a wide range of companies are likely to be affected.

So, should we be joining the panic and selling shares where possible? The answer is complicated by the fact that no-one knows exactly how great the pandemic threat really is. While we take some comfort from the response – both in medical and investment terms – to previous outbreaks such as SARS and African Swine Flu, there is little way of knowing how relevant these episodes are to the current situation. Nonetheless, we can argue that, historically, selling shares at this stage would lock in losses and forego future gains.

Though some questions remain over the strength of future company profits, we believe that in most scenarios the impact of the virus should prove temporary. Once contained, manufacturing activity should recover while consumers may well make up for the purchases they have recently deferred. Furthermore, to our minds, valuations are all important. The recent sell-off has left the majority of global stock markets at valuation levels we consider reasonable, even against a more uncertain outlook for profits. In short, we are more likely to consider yesterday’s sell-off as an opportunity to top-up share holdings in OMPS portfolios rather than to cut them.

As ever, we will continue to monitor developments closely. Heeding the words of the seminal economist John Maynard Keynes, we must stand ready to change our minds if presented with a change in the facts. For now, however, we believe history, valuations and the economic outlook argue investors will be best served by maintaining their share holdings.