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A Note on Market Volatility

by PMA Investment Committee

It has been a challenging few days in the markets and the world. We are writing with our thoughts about the implications of the Coronavirus and its effects on the economy, the financial markets, and your portfolio assets at PMA.

On the one hand, we offer the usual context when writing these e-mails: declines like the one we just experienced are, unfortunately, the price we pay for investing in stocks: 10% declines happen about once every three years, and 20% declines happen about once every six years. During the last ten years we have seen unusually strong returns with muted volatility, and stock prices have approached but not reached a 20% correction twice. The Dow Jones is still up almost 50% from five years ago.

On the other hand, what is happening now is somewhat different because, in the past, large declines were typically driven by more standard economic reasons: recession, slowdown in corporate profits, the popping of a real estate bubble, or other unexpected bad economic news. With the Coronavirus we move from the world of finance and economics to the world of epidemiology, a world in which PMA has no expertise. Therefore, it would not be responsible to offer any blithe assurances about how all of this is an overreaction of panicky human beings, and that sooner or later all of this will be resolved. And, as usual, one can find reasonable opinions from experts that sharply disagree on the likeliest outcome.

Some of these experts argue that the picture is reassuring if we look at past epidemics – SARS, MERS, Ebola – and their effect on global markets. These viruses also generated media hysteria but they were contained and the markets did not suffer serious long-term losses. But, do these precedents have any relevance for this situation? The last real pandemic was the Spanish Flu of 1918. If the Coronavirus is anything close to the range of that pandemic, in which at least 50 million people died worldwide and around 675,000 in the US, the effect on the global economy could be severe.

Here are two possible and simplified scenarios as to how this will all play out: in the first scenario, the virus will be contained, a global pandemic will not occur, and we will see the “V-shaped” recovery that the more optimistic financial commentators predict. In the second scenario, the pandemic occurs, a material percentage of the global population is infected (including, yes, the United States), and the effect on the economy is severe. How severe? No one knows. Kristalina Georgieva, the managing director of the International Monetary Fund said this: “We are still learning about how this complex virus spreads and the uncertainties are too great to permit reliable forecasting.”

What does this all mean for your assets at PMA? In the face of this uncertainty our recommendation is to not make any changes, for the following reasons. First, selling stocks during a time like this means turning paper losses into realized losses. You do not truly realize losses until you sell. Second, for clients in taxable accounts, selling now may generate large capital gain taxes, a consequence of the decades-long bull market. Third, we have always stressed long-term investing in the context of a natural and deep-seated optimism about the long-term prospects of America and the world’s future. It’s hard to hang on in difficult circumstances but it has proven to be the best strategy in the past. In short, the three days of market declines that have occurred so far this week do not cause us to reconsider the underlying philosophy that has guided this firm for almost 40 years.

What this situation illustrates, once again, is the absolute folly of trying to anticipate the direction of markets from one moment to the next. As 2019 wrapped up, the various market sages offered their predictions as to what the market would do in 2020, supporting their thesis with data about corporate earnings, interest rates, GDP growth, stock valuations and the like. Did any suggest that equities would be blindsided by a new and deadly virus, originating in bats and emerging out of a so-called “wet market” (where both live and dead animals are sold) in the Chinese city of Wuhan? We think not.

The smartest people in the world have at some point in their careers been made to look foolish by their predictions. Throw into the equation a deadly virus with the potential to cause a global pandemic and you have made a challenging activity that much more difficult.

As always, we value the trust you place in PMA and take very seriously the responsibility we have for the management of your financial assets. We encourage you to contact us if you have any questions or thoughts about the issues raised in this note.