Market overview

CORONAVIRUS OUTBREAK SPREADS OUTSIDE CHINA: WHAT MARKET IMPLICATIONS?

Lyxor Cross Asset strategist Philippe Ferreira looks at renewed market concerns related to the Coronavirus outbreak and provides the team’s investment views.

 

 

We believe current market movements open opportunities for defensive investors. It may be premature to add risk now as the global economic impact of the lockdown remains unknown and upcoming data releases are likely to experience disruptions. Risk assets are likely to fluctuate until i) the spread of the disease appears to be under control and ii) there is more clarity on the economic impact. This may take a couple of weeks. Overall, we believe that the probability of a protracted market sell off is low. 

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A SENSE OF MARKET PANIC

 

  • The spread of the Coronavirus in Asia (South Korea, Iran) and Europe (Italy) is raising alarm bells and giving investors reasons to take profits on risk assets after an impressive rally.
     
  • The lockdown of several thousand people (52,000) in northern Italy raises additional questions about the global economic impact after several million people were locked down in China. The situation has started to normalize in China with regards to mobility: most car plants are reported to have reopened last week; passenger traffic remains low but migrant flows into major cities rebounded last week; coal consumption has started to pick up; container ship activity almost recovered to normal levels; property sales rebounded as well but remain below normal levels. Most industrial firms have resumed production but capacity utilization stays low. In Europe, Germany’s business association expects supply shortages related to the Coronavirus. 
     
  • Macro data releases in the coming weeks will be highly distorted. China has delayed most data releases in February. In the coming days, PMIs for February will give some indications of the economic disruptions.
    • In the U.S., both the (preliminary) manufacturing and services (Markit) PMI fell vs. January and missed expectations by a significant extent. This suggests the market has had trouble evaluating the economic damage and is a bad omen for the ISM to be released next Monday. Yet, regional manufacturing surveys for February (Philadelphia, NY, Dallas) were reassuring.
    • In China, there has been renewed downward pressures on the CNY vs. USD since mid-February when a new methodology sharply increased the number of confirmed cases.
    • On a positive note, EMU preliminary PMIS for February were above the January print and better than expected.
       
  • The WHO suggests the search of a vaccine is progressing but could take several months. Vaccines often require lengthy testing on thousands of people before they are allowed to be sold. Regarding Ebola, the first vaccine was successfully deployed in Guinea in 2015. At the time it was an unlicensed drug, yet it was rolled out in the country for "compassionate use" after authorization by the government. In 2002 and 2003, the SARS outbreak came and went before a vaccine could be produced.​
     

OUR MARKET VIEWS

 

  • Taking a longer perspective, we note that it is not uncommon for markets to have second thoughts after a viral outbreak (although it is difficult to isolate the effects of epidemics on markets). In the case of the Swine flu in 2009 and SARS in 2003, the market recovery (after the initial hit related to the outbreak) was interrupted by renewed uncertainties before rebounding.
     
  • The growth rate of confirmed cases has continued to decline globally despite the concerning news about the international propagation of the virus. It stood below 3% in the last seven days. The number of recovered cases has reached 28,000 people (1/3 of confirmed cases have thus recovered).
    • Quoting Columbia University’s Director of the Center for Infection and Immunity, “If measures taken so far to contain the outbreak are effective, some dramatic reductions in infections should be observed in the third or fourth weeks of February. Warmer, early-spring weather might also impede transmission.​ Read complete Quote
       
  • Three market scenarios:
    • Worst case: The Coronavirus outbreak spreads in China and in Europe. Lockdown extends to several million people in Europe. The MSCI World is down -15% from levels as of February 27th, 2020 (equivalent to the drawdown between Aug. 2015 and Feb. 2016 when global recession fears jumped). 10Y Bund yield falls to -0.8% (record low). VIX spot  spikes to 35-40 (levels reached in Aug. 2015; Feb & Dec. 2018). EURCHF falls in a range between 1.00 and 1.05; USDJPY below 105. HY credit spreads jump by 300bps in EUR and 500bps in USD to 650bps and 850bps, respectively (back to early 2016 highs). We evaluate the probability of this scenario at 15%.
    • Base case: Market volatility continues over the next days and risk assets bottom in the first half of March as the epidemic peaks. The MSCI World index bottoms at -5% from levels as of February 27th, 2020 (back to end-Nov 2019 level). 10Y Bund yield bottoms at -0.6% (end-Sep 2019 level); 10Y Treasuries bottom at 1.3% (all time low). VIX spot stays below 30. We evaluate the probability of this scenario at 75%.
    • Best case: If the Coronavirus peaks in the coming days and/or a change in methodology narrows down the number of confirmed cases and/or the number of recovered cases jumps significantly, the market will experience a sharp rebound. Concurrently, the economic impact could remain contained but in the face of uncertainty, fiscal and monetary authorities signal more accommodation. Risk assets rebound from from levels as of February 27th, 2020. Bond yields stay nonetheless below pre-17/01 levels until early Q2 (10Y Bund yield stays in the -0.2 to -0.3% range; 10Y Treasuries in the 1.7-1.8% range) and contribute to fuel equities. We evaluate the probability of this scenario at 10%. 

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MARKET REACTION TO VIRAL OUTBREAKS (IN TRADING DAYS)

MARKET REACTION TO VIRAL OUTBREAKS (IN TRADING DAYS)

 MSCI World as of February 24th, 2020.

Vix spot as of February 25th, 2020. 

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Source: Lyxor Cross Asset Research, Macrobond, Bloomberg. THE FIGURES RELATING TO PAST PERFORMANCES REFER OR RELATE TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA.

Methodology: market indices are set to 100 on day 0, which corresponds to: 17/01/2020 for the Covid-19 (*); and 15/09/2014 for Ebola (**); 31/03/2013 for Avian flu(**); 11/06/2009 for Swine flu(**); and 27/02/2003 for SARS(**).  (*)  date of the Covid-19 “media buzz”. (**) the date of the first case of disease reported in a foreign country outside the initial outbreak.