News on the coronavirus from ground zero – China – has been more reassuring recently: patient numbers have stabilised and the reported mortality rate is relatively low. Of more concern is the spread of COVID-19 to other continents. Contagion is stoking worries about global growth. The result is a flight to quality by investors at the expense of risky assets.
- Between 21 and 28 February, global equity indices fell by over 10%
- Expectations of cuts in key interest rates strengthened. On 28 February, the US Federal Reserve issued a brief statement that markets interpreted as signalling a cut in the near future
- At the end of February, 30-year US bond yields fell to all-time lows as investors sought safe havens. The yield on the German 10-year Bund finished the month at -0.61% (-17bp vs. the end of January), close to last August’s all-time low of -0.71%.
Market movements were increasingly driven by updates on the Covid-19 epidemic in February. Initially the stabilisation of the number of new cases reassured investors. The rapid reaction of the authorities, particularly rate cuts by the People’s Bank of China (PBoC) on 3 February, led to a significant rally in equities in the first half of the month.
Confronted with uncertainty, investors made an optimistic assumption (peak of the epidemic reached in the first quarter, a rapid rebound in activity after temporary business closures and travel restrictions). Announcements by the Chinese authorities appeared to support this optimism. As a result global equities rose by 4% between the end of January and 12 February (MSCI AC World index in US dollars).
A full scale reversal
In the second half of February, the trend reversed entirely. Market movements became much more erratic as new coronavirus cases outside of China came to light. News of outbreaks in South Korea and Italy was of particular concern.
Fears of a COVID-19 pandemic led to a sharp decline in stock markets from 24 February onwards. The fall was of a scale only seen three times since 1960 for the S&P 500 (during the crash of 1987, the first week of trading after 11 September 2001, and the worst week of trading during the Global Financial Crisis).
The VIX index, which measures the implied volatility of the S&P 500, rose as high as 50 on an intraday basis on 28 February, a level not reached since 2011.
Widespread declines in equity markets
Global equities fell by 8.2% in February, while emerging markets (MSCI Emerging Index in USD), which fell sharply in January, outperformed in February (-5.4%).
In the US, the S&P 500 lost 8.4%, with the energy sector’s underperformance linked to the drop in oil prices (-13.2% for WTI to under USD 45 per barrel), as well as falls in financials and utilities. Not surprisingly, the healthcare sector outperformed. The Nasdaq index posted a smaller decline (-6.4%).
Japanese equities underperformed (-8.9% for Nikkei 225 and -10.3% for Topix) due to the country’s proximity to the epicentre of the epidemic and Japan’s already weak economy. Transport (air, marine, land) and basic materials stocks fell sharply.
Eurozone equities lost 8.6% (EuroStoxx 50 index). Utilities and telecommunications outperformed thanks to the fall in long-maturity bonds yields. The Italian market underperformed due to an outbreak of the coronavirus in Northern Italy.
Exhibit 1: Equities in free-fall in February (data as of 28/02/2020)
Is the global economy already sick?
Economic indicators have not received much attention from investors. The publication of the flash PMI on 21 February could have been a trigger, but the purchasing manager surveys have sent contradictory signals.
In the eurozone, the improvement in the composite index was confirmed in February. In the US, it was the contrary: The composite index fell below 50 for the first time since October 2013 due to a sharp decline in services activity. It is still too early to say whether these results reflect a greater sensitivity of the US economy to the slowdown in China or simply anxiety among respondents. It should be noted that the surveys carried out by the regional offices of the Federal Reserve in the manufacturing sector had sent a more reassuring message. The real-time GDP growth estimate for Q1 (Atlanta Fed’s GDPNow) remained relatively stable at around 2.5% annualised (after 2.1% in Q4).
In China, the official PMI published by the National Bureau of Statistics was 35.7 in February for the manufacturing sector (after 50 in January). It was an all-time low. The non-manufacturing index plummeted from 54.1 to 29.6, reflecting travel restrictions to control the epidemic.
In Japan, the PMI fell by more than three points to 47 (preliminary estimate), which could signal a technical recession in the Japanese economy in Q1. Initial information shows that the tourist industry has been particularly hard hit.
Exhibit 2: Mixed message from PMI (Purchasing Managers’ Index) (data as of 28/02/2020)
A lack of visibility and investor nervousness in the short-term
The coronavirus epidemic presents a new and major risk to growth. As yet it is impossible to predict the consequences for the world economy. Economic data published in the coming weeks will of course be folllowed keenly but the situation is likely to remain uncertain for several months.
Investors will now look for any signs of a recovery in activity. If the next stage of contagion do not undermine the consensus scenario of a rapid catch-up after the first quarter (a “V profile”), confidence should return. The global economy should be able to withstand a temporary shock.
In addition, support measures may be imminent. The Federal Reserve’s statement in late February and those of the Bank of Japan and the ECB in early March suggested that even more accommodative monetary policies could be implemented quickly, and perhaps concertedly. This will likely reassure investors.
On 3 March the Federal Open Markets Committee (FOMC) announced an inter-meeting cut of 50bps. The decision was unanimous and markets the first inter-meeting rate cut since October 2008.
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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.