7 minute read
There are four main market narratives around the coronavirus theme, all interrelated. Jim McCormick, Global Head of Desk Strategy assesses each one.
Some are right, others less so
As the coronavirus continues to spread outside of mainland China, there has been lots of talk about the threats, risks and how the novel virus will impact global economies and markets. There are four main market narratives, all of which are naturally interrelated, but each worthy of separate discussion. Some I agree with, others less so. Here are the highlights:
- Impact on global growth: The hit to near-term global growth will be significant and will remain a drag on industrial commodities, Asian currencies/equities and commodity-linked currencies. A rough estimate for the February global manufacturing Purchasing Managers Index (PMI) is 47.5, with more downside risks in March and increasing risks of a slower recovery.
- Policy easing from central banks: Markets should not expect broad-based policy easing across G10 countries, although coronavirus tilts the odds more in favour of our base case of two US Federal Reserve (Fed) interest rate cuts this year
- Equity market recovery: As we discussed several weeks ago, equity market resilience looked very tenuous and with a quick recovery looking less likely, risks are now even more pronounced.
- US immunity: Given the risks to global equity markets, it looks as though the US can no longer be considered immune from coronavirus threats. In fact, the US dollar has been a relative winner from coronavirus, but some downside risks are bubbling just below the surface
1. Impact on global growth
Market narrative: Markets linked to growth will be most impacted
Jim’s view: Some good news, but mostly bad
The first market narrative is that coronavirus will be a big hit to near-term economic growth and to those markets most closely linked to growth, especially industrial commodities, commodity-linked currencies and Asian currencies and equities. Although these markets have been badly hit, they will struggle to recover until the magnitude and length of the growth impact is better understood.
Manufacturing PMI data
We have broadly agreed with this narrative before and based on new available data, there is some good but mostly bad news on the near-term growth outlook. Based on the February flash PMI data, our best-guess estimate for the February manufacturing PMI is around 47.5, up from our initial estimates of 46. This would be a level not seen since 2009. It is also pretty much the extent of the good news.
The bad news is that the globalisation of coronavirus in recent days suggests an even lower PMI in March, and most likely a slower recovery. Our best guess is the negative growth impact will be felt well into the second quarter of this year. In short – we don’t see much respite for those asset prices most linked to the economic growth shock.
Our best guess is the negative growth impact will be felt well into the second quarter of this year.
2. Policy easing from central banks
Market narrative: Expect a quick response
Jim’s view: Action will come, but not immediately. And in Europe, it should be fiscal
The second narrative is that central banks will be quick to respond to the growth shock by easing policy again. We agree with this, but only to an extent. Asian central banks are already easing and this is likely to continue (the Bank of Korea passed on cutting this week but left the door open). G10 central banks are more reluctant and will remain so. As a start, recent data has been surprisingly resilient, in Europe especially. This will change, but take time to show up in hard data.
Central bank action
The main take away here is that more monetary policy easing is unlikely to be very helpful in cushioning the impact. We wouldn’t expect a major central bank response, certainly not so in Europe, especially by the European Central Bank. Indeed, as the coronavirus has become front and centre for the region, the debate has focused more on the need for a fiscal response, rather than a monetary one.
We still believe the US Federal Reserve (Fed) will ease policy later this year and the rise in coronavirus anxiety has brought the market in line with our view. But coronavirus on its own is not (yet) a sufficient condition for Fed easing – it will need to combine with more domestic US stress. This is likely coming, but perhaps not quickly enough for the market.
3. Equity market recovery
Market narrative: The fall in equity market will recover quickly
Jim’s view: Slower recovery is more likely
The third narrative is that the coronavirus impact would see a quick recovery for declines in equity markets, similar to past virus-related episodes (such as the 2003 SARs episode). We call this a ‘V- shaped’ recovery. I disagree with this and see a much slower rate of recovery – a ‘U-shaped’ recovery.
For one thing, the quick V-shaped recovery scenario is no longer as certain. Coronavirus has already safely surpassed the SARs episode in both numbers and geographies. And while the response by various governments looks reasonable, it will hit economic growth substantially for what is likely to be an extended period. The fact the world is far more interconnected than it was in 2003 further complicates things.
The fact the world is far more interconnected than it was in 2003 further complicates things.
Irrespective of how the growth trend evolves, it has been clear for some time that risk assets have diverged a fair distance from the global business cycle. If you look at our growth asset framework, our estimate of the global Morgan Stanley Capital International (MSCI) Index drop needed to fully reflect the expected decline in actual growth is somewhere north of 15% (chart below). Maybe it doesn’t fall that far. But I don’t think anyone can claim that global equity prices are well positioned for a sustained shock to global growth. Recent performance is clear enough evidence of this.
Rolling change in global manufacturing PMI (with Feb/March estimates and % change in the MSCI World Index
Source: NatWest Markets, Haver, Bloomberg
4. US immunity to coronavirus risks
Market narrative: The US equity market should be more immune than other countries
Jim’s view: Valuations are stretched
The case has been made that the US equity market should be more immune to the coronavirus risks, partly because of its heavy composition of big tech and partly because the US economy should be more immune to the coronavirus growth shock. Both of these arguments are reasonable, but only to a point. US equity valuations are very stretched according to common valuation measures – both the forward Price-to-Earnings (P/E) multiple and the longer-term Shiller P/E multiple were at multi-year highs just a few weeks ago.
Market narrative: The US dollar is strong
Jim’s view: Risks are prevalent
This leads me to the last narrative – that the US dollar is strong in the current coronavirus backdrop. In the first, more regionally-centred stage of the coronavirus story, the US dollar was a clear holding up, understandably so. And even in the current, more globalised version of the coronavirus theme, you can make a case the US dollar is still doing well, partly for safe-haven reasons and partly because the US economy remains relatively sheltered, at least for now.
…you can make a case the US dollar is still doing well, partly for safe-haven reasons and partly because the US economy remains relatively sheltered, at least for now.
Watch out for the data and of course, the election
That said, I think there are dynamics coming to the surface that look a little less dollar positive, and certainly inconsistent with the very low level of foreign exchange volatility. For one thing, the ebb-and-flow of US data has been more mixed recently. Perhaps more importantly, the US election is now heating up, and already it looks like early market expectations have not been going to plan.
Our base case remains that it will be a close election no matter the Democratic candidate and this will lead to a bout of market and business anxiety in the run up to the November election. This, along with the expected Fed response, remains the big risk for the US dollar this year.