Trading Volatility: Resist the temptation to pick tops and bottoms

• Market base assumption is a swift decline in global growth.

• Duration and extent of slowdown is unknown.

• Where might signs of recovery emerge?

A quick Q&A on the economics of the coronavirus

What a trader wants is the right side of a new trend. It is not necessary to pick the turning point.

Remember. If you get 50% of any move you have done your job.

Has a basic assumption changed to enable a new trend?

In the current case, the base assumption of the credit, currency and equity markets is that the Coronavirus will force a serious decline in global growth. 

Is there any proof?

Yes but only in China, February manufacturing PMI was 40.3, services 26.5 and imports and exports were down farther than forecast. Fixed asset investment, industrial production and retail sales were much worse than predicted. Sales were off 20.5% on the year, but with much of the country under quarantine or restriction that is hardly a revelation.

China Retail Sales (YoY)

FXStreet

For the US only Michigan preliminary consumer sentiment for March is out and at 95.9 it was slightly better than expected. Though it is down from 101 in February it is in the middle of the elevated range of the last three years.  

According to the statement accompanying the release, “perhaps the most important factor limiting consumers' initial reactions is that the pandemic is widely regarded as a temporary event.”

However, as Richard Curtin the chief economist of the survey observed, the component that fell the most was that which measured the prospects for the economy in the year ahead. This dropped by 29 points and constituted 83% of the decline in the overall index.

Michigan Consumer Sentiment

FXStreet

As closings and possible layoffs emerge in the United States a decline in consumer sentiment seems likely and that will carry over into spending.  If quarantines affect many locales the economic burden and the drop in sentiment will be greater.

Certainly, stocks are convincingly panicked that a recession starts in the second quarter. On the other hand, there is the old saw about the stock market have picked 10 of the last three recessions.

What factors might indicate a change in trend?

China seems to have controlled its outbreak. There are reports from non-Chinese sources that factories are reopening.  If true the supply disruptions for factories and stores in the rest of the world will be transitory.

Will that be sufficient to end the market panic?

Probably not. Even though it was the expected decline in Chinese production and its ripple effect around the global supply chain that was the original event that drove markets lower that has been replaced by a much more emotional fear, the spread of the virus in Europe and the United States.

It is this second development that is pushing equities and credit to extremes.

Do temporary quarantines in Europe and the US have the potential to reduce global growth?

Of course. The severity depending on the length of the disruption.

Will some industries be struck much harder?

Yes. Airlines, always a low margin business will probably need government help to survive. Anything connected to travel is in for a rough time.  It is even possible that there will be long term changes in the way people view overseas adventures. Retail sales in malls and stores will take another difficult charge, but that sector has been evolving rapidly for the past 15 years.

On the other hand, Amazon is looking to hire 100,000 workers to handle its explosion of sales. Delivery companies will continue their prodigious growth of the past decade and there will be many other beneficiaries from gene tech firms to home entertainment.

So far there is a great deal of speculation and very little proof about the economic impact.

What might convince markets that the actual impact will be far less than the feared?

China first. If the Chinese economy recovers quickly then there will be no reason to assume the West, Japan and Korea will not do the same.  

That could be the beginning of a new trend.  But markets in the US and Europe will not likely act on that until there is evidence their own outbreaks are submitting to control.

Remember, if you can provide a logical structure for the change in trend and if there is evidence, even if very preliminary, then you are not picking tops and bottoms but choosing a new market direction.    

That is something every trader can get behind.