Shortly after the market opened this morning, the S&P 500 fell 7%, triggering a circuit breaker halt that paused trading for 15 minutes. The New York Stock Exchange will halt trading at three key levels: with 15 minute halts if the index is down 7% and down 13%. If the index falls 20%, trading will halt for the remainder of the day. The current set of breakers was established in February 2013, and today is the first time since then that it was put into effect.

While it was shocking to witness the triggering of these circuit breakers, it is also an indication that the mechanics of the market are working. The Federal Reserve has also taken steps to stimulate through an emergency 0.50% rate cut and an injection of cash into the market. The Fed’s actions have provided guardrails to ensure that capital markets continue to operate, but beyond maintaining that liquidity, many agree that the Fed’s impact is limited.

So what changed today? In addition to the news that coronavirus cases are spiking outside of China, markets were shocked over the weekend when oil price talks between Russia and Saudi Arabia broke down, effectively triggering a price war that sent the price of oil down more than 30%. Energy stocks reeled, as oil prices in freefall may now lead to a cash flow problem for many of these companies. Furthermore, the “flight to quality” into U.S. Treasuries sent yields sharply lower; the entire U.S. Treasury yield curve is now below 1.00% for the first time in history. Stock prices of banks and other financial companies swooned as their primary revenue source will be hurt by lower interest rates.

With regard to coronavirus, we predict that there will be more negative news to come. Assuming the data is correct, China is looking like it has the outbreak under control. Active cases outside of China, however, will very likely go much higher before they peak. Given the lack of testing in the U.S., we are likely just at the start of counting cases. It is all but certain we will see more headlines of active cases spiking in the U.S.

At this point, there is absolutely no doubt that the economic impact of the outbreak response will be meaningful. Event and travel cancellations, school closures, halted production—these things all have real economic consequences, and we currently have little visibility or a timeline on when things will get back to normal. Until they do, we are in the dark on what the true economic impact could be. Furthermore, the longer the situation drags on, the more likely it is that we will see a recession. But we are challenged to see a scenario where consumer behavior is permanently affected. If that is the case, demand is being pushed off, not evaporating completely. Certain sectors that will be hardest hit (airlines, travel and entertainment, energy companies) in the short term will need to be evaluated from a cash flow/liquidity standpoint, but most companies’ balance sheets should be in good shape and able to weather the storm.

Nevertheless, some things may be permanently shifting. Considering the prior years’ trade war with China and this new coronavirus disruption, companies may be seriously rethinking their supply chain and exposure to China. This could lead to a new normal for labor pricing and therefore company margins, depending upon how the supply chain is altered.

We actively monitor the price-to-earnings (P/E) ratio of the market to gauge valuation, and while this measure has fallen from about 19x forward earnings to 15.5x, we acknowledge that the forward earnings number is currently a very large question mark. Given the large number of unknowns, companies have pulled their forward guidance without adjusting it, so we really do not have a reliable “E” in the P/E ratio at this point.

What do we recommend to clients right now? First and foremost, it is time to take a deep breath. Fear and panic is clouding out logical thinking. We spent the last year reviewing appropriate asset allocations with clients, and this is exactly the type of scenario that demonstrates the importance of that practice. It is also time (again) to look at refinancing any outstanding debt. The 10-year Treasury yield is hovering at all-time lows. Many interest rates, including mortgage rates, are tied to this benchmark. In equities, we think there is a significant buying opportunity on the horizon, but we do not advise trying to catch a falling knife. We are following the best information while we watch for signals of a resolution to this outbreak.

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