Equity markets beginning to reflect coronavirus threat
FEB. 24, 2020
As the coronavirus spreads, the odds that it goes from a headline concern to a fundamental headwind rise
Equity markets are beginning to catch up with bond and commodity investors in the view that the coronavirus will be disruptive to the global economy beyond the first quarter
With a market that is highly dependent on a 2020 earnings rebound, headwinds are emerging, including a rising dollar
Equity markets are beginning to catch up with bond and commodity markets in concern around the coronavirus outbreak, though a substantial divide remains. The outbreak is spreading beyond China (including Japan, South Korea and Italy), which raises the prospects for a drag on global growth. It is difficult to estimate the impact due to the uncertainty surrounding the scope and duration of the impact. The outbreak comes at a difficult time for the global economy, as signs had emerged that the environment was improving.
The S&P 500® fell last week, though remained less than 2% from an all-time high. The 10-year Treasury yield broke through 1.4% on Monday, and the 30-year yield is at a record low, reflecting the flight-to-quality in the period of uncertainty. Oil prices have fallen as global growth worries intensify, with gold prices hit their highest level since 2013.
Equity markets touched a record high as recently as last week as investors focused more on improving earnings than global uncertainty. At that point, the P/E ratio for the S&P 500 hit the highest level in 18 years at 19.0x, reflecting optimism in near double-digit growth in 2020. The ripple effect of the coronavirus outbreak could be a headwind to growth, as the global supply chain is disrupted and travel is curtailed. Also, the dollar index has spiked to the highest level since 2017 and near the highest since 2002 as the U.S. is seen as a safe haven. While a strong dollar should keep rates low and inflation controlled, it will also be a headwind to earnings, both in global competitiveness and translation of foreign earnings.
Bernie Sanders was the clear winner in the Nevada on Saturday, strengthening his position as the front-runner, and giving him momentum heading into Tuesday’s debate and the Super Tuesday primaries next week. Investors have been largely dismissive over Sanders’s rhetoric, betting that a moderate would ultimately emerge from the primary. Betting markets have dramatically shifted in favor of Sanders, with a 65% chance of winning the nomination. If the coronavirus outbreak causes recessionary conditions in the U.S., the odds of a Sanders presidency increase, which is not currently priced into markets.
The FOMC minutes were released last week with a balanced tone suggesting patience over the next rate move. Officials expect the economy to continue at a moderate pace. Positives include an easing of trade tensions, shrinking risks from Brexit and stabilizing global growth, though the coronavirus outbreak is a risk. While the Fed is not signaling a rate cut, the Fed Futures curve embeds a 75% chance of a cut by June, with a 70% chance of two-or-more cuts this year.
Domestic economic data was mixed last week, with a better-than-expected leading indicators index offset by a weak PMI. Outside of the U.S., Europe showed improving PMIs, while Japan was weak.
What to Watch
Economic data this week include consumer confidence on Tuesday, new home sales on Wednesday, durable goods, revised GDP and pending home sales on Thursday, and core PCE deflator, personal income and spending and consumer sentiment on Friday.
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