Global Weekly: Coronavirus drives markets downward

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The further spread of the coronavirus around the globe caused higher volatility and lower stock prices this week. Investors were not calmed by some relatively better economic data or the prospect of central bank intervention.

Surprisingly, US February Markit Services PMI data was below expectations. Strong readings from services activities have been one of the pillars of the stock market’s performance over the past year. The data therefore disappointed investors. In Europe, the manufacturing slump seemed to ease despite the coronavirus threat, while the dominant services sector also showed resilience. In Germany, the February Ifo producer confidence data confirmed the bottoming out process.

On a sector level, technology stocks were among the main victims of the selling spree. Fears of longer-term supply chain disruptions were fuelled by the growing number of coronavirus infections in South Korea and other countries in Asia. Travel and transportation companies have been suffering from the virus outbreak for a while now, but the strongly performing technology sector initially showed resilience.

We also see the financial consequences of the outbreak on the company level, as management outlooks have dimmed and additional cost cutting actions are being taken to partly mitigate the effects on the bottom line. The virus outbreak in China is hurting Microsoft more than expected, as the company on Wednesday said it will not meet targets that had already factored-in the uncertainty. On Wednesday, online travel agent Booking indicated the coronavirus outbreak has had a significant and negative impact across its business during the first three months on 2020. The company also said that it is not possible to predict the extent of the impact on travel patterns. KLM (Air France KLM) is also taking measures related to the effects of the outbreak, including limiting the hiring of temporary staff and consultants, postponing investments and asking operational staff to take days off.

Bonds: Rally in the face of uncertainty

US Treasuries gained over the week, leading to a global bond rally as investors increasingly bet on central banks easing their monetary policies to cope with the global impact of the coronavirus outbreak. US Treasury ten-year yields dropped to a new 1.292% record, after the US warned of the possibility that the virus is circulating in the US. Meanwhile, infection counts mounted in Europe and Asia. The markets are struggling to forecast the future economic impact of the outbreak. As a consequence, inflation expectations are falling too. For some countries, this could lead to a much lower growth outlook, which could eventually lead to a certain form of recession. Therefore, an additional political debate could start, in certain countries, to make fiscal stimulus an additional measure, given that it can be quickly implemented and specifically targeted.

For now, the market is waiting for confirmation from central banks that they will act. Over the past weeks, markets were dominated by rate cuts from numerous emerging-markets central banks, with the potential for the Bank of England and Peoples Bank of China to lead the moves in the coming months. Concerns over a global economic slowdown have resulted in markets implying two rate cuts by the US Federal Reserve by year-end. For us, this has happened too quickly. The cause of the move is a fear of a pandemic. That said, it is understandable that there is a flight to safety, and with bonds hardly providing yield, gold could see new higher levels as a consequence.

Our take is, yes, there is a reason to buy ‘insurance,’ but, equally, given the uncertainty, investors are unlikely to be willing to sell bonds, even if they disagree with the values. Liquidity could therefore become an issue to trade the strategy you want. As a trader, you might want to go with the trend, but we would rather take a fundamental view on value. The coronavirus outbreak could be a one in every 10- to 20- year event. History suggests that an overshoot is likely. We recently increased our allocation towards positive-yielding investment-grade corporates and hard currency emerging-market debt. We remain positive on these allocation preferences.

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