1. Coronavirus, what coronavirus?
Stocks may have had a subdued end of the week, but European and US stocks hit record highs last week even though coronavirus fears went into overdrive. When Chinese officials revised higher recent cases of the virus on Thursday, stocks took a tumble, however, they remain relatively unaffected by the pandemic that is gripping headlines around the world, and which has claimed its first victim outside of China after someone died in France. The situation remains fluid, the impact on growth in China, where thousands of cities remain in lockdown and where millions of people are in quarantine or strict curfew situations, is unclear. Although Asian stocks have taken the brunt of the sell-off, Chinese shares are down 6% since the first reports of the coronavirus, while in Hong Kong shares are down 4%, this is still fairly mild considering everything that is going on. The problem is that we don’t know what the impact on Chinese growth will be, the coronavirus is expected to have a larger impact on the economy than the Sars virus in 2003, but this is because China’s share of global trade is much larger now, at almost 11% of global trade. However, the impact on global supply chains is still unknown. China remains the world’s production powerhouse, where key global products are made, as well as consumed. Take Apple products, they have major production facilities in China, operated by Foxconn, which have only just opened after an extended break since Chinese New Year. This would normally cause investors to fret, not so this time, Apple’s share price is currently 4 cents below its all-time high. The same pattern is occurring across the world, even Toyota, based closer to the epicentre of the coronavirus, has seen its share price fall, but not by as much as expected, and it remains within its 6-month range. Some shares have struggled, for example luxury goods makers including Burberry, but they remain the exception rather than the rule.
So, do investors not care about the coronavirus? Investors do care about the coronavirus, as evinced by the increase in volatility this year, however, they have the ultimate card up their sleeve – the support of central banks. Traders across the world feel confident that if the virus gets any worse, or the economic impact deepens, then central bankers will come to the rescue. Weak growth and low inflation caused the ECB to re-start its QE program at the end of last year, the US cut interest rates in 2019 and remain ready to loosen monetary policy further if low inflation persists, Japan is also pumping liquidity into the global economy. This global tide of liquidity is propping up global stocks and protecting them from the worst of the coronavirus. Interestingly, the one central bank that may not come to the rescue is China’s PBOC. It implemented a one-off liquidity measure at the start of the crisis, but its hands may be tied as inflation for January rose above 5%. Thus, we may need to see a sharp slowdown in economic growth reports in the coming weeks before we see China loosen its monetary policy further.
Due to the market’s reliance on central banks, we believe that the Fed minutes released on Wednesday, are worth watching closely. The market will want to know if other members of the FOMC remain as dovish as Chair of the Federal Reserve Jerome Powell did when he testified to the US Congress last week.
2. Economic updates
We will have to wait until Friday, but PMI reports for February for the Eurozone, UK and the US are critical economic reports for traders in the FX and stock markets. Economists are predicting a small decrease in reports for February, after a general upbeat tone to January’s PMI surveys. These reports are important because they are likely to give us a better view of the global economic impact of the coronavirus. As we mention above, the markets have been incredibly tolerant of the coronavirus to date, but will signs of a larger than expected slowdown send shock waves through previously buoyant markets, in particular, the major stock indices?
We believe that weaker than expected PMIs could cause a sell-off in major stock indices at the end of next week, particularly if reports are worse than expected. On the FX front, the impact could be large on the euro. EUR/USD fell below the $1.0850 level, a 3-year low, at the end of last week, which is a key sell signal from a technical perspective. Momentum is to the downside for EUR/USD, as the euro remains the funding currency of choice ever since the ECB restarted its bond-buying programme at the end of last year. The dollar is also in demand, partly because US Treasuries are the safe haven asset of choice in Asia, and also because the coronavirus has reinstated the US dollar’s dominance as the world’s reserve currency, with the euro and the Chinese renminbi unlikely to overtake the dollar’s influence any time soon. Weak European PMIs could send EUR/USD below $1.08, with $1.06, the low from March 2017, a key support level in the medium-term.
3. Earnings season – the next big challenge
Earnings season for Q4 2019 is drawing to a close, so how worried are corporations about the coronavirus? According to FactSet, who trawled through transcripts of 364 S&P 500 companies who have reported Q4 earnings between January 1- February 13, 138 mentioned the coronavirus during their calls. The industrial, Information Technology and healthcare sectors were the sectors who referenced the coronavirus the most. Of the companies that mentioned the coronavirus, the average revenue exposure to China is 7.2%, for all S&P 500 companies the average revenue exposure to China is 4.8%.
Of these companies, 25% modified their forward guidance based on the coronavirus, although a majority said that it was still too early to quantify what the effect would be. So far, companies that have issued forward guidance have been less negative than normal, but the fact that 75% of companies that sound concerned about coronavirus had not changed their forward guidance, is worrying. If the economic impact from the virus looks like it has impacted Chinese consumption or that it is causing prolonged production delays for US companies who base some or all of their manufacturing in China, then we may see a rush of companies update their forward guidance in the coming weeks.
Thus, the coronavirus remains an ongoing concern for US stock markets, and even though they reached record highs last week, if they update their forward guidance due to fears about the virus, and if they sound more negative than they did during Q4 earnings season, then investors and traders could easily lose confidence, triggering a sharp pull back in US stocks. Thus, US stock market bulls should remember to protect themselves, this rally could be vulnerable.
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