What led to the market sell-off this year?
While new coronavirus cases are growing less rapidly thanks to the progress achieved in China, fears of a global pandemic are rising, as the number of new cases outside China is now outpacing that of new cases in China.
As if the coronavirus outbreak wasn’t enough to deal with, on Monday crude oil had its biggest one-day drop since the 1991 Gulf War after Saudi Arabia launched an aggressive price war after OPEC negotiations fell through. This move sent rattled stock markets plunging and spurring a rush into government bonds as investors sought havens.
The cherry on the cake came Wednesday evening when President Donald Trump announced a ban on travellers to the US from Europe for the next 30 days.
What started as a virus-driven de-risking has now mutated into a broad-based, multi-asset capitulation.
Did you see large discrepancies among different sectors during the sell-off?
At the start of the sell-off, all sectors were severely impacted. However, sector drops have been very homogeneous. Defensives (telecommunication services, consumer staples, healthcare) outperformed cyclicals and financials, helped by a collapse in long bond yields.
However, this outperformance was not that big, and lower than expected, suggesting a lot of indiscriminate selling. The current pattern is actually very similar to that of December 2018.
What we also noticed was that emerging markets equities outperformed developed markets as fears moved from China to Western countries.
At the start of last week, following the steep drop in oil prices, big energy groups came under acute pressure. Shares in BP and Royal Dutch Shell lost about a fifth of their value in London trading. Smaller oil companies fell more sharply, with the UK’s Premier Oil collapsing in value by a half.
Which sectors were the worst performers this year?
Travel and leisure, oil and gas, basic resources, auto and parts and banks were the worst performing sectors. The sectors which fell at a lower rate were utilities, healthcare, telecommunications, technology and food and beverage.
Why is a low oil price an issue for the markets?
Oil was already under pressure due to lower demand caused by the disruption on global economic activity by the coronavirus. The price war is expected to accelerate the slowdown in economic growth of exporting countries. A low oil price is also deflationary. So, all the things that central banks have been striving to avoid deflation, is brought forward.
The biggest threat at this stage is oil prices falling to operational levels for high cost producers with costs to extract oil near $20 a barrel. This is threatening the US shale industry and increases the probability of oil companies going bankrupt as banks – under pressure because of their exposure to the oil and gas industry – step away from lending to these companies.
Has the market bottomed?
It appears we have reached the panic stage of this decline and the markets have undergone quite a bit of technical damage already that will likely take some time to fully repair. I want to see actual bottoming signs before I worry about trying to buy the low. My message for the last few weeks has been about protecting what you have rather than trying to make more. That is still my message for now.
Markets are short-term oversold, however we are of the view that that they have not reached capitulation levels yet. Fears are unlikely to abate as long that there is no turning point in new contamination cases.
What is the state of the Chinese economy?
First quarter GDP contraction could probably be as high as five per cent (annualised). This bleak forecast has unfortunately been confirmed by the awful February PMI figures.
China manufacturing PMI plunged to 35.7. The drop in the non-manufacturing index was even more pronounced (to 29.6 from 54.1, the previous low being 49.7 in November 2011).
On the positive side, albeit slow, the activity normalisation process seems to take place with some factories reopening, thus alleviating the tensions on the supply chain.
The Chinese GDP contraction gives us an idea of how much the US and Europe economies could contract should similar containment measures be needed to fight the pandemic.
Do you think there will be a global economic recovery?
The essential question for financial markets is the shape of the subsequent global economic recovery (V, U or even L for the most pessimistic). We still favour the V-shaped recovery.
In our view, the impact of a pandemic should only be felt over one or two quarters. This is a much shorter period than that of an outright recession.
Why didn’t the markets cheer the rate cut by the Federal Reserve?
The US Federal Reserve surprised the markets by cutting interest rates by 50bps in response to economic risks arising from the global coronavirus outbreak. The decision was unanimous among the Fed board members and represented a rare out-of-cycle Fed rate cut.
With the Federal Reserve dramatically cutting interest rates, we need to stop assuming that the coronavirus outbreak will have only a minor impact on the US. With the virus that causes COVID-19 now spreading in communities around the country, it’s becoming more likely that the epidemic will slam consumer spending, at least for a few months.
Last Thursday, European Central Bank president Christine Lagarde followed through on her pledge to counter the economic shock of the coronavirus outbreak with a stimulus package that included more bond purchases and loans for banks but not an interest-rate cut.
Are companies issuing profit warnings?
Apple has drawn the first blood, but it will be far from the last. Tesla opened its Shanghai factory at the end of December. Nike and Disney are also heavily dependent on the Chinese consumer. There will be more such warnings in the weeks to come.
German sportswear makers Adidas and Puma warned of a major decline in sales in China due to the coronavirus. Carnival’s Princess Cruises suspended all operations for two months due to concerns over the COVID-19 pandemic.
Are equities cheap now?
The PE has borne the brunt of the adjustment. Valuation have become more reasonable. Following corporate warnings on earnings, analysts are revising down their estimates for 2020. The magnitude of these revisions remains an open question however as we do not have any visibility on the duration of the epidemic.
Which stocks would you start looking at given current valuations?
With equity markets in bear market territory, there are many stocks out there, which start to look attractive. If investors are tempted to start entering the market, the advice is to do so in batches rather than at one go.
Some individual names of international stocks, which we like at current prices include Amazon, ASML, Alphabet, Home Depot, Microsoft, Sanofi and SAP. There are interest names to look at also in the local market. Equities like RS2, GO, PG, Tigné Mall, Simonds Farsons Cisk and HSBC are on our radar.
I suggest also looking at exchange traded funds. One which stands out at this point in time is the iShares Edge MSCI World Minimum Volatility UCITS ETF. The ETF is composed of selected companies from developed countries that, in the aggregate, have lower volatility characteristics relative to the broader developed equity markets.
What is your outlook for the equity markets?
For the time being our base case scenario remains one of a severe but short-lived shock. Before the epidemic, the global macro backdrop was favourable (growth recovery and policy support).
Hysteria regarding the COVID-19 epidemic has brought the valuation of equity markets more in line with macro fundamentals. The repricing can continue for a while.
However, we expect a V-shape recovery (liquidity, macro improvement) but the timing remains unclear as the epidemic’s turning point is not in sight and damages on global growth difficult to assess.
Disclaimer
The information, views and opinions provided in this article are provided solely for educational and informational purposes and should not be construed as investment advice, tax or legal advice. This article was issued by Calamatta Cuschieri Investment Services. For more information visit https://www.cc.com.mt.