Markets pause as the coronavirus outbreak adds volatility
JAN. 27, 2020
Markets have paused following an impressive period of strength and stability, as investors react to the continued spread of the coronavirus in China, with nearly 3,000 reported cases and 81 deaths. This has caused a “risk-off” trading environment, with a spike in the VIX, a rally in U.S. Treasuries, and a drop in global equities and commodities. Markets have spent much of the past six months rallying as exogenous risks (trade, yield curve, geopolitics) faded. The market strength resulted in a spike in investor sentiment, bordering on complacency, with the forward P/E reaching 18.6x (highest level since 2002) versus the 10-year average of 14.9x. This environment makes the market susceptible to sharp moves when new risks emerge, as is the case with the coronavirus outbreak.
Earning season has begun with a positive bias, with 73% of the S&P 500 Index reporting a positive EPS surprise and 67% beating revenue estimates. The current expectation is for a decline in earnings for the fourth quarter of 2% on revenue growth of 3%. That would bring the rate for the full year 2019 to flat on 4% revenue growth. An earnings acceleration is expected for the first quarter to 4%, with 9% projected for the full year. Utilities, Financials and Health Care should see the strongest growth this quarter, with Energy, Consumer Discretionary and Materials the weakest.
There are growing signs of stabilization in the global economy, with PMI data in Europe ahead of expectations. In the U.S., services PMI data continue to suggest expansion, while manufacturing PMIs struggle to recover. The IMF cut its outlook for global growth to 3.3% for 2020, down from 3.4% in October, with 2021 down to 3.4% versus 3.6% previously. A sustained impact from the coronavirus outbreak could put downward pressure on the global economy, as 56 million Chinese are facing travel restrictions. This comes at a bad time for China’s economy, as the Lunar New Year is a time of significant travel, and the government has been adding stimulus to drive consumer spending. In 2003, the SARS outbreak shaved several points off China’s GDP growth in the impacted quarters, and analysts forecast this outbreak could be a 1% drag on 2020 growth.
This week’s scheduled FOMC meeting has received little investor attention, signaling the degree that Fed uncertainty has faded from investors’ minds. There is little chance of a move in rates, with the Fed Futures curve implying a 13% chance that rates move 0.25% higher. For the full year, there is a 36% chance of one additional cut, a 38% chance of two or more cuts, a 23% chance of no move, and a 3% chance of a hike. Investors will be listening to Chair Powell’s commentary for guidance on the direction of the Fed’s balance sheet, which grew by nearly $400 billion since September.
What to Watch
Earnings will be a driver of headlines this week, as it is the busiest of the season. Economic data includes new home sales on Monday, consumer confidence and durable goods Tuesday, pending home sales on Wednesday, the initial read on fourth-quarter GDP on Thursday, and consumer sentiment, PCE deflator and personal income and spending Friday.
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