Thoughts on the Market

February 24, 2020

Global stocks are suffering a steep decline this morning. At the time of this writing, the S&P 500 is down roughly 3%. The drivers of today’s sell-off are fairly clear: coronavirus and Bernie Sanders. Here we discuss our understanding of both of these events and what it means for your portfolio management at GGS.

Coronavirus:
The spread of high rates of coronavirus infection to Iran, Italy and South Korea over the weekend have increased fears that the virus could become a global pandemic and thus have a significant negative impact on global GDP growth.

It was already well understood on Friday (prior to today’s sell-off) that the coronavirus would be a major negative for China’s Q1 GDP growth. The hope is that China’s travel restrictions and quarantines will keep the virus isolated to a few cities and that the rest of the country’s economy will rebound in Q2 helped by new government stimulus. This weekend’s headlines don’t really change the China situation but obviously don’t help as they reiterate how quickly this disease can spread.

Bernie Sanders:

Sanders dominated the Nevada caucuses on Saturday, and most importantly, he showed unexpected strength throughout all major demographics. This is leading to speculation that he will both (a) quickly be the clear Democratic nominee and (b) be a much more viable candidate than previously expected.

Most importantly for the stock market, Sanders has campaigned on a platform of raising the US corporate tax rate back to 35% from its current 21% to help pay for new government spending programs. This would deliver a major hit to corporate earnings, just as President Trump’s tax cuts provided a major boost to corporate earnings. In our view, US corporate earnings are the most important long-term driver of the US stock market.

In addition, his policies would have a major impact on certain sectors of the US economy, most notably Healthcare with his Medicare-for-All/single payer plan.

It is unclear whether his policy of dramatically increased government spending and student debt forgiveness would raise US GDP growth when balanced against significantly higher tax rates, new regulations and a higher government deficit.

While Sanders’ most aggressive policies would only be enacted if the Democrats also control the House and Senate, some strategists believe that the only way Sanders wins in November is coupled with much higher Democratic voter turnout that could also flip the Senate, so this possibility cannot be completely discounted. In addition, as much of President Trump’s support rests on the belief that he has helped create a stronger US economy, a major coronavirus global economic impact or recession fears sparked by some other reason could lead to a Democratic sweep. Note that President Trump is still a heavy favorite to retain the Presidency at this point.

The next events in the Democratic primary are the South Carolina primary on Saturday and “Super Tuesday” on March 3, after which we should have much clearer picture.
What does this mean for your GGS-managed portfolio?

The short answer is that nothing changes in the management of your portfolio. Investing involves risk, and we believe you are rewarded long-term for taking on that risk. We have taken precautions to limit clients’ exposure to specific event risk to a manageable level, such that an event like coronavirus’s spread or a Sanders’ presidency should not create a negative material impact vs. the benchmark on the portfolio as a whole. We have done this by ensuring on a daily basis that clients are not over-exposed to any particular company, industry, sector or geography. In the case of the coronavirus, the most direct negative impacts have been on businesses operating in China, the travel industry, and companies directly exposed to commodities, as Chinese demand for oil, copper, plastics, etc. have dropped dramatically. For Sanders, the most acute risk vs. the benchmark is in client exposure to the healthcare sector, most notably the insurance industry. While many clients have a position in a provider of healthcare insurance, we have explicitly limited how much of client portfolios can be invested in that industry. At GGS, we strive to stay apolitical and unbiased, but we do incorporate facts and known risks into our analysis; for example, we first penalized certain companies in our stock selection process for Medicare-for-All risk in February 2019 and have increased the penalty as the risk becomes more likely.

The question is should we take action to further mitigate clients’ exposure to coronavirus or a Sanders presidency based on this weekend’s headlines. Given that we are already incorporating these risks in our analysis and limiting these risks in relation to our benchmark, we strongly believe that we should not. We believe we should only take a significantly different positioning vs. the benchmark when we have proprietary research to back it up. That is the case for our individual equity research and our bottom-up security selection often results in different industry/sector weights than the benchmark. But to say that we at GGS have more information on how coronavirus will spread or how the US presidential race will unfold than what is currently already contained in market expectations would be foolish. If the virus ends up being more benign than current expectations, then we would miss out on the recovery in these securities. If President Trump secures a second term, then Medicare-for-All risks will be removed. Again, investing involves risks, and as long as we are aware of what our exposure is and are comfortable with it, then there is no reason to take action to lessen it and harm future expected returns.

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