Quick Update on Market Volatility Stemming from the Coronavirus Outbreak
As we caveated in our January 2020 Market Commentary, any update on the coronavirus situation will likely not age well as the story is ever fluid and markets react to every new development. Nonetheless, we provide a quick update in light of this past week’s market sell-off in global equities and commodities.
Prior to the outbreak and coming off the heels of a Phase 1 trade agreement between the U.S. and China, global investors were pricing in quite a bit of optimism into risk assets especially U.S. equities which hit a cycle peak of 19x Price/Earnings multiple and corporate credit spreads narrowing to their richest levels over the past 5 years. We commented on this ‘rich’ environment even as the coronavirus was spreading throughout Asia and starting to threaten global supply chains (see “2020: The Year the Carry Trade Died?”). What led the metaphorical dam to burst on U.S. equities was the shocking development that the virus had spread throughout the northern region of Italy, a key industrial region for continental Europe. Now, infections have been reported worldwide although the magnitude of the virus spread has varied by region.
For now, Wall Street is treating the economic disruption as ‘temporary’ with expected earnings growth pushed out further into late 2020 and beyond assuming we eventually see a peak in the contagion (warmer weather should help). The disruptions from the virus will likely be treated as ‘one-time’ hits to earnings, sort of like how companies occasionally blame adverse weather conditions as impacting winter earnings releases. Expect to hear comments that the near-term corporate outlook is ‘opaque’ until companies start communicating the known and expected disruptions to their operations and end-client demand.
The virus is also testing the resiliency of supply chain management and whether companies were able to establish appropriate contingencies as well as having diversified enough of their supply chain outside of concentrated regions, like China. Companies may get a reprieve from local governments concerning tax payments, employee costs, and/or licenses. The global economy may benefit from a coordinate global policy response, both fiscal and monetary (the bond market is pricing in three rate cuts by the Federal Reserve by year-end).
So, the consensus outlook appears to view the sell-off as ‘temporary’ as the damage to the economy isn’t viewed as long lasting. Whether the economic damage from the virus will be long lasting remains the crux of the current debate. If you become sick and miss work for a short period of time, the business franchise is not likely at risk from suffering long-lasting damage due to your absence. However, if your sickness is prolonged, it could have greater ramifications. The Asian economies (China, South Korea, Japan) are struggling to contain the impact from this virus, where both China and Japan have shut down schools through the end of March. Some are even questioning whether Japan can proceed with hosting this year’s Summer Olympics.
The base case scenario is a series of short-term shocks, whose longer-lasting damage to the global economy will be a function of how extended this viral outbreak becomes. Carriers of the virus can be contagious long before symptoms manifest themselves; hence, draconian quarantines and other countermeasures adopted by governing authorities appear to be most effective in containing further outbreaks.
Fortunately, it appears that active cases worldwide appear to be are declining, mainly driven by reported cases out of China, even if cases outside of China continue to rise. China also has the fiscal resources to support local growth conditions, unlike other regions such as Italy, which have little to no scope to implement fiscal countermeasures. As mentioned above, the situation is fluid and markets become more volatile as the coronavirus outlook grows more uncertain.
The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes and opinions of others are assumed to be true and accurate however 3D Asset Management does not warrant the accuracy of any of these. There is also no assurance that any of the above are all inclusive or complete.
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By: Benjamin Lavine