Why impact of virus on markets remains unclear

Uncertainty builds despite equity resilience and market set up for a correction

Why impact of virus on markets remains unclear

The full extent of the Coronavirus crisis on the markets is yet to be understood – although history points to a buying opportunity.

The epidemic is the tip of the iceberg as January got the new decade off to a wild start, according to Purpose Investments CIO Greg Taylor, who admitted his surprise at how North American equity markets weathered the storm and ended flat.

He did point out, however, that the CBOE Volatility Index (the VIX) reawakened to get back over 15, adding: “Investors had become complacent into year-end and nobody could have predicted the black swan event of a virus derailing global growth expectations. One month into the year and, so far, calls for an increase in volatility have proven accurate.”

Concern among investors is likely to increase the longer the Coronavirus claims victims and disrupts industry. Taylor said that, from a global growth perspective, the longer people are told to stay home and factories are shut, the harder it is to say there won’t be a hit to both supply and demand.

“Some markets priced this in very quickly, notably in commodities, where copper fell 10% and oil declined 15%,” he said. “[But] it’s much too soon to know what the overall impact of a shutdown in China will mean for markets and global growth. Past virus scares have proven to be an excellent buying opportunity, but there are no points for being early. Markets fear uncertainty and this is an example of an event not in the models. “

While equities held firm, other areas did not show such resilience. In two short weeks, oil moved from a spike over $65/bbl on Iranian threats to below $52/bbl on demand fears. Also, yields fell in the bond market, reclaiming much of the recovery seen at year-end. The benchmark US 10-year Treasury yield moved from close to 2% to finish around 1.5%. The yield curve is flattening back to levels close to what was seen last summer, which brought about recession fears.

It adds to the uncertainty as we barrel through February, having already had missiles flying between Iran and the US in the Middle East to an entire continent on fire in the midst of a heatwave and a rapidly spreading virus that has shut down borders.

Taylor said: “You could be forgiven for looking over the horizon expecting to find the Four Horsemen of the Apocalypse.”

But while the market ended flat, this was primarily down to record earnings from the tech sector.

Taylor said: “The market entered the year overbought and set up for a correction. So far, equities have weathered the storm very well. Will February be a return of the narrow momentum market of last year or will it prove to be a time to rotate to the oversold cyclicals that have priced-in the worst-case scenario?

“We’ve seen some similar themes play out early this year: a flattening yield curve, falling rates and tech leadership, to name a few. While this market undoubtedly feels long in the tooth, it’s hard to make a definitive call about when it’s going to end.”