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The stock market, particularly in the U.S., had paid little attention to the risks from the Coronavirus, at least until the last week of February, when the virus was shown to have spread to South Korea, Italy, Iran and a host of other countries that had to that point shown no cases. This became the ‘catalytic event’ for a stock market that was flying high on low interest rates, optimistic views about the economy, ‘buyback induced’ earnings growth and massive money flows into passive index funds. As stocks typically do when ‘everyone is invested and no one is worried’, they go in the opposite direction. Also, like most of these periods, stocks effectively ‘take the escalator up and the elevator down!’ That scenario played out in a major way in the past week as the stock market had its quickest 10% correction on record. We agree that investors should be worried about the economic impact of the coronavirus since the shutdown of manufacturing in China, the inter-relationship of supply chains and the reduced level of consumer spending, particularly on travel, could push the global economy into a recession. While our view had been that the stock market was overdue for a correction, the additional danger for stock markets now is that these fears will continue to unwind the bubble in financial assets. We have certainly seen that in the past week as the biggest winners of the past year (big tech) turned into the biggest losers. The other risk is that valuations had been at such high levels that the ‘ride down’ to fair value is very steep, and markets generally tend to overshoot those levels in the short term. As an example, the cyclically adjusted price-to-earnings ratio, or CAPE, which compares current stock prices with their underlying earnings over the past decade, had been more expensive than at any time since the height of the dot-com bubble in the late 1990s. (more…)