Financial market movements over the last two weeks of January have marked a ‘risk-off’ phase and a flight to safety by investors. This is clear from the decline in equities as well as gains in government bonds, the Swiss franc and gold. Talk of a panic would be going too far, though.
- With economic indicators still encouraging and a better-than-expected start to the earnings season in the US, stock markets began the year prolonging their upward trend of late 2019
- The official announcement by the Chinese authorities on 21 January that the pneumonia-like coronavirus is capable of inter-human transmission marked the beginning of the decline in equities.
- This decline in sentiment led to a fall of 1.2% in the MSCI AC World index and of 4.7% in the MSCI Emerging index (in USD terms).
Tensions between the US and Iran early in the month bumped oil prices up, but equity markets’ qualms over that were short-lived. As of 17 January, the MSCI AC World index (in USD terms) was 2.5% higher than at the end of 2019, perhaps a sigh of relief at the signing of the Sino-US Phase 1 trade agreement a couple of days earlier.
Markets then turned down as global equities reacted to news of the coronavirus outbreak in China. Investor jitters were fuelled by the accelerating impact of the virus and comparisons with the 2003 SARS epidemic.
These worries were compounded by speculations about the direct effect on economic activity in China and Asia, possible disruptions in production chains and trade, and how much all this would knock economic agents’ confidence.
In the second half of January, the equity market fell almost without interruption, and steeply across Asian equities (Hong Kong in particular). In addition, the closing of Chinese markets for the Lunar New Year holidays limited visibility.
Fears that the epidemic would have a lasting impact on global economic growth also caused a drop in oil prices. WTI finished the month at USD 51.6 a barrel, down by 15.6% compared to the end of 2019.
Developed equity markets – slippage, not free-fall
Within developed markets, the major US indices fell only slightly, by 0.2% for the S& P500 and 1% for the Dow Jones 30. The Nasdaq even rose by 2% thanks to the good results of several iconic tech companies. The sharp decline in the energy sector as oil prices fell and, to a lesser extent, in basic materials and financial stocks, weighed on the overall market.
Despite the worries about the coronavirus in Asia, Japanese equities only slipped slightly (Nikkei 225 -1.9%), perhaps thanks to the good news published at the beginning of the month on Chinese exports, which were encouraging for Asia as a whole. However, sectors whose activities relate to international trade and travel encountered difficulties.
Eurozone equities fell by 2.8% (EuroStoxx 50 index) led by the significant fall in several cyclical sectors (basic materials, automobile construction) and banking stocks were hit by the further fall in long-term rates. The UK Footsie 100 lost 3.4% while the Swiss market remained resilient (+0.1% for the SMI).
Exhibit 1: Bonds gained and equities gave up ground as investors became more risk-averse – graph shows January’s total returns (in %, in local currencies as of 31/01/2020)
Long-term yields fell sharply
The flight to safety caused by fears related to the coronavirus in China led to a clear fall in long-term interest rates. The yield on the 10-year US T-note, which stood at 1.92% at the end of 2019, ended at a five-month low of 1.51%, a monthly easing of 41bp.
The yield on the German 10-year Bund ended the month at -0.43%, its lowest since mid-October. This 24bp monthly easing reflected the equity markets’ woes and concerns about global growth in connection with the coronavirus outbreak in China.
It was accentuated at the end of January by disappointments about eurozone GDP growth in the fourth quarter, particularly the slight contraction in activity in France.
The rise in government bonds did not do justice to the improvement in other economic indicators (business surveys and hard data on consumption and employment), which pointed to growth close to potential in 2020. The fall in interest rates was widespread.
Exhibit 2: Risk-off stance reverses fourth-quarter 2019 steady rise in government bond yields – graph shows recent trends in 10-year yields (US and eurozone) as of 31/01/2020
Despite the coronavirus crisis, downside economic risks have receded
The year began with the eruption of a dramatic and unpredictable event, one that was external to the economic and financial sphere. We had already stressed the importance of the politics as a market factor in this US election year and reiterated that the signing of Phase 1 of the Sino-US trade agreement would not mark the end of protectionist policies.
In late January, the World Health Organization declared the epidemic coronavirus 2019-nCov a ‘global health emergency’ without recommending any travel or trade restrictions. Investors fear the consequences for economic growth, Chinese and global, of a possible pandemic.
This event also served to crystallise uncertainties that remained latent despite the sharp rise in equities in 2019. It is still too early to assess the effects of the coronavirus outbreak on activity and confidence, but the recent improvement in economic data seems convincing to us for now.
We are likely to see large swings in equities over coming weeks but, given the good fundamentals of large economies and the still dovish attitude of major central banks, there could be buying opportunities.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.