The market decline on coronavirus worries is not only a reaction to the uncertain magnitude and duration of the outbreak, but also because of the embedded complacency in markets entering this period
Earnings are modestly ahead of expectations, and the forward outlook is incrementally positive, though market returns are increasingly dependent on an earnings recovery in 2020 as uncertainties rise
The FOMC is officially in neutral territory, though Chair Powell’s comments stressed downside risks and Fed Futures are betting on a cut. If the Fed chooses to stay neutral in an election year, investors could be disappointed
Equity markets suffered their first back-to-back 1% declines for the first time since August on fears surrounding the coronavirus outbreak. Markets entered that period at extremes for investor sentiment and momentum, which makes them vulnerable to declines and heightened volatility when uncertainty arises. Investors had become a bit complacent following 2019, which saw a strong and stable return, and have since been reminded that gains do not always follow a straight line.
The coronavirus is a challenging risk for investors to assess, given the degree of uncertainty in the magnitude and duration of the impact. To date, 17,000 people have been infected, with 361 fatalities, both eclipsing the SARS outbreak from 2002. Given that more than 99% of cases are in China, governments across the globe are enforcing new regulations to block visitors from China. The economic impact will be material, as many global supply chains will be impacted with these restrictions. Also, the Chinese traveler accounts for $277 billion in tourism spending, nearly double the U.S. at $144 billion. Given the growth of China’s economy and the rapid spread, economists are estimating that it could cut 0.2% from global economic growth this year, though precision at this point is difficult. Chinese markets opened for the first time since January 23 following an extended Lunar New Year holiday, with the Shanghai Composite Index down 7.7%, the steepest decline since August 2015.
Earnings season is half done, with 69% of companies beating on the bottom line and 65% reporting positive revenue surprises. If the current trend continues, it is possible that the S&P 500 Index reports a modest gain in earnings for the first time in three quarters. Eight of the 11 S&P 500 sectors are showing growth, led by 19% for Utilities, 6% for Communication Services and 5% for Technology. Energy has the most severe decline at -42%, followed by Industrials at -11% and Materials at -10%. Revisions for the first quarter are at the best level in six quarters through a combination of low expectations and fading headwinds. The outlook for 2020 has remained steady at 9% growth, with 4% expected in the first quarter.
Political noise has been largely ignored by investors, as the impeachment trial nears its end. A final vote is set for Wednesday, which will be after both the Iowa caucus and the president’s State of the Union Address Tuesday. With two-thirds of the Senate needed to remove the president, Trump is almost certain to be acquitted. In Iowa, Senator Sanders has overtaken Vice President Biden in the polls, though investors have shown little reaction to shifts in the democrat party primary.
Last week’s FOMC meeting drew little attention, and as expected, the committee voted unanimously to keep rates unchanged. Chair Powell’s comments suggested that current risks are weighed to the downside, including then uncertainty from the coronavirus and the difficulty in achieving the 2% inflation target. While the Fed’s outlook is balanced, Fed Futures markets are increasingly dovish. The curve embeds a 70% chance of a cut by June, double that from a month ago.
What to Watch
Economic data includes ISM manufacturing data on Monday, durable goods on Tuesday, ISM nonmanufacturing on Wednesday and the payroll report on Friday.
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