Last week, we learned that investors were still brave enough to continue with a ‘buy-the-dips’ mentality in equity markets. All three major US indices made new record highs on Thursday with the S&P 500 up 3.2% for the week, its best performance since June 2019. It wasn’t just Wall Street that saw solid gains, similar patterns were seen in Europe and Asia.
It seems investors have returned to risk assets, despite the spread of the coronavirus showing no evidence of abating. This clearly reflects their trust in central banks, in particular the Federal Reserve, who they believe will always step in when the global economy shows any signs of weakness.
This kind of way of thinking is alarming, as central banks cannot influence the supply side of the economy, especially when it’s hit by uncontrollable factors. If the coronavirus doesn’t get contained, the supply chains will be severely disrupted, not just in China but across the globe. While it is difficult at this stage to measure the effect on global growth and corporate earnings, there will definitely be a significant impact.
Even if the spread of the virus is controlled and we avoid hitting the tail risks, the cost of recovery is going to be high. Some economists are now fearing the global economy may experience it’s first quarter-on-quarter growth fall since the global financial crisis. When risk assets are priced for perfection, it’s difficult to believe they can hold for so long.
The Dollar’s value had been steadily appreciating even before the coronavirus outbreak, but it strongly rallied at the beginning of February taking it’s year-to-date gains to 2.3% against a basket of major currencies. Emerging market currencies followed a corresponding downward trajectory with the MSCI emerging market currency index lower by 1.6% since mid-January. This may complicate issues for many emerging economies who have huge borrowing in US Dollars. It will also have a negative impact on US corporate earnings as a stronger dollar leads to currency losses from foreign sales and also makes products less competitive.
That said, investors do not need to panic and liquidate their equity portfolios, but it may be a good time to review their asset allocation, current positions and whether to consider buying insurance against a 10-15% drop in prices. Growth stocks will likely be hit the most in case the global economy slows significantly in Q1. Meanwhile, gold remains one of the preferred assets in difficult times so if it’s not a part of the investor’s portfolio it’s still not too late to add it.