CORONAVIRUS MARKET STRATEGY UPDATE Whilst the headline news on markets is clearly negative, for longer-term investors looking for a potential entry point the key to markets may be when news gets less bad, as the delta of change typically drives market direction. This will not be related to deaths which are a lagging indicator, but rather when new cases peak. The best judgement on this is that this is still at least a couple of weeks away. However both in China and Hong Kong there is reasonable evidence to suggest that the situation is coming under control and that the containment measures, in China, Hong Kong and Singapore are working. Hong Kong has only had two deaths and Singapore none, in contrast to Iran where the healthcare system is less well developed and the mortality rate has been much higher for those infected. In China outside of Hubei and Wuhan it appears the number of new cases is falling.
Anecdotal evidence from some emerging
market managers is that firms are getting back to work, and in fact a statement from Foxconn on Tuesday 3rd March saw the world’s largest contract electronics manufacturer and key Apple supplier stating it expects its China based production capacity to return to normal seasonal levels by the end of this month. Whilst there are still labour shortages workers are flat out now working seven days a week to make up for lost production. Also, the company indicated that it expects the production disruption to delay rather than entirely derail operations and that it had not seen the large-scale component shortages that had been rumoured in the industry. There had been price rises for packaging materials as the raw materials for these are being diverted and used for surgical masks. Chairman Liu Young-Way stated judging from the current state of work the second quarter could be like what the first would be under normal circumstances. Whilst the Fed unexpectedly cut interest rates yesterday an important factor is that compared to the GFC the transmission mechanism for economic weakness this time is the real economy to financial markets, rather than the other way around. This means that the efficiency of monetary policy to stimulate demand is likely to be lower. Fiscal stimulus at a time of a demand shock to the global economy would be the most effective response Another subject of debate is the impact of systematic trading on market falls. Work by strategists at both Morgan Stanley and other leading investment banks suggests that daily flows are now dominated by shorter term traders and there is a big shift compared to a decade ago on what moves share prices in the short-term. The market structure is much changed from a decade ago. In fact, 4 of the 75 fastest market corrections in history measured as the fall from a peak have occurred since 2015.
A danger for investors is they get caught up in market noise and sentiment. To avoid this a focus on the three pillars of the process utilised on asset allocation looking at fundamentals, valuation and sentiment is a way not to get caught up by emotion. This process will not try and catch the market low point, but try and highlight when investors are likely to be on the right side of probabilities when looking to put money to work. While markets have sold off and equities relative to interest rates look potentially attractive, valuations are not screamingly cheap as yet. The catalyst for a market rally is likely to be when news gets less bad, which may well be a few weeks away. In the short term headline news may well get worse. Investors will be looking at the intensity of cases, and this will depend on a number of factors. The first of these is how effective containment measures are. The northern hemisphere will soon be moving out of its peak flu season and whether better weather, more sunlight and as a result higher levels of Vitamin D will help improve immune systems remains to be seen but is a possibility. It is also possible that there could be some announcements re vaccines, which may be a year away, but will give markets a belief that an end is in sight to the disruption caused by the coronavirus and this will not be a multi-year influence on markets. There could also be some news on drugs which will help alleviate the worst of the disease. On the technical side, systematic trading is clearly an influence and risk parity funds will often reduce equity exposure when implied equity market volatility spikes, as is the case now. The best short term entry points will be when markets are deeply oversold and this was the case intra day last Friday the 28th February when the market actually fell 1,000 points at one stage. A resistance level to watch is 2,800 on the S&P which is when the 2016 upturn kicked in.
At this stage it is hard and dangerous to be dogmatic about how substantial the downturn will be. A risk for markets is that there is a loss of confidence in Western economies and businesses and consumers cut back on spending so dramatically an unnecessary recession occurs. London is undoubtedly a lot quieter than normal with hotel occupancy rates falling below 50% and the streets quiet with an absence of tourists. At present, anecdotal evidence suggests a lot of fundamental investors are waiting on the side lines to see how extensive the downturn will be before committing to equities. If investors see rolling downturns and recoveries, meaning that countries affected early emerge quicker from the problems, a case point being China, this could be an encouraging factor for equities. Some sectors will be worse affected than others and western banks are not helped by lower for longer interest rates. The moves in bond markets are more supportive of growth equities than value ones. The US$ has not been strong in this crisis period and this again is a positive for emerging markets as it allows rate cuts and monetary easing in these countries. Oil has rallied about 10% from its low point on hopes of production cuts at the forthcoming OPEC meeting where there is a recommendation to cut output by 1 billion barrels a day, but whether this will be effected in practice remains to be seen. An eye should also be kept on the Democratic primaries, as a potential concern for markets was the nomination of a left wing Presidential candidate for the Democrats and markets might be reassured if Biden looks like securing the Democratic nomination, helped today by the withdrawal from the race by Bloomberg.