Global equities are far from immune to the coronavirus

Brian Nick

The last week’s market highlights:

Quote of the week:

“Shoeless” Joe Jackson: “Is this heaven?”
Ray Kinsella: “No. It’s Iowa.” – From “Field of Dreams”
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2020 Outlook :
  • U.S. economy: No recession in sight. 
  • Global economy: A clearer path for growth.     
  • Policy watch: Fed looking to stand pat as Brexit and trade risks abate. 
  • Fixed income: Low yields, tight spreads.   
  • Equities: Cyclicals and eurozone stocks set to lead. 
  • Asset allocation: No big bets with valuations rich in most spots.

Policy watch: Little fanfare from the Fed to start 2020

To no one’s surprise, last week the Federal Reserve (Fed) maintained the target range for the federal funds rate at 1.50%-1.75%. This was the second consecutive meeting at which the Fed declined to reduce interest rates after cutting them three times last year. That 2019 policy easing appears to have loosened financial conditions, enabling the Fed to bide its time before determining when—and what—its next move should be.
The Fed’s few changes to its policy statement included downgrading its description of consumer spending growth from “strong” to “moderate” and no longer describing inflation as near its 2% target. Markets interpreted these adjustments as incrementally dovish. The yield on the 2-year U.S. Treasury note, which tends to track expectations for Fed policy, fell 3 basis points (0.03%), to 1.42%, on January 29.
In his post-meeting press conference, Chair Jerome Powell expressed cautious optimism about the global economy, noting “signs and reasons” supporting a rebound. And while Powell mentioned the coronavirus outbreak as a new source of uncertainty, he’s taking a wait-and-see approach regarding its impact on global economic activity.
We think this patient stance will extend to the Fed’s decision to either raise or lower rates. Last week, the government reported that the economy grew at a better-than-forecast 2.1% annualized rate in the fourth quarter and 2.3% for 2019 as a whole. If the U.S. continues to expand at or around that pace, it’s likely the Fed will stay on hold throughout 2020.
Markets disagree, according to the latest fed fund futures reading. As of Friday, this measure—used by traders to bet on the direction of interest rates—reflected a 100% chance that the Fed will cut rates twice in 2020, rather than remain on the sideline. The odds of a rate reduction occurring in March, which were just 2% as recently as one week ago, have crept up to 31%.5
As we see it, the Fed might consider further easing only if the U.S. economic outlook deteriorates unexpectedly and materially. Given improving U.S. housing data and resilient consumer spending, that doesn’t appear likely, in our view.

How might the Coronavirus affect portfolios? It’s hard to tell. 

With the Chinese government confirming nearly 1,400 severe cases and 170 deaths from the coronavirus, there’s no denying the humanitarian crisis at hand.6 At the same time, investors can’t be blamed for wondering how the outbreak might affect their portfolios. The coronavirus has stirred memories of the November 2002-July 2003 spread of SARS, another deadly illness that first appeared in China and slowed its economy.
What investors might not recall, though, is that U.S. equities shrugged off the SARS outbreak. The S&P 500 Index, for example, gained 10% during that epidemic.7 How might the index perform before the coronavirus is stopped? Unfortunately, comparing market backdrops is unlikely to provide much guidance. Here’s why:
  • Equity valuations are far more stretched now than they were during the SARS period. This provides less room for a rally when the disease is eventually contained, and greater scope for a drop should sentiment decline sharply. To illustrate, the price-to-earnings ratio of the S&P 500 Index stood at 18.0 on January 1, 2020. In contrast, that ratio was a much lower 14.8 on January 1, 2003, as the index had yet to fully escape from the three-year bear market dating back to 2000.8

  • Although the global economy today is somewhat less vulnerable to shocks—thanks to easier financial conditions and lower interest rates worldwide—China now plays a far greater role. Given Chinese GDP of $13.6 trillion at the end of 2018 (versus just $1.7 trillion in 2003, during the SARS outbreak), a deceleration of growth there would be far more damaging.9
Amid reports of the coronavirus spreading, large international firms are limiting travel to China, and retail operators like McDonalds, Starbucks and Apple have either reduced store hours or closed locations entirely. As a result, China’s GDP could take a 0.5% hit in the first quarter, according to some estimates. The economic pain could easily spill over to the U.S. and Europe—China’s main trading partner—via lower exports and reduced tourism, as millions of Chinese have been restricted from leaving the country.
Last week, coronavirus fears dominated market sentiment. Despite strong earnings reports from Tesla, Amazon, Apple and McDonalds, the S&P 500 ended its worst week (-2.1%) since last August. Europe’s STOXX 600 Index (-3.1% in local terms) was also hurt by a softer-than-expected GDP report showing that the eurozone had expanded by just 0.1% in the fourth quarter. Chinese stock markets were closed last week for the Lunar New Year holiday. We anticipate a rough ride this week when they reopen.
The risk-off mood benefited safe haven assets such as U.S. Treasuries. The yield on the bellwether 10-year note, which began the week at 1.70%, tumbled 19 basis points (0.19%) to close at 1.51% on January 31. (Bond yields and prices move in opposite directions.)
  1. S&P data (Haver, MarketWatch); utilities (Bloomberg, Morningstar)
  2. STOXX 600 (Bloomberg)
  3. BEA
  4. All Treasury data (Treasury.gov) 
  5. Bloomberg, Federal Reserve
  6. World Health Orgainzation (WHO)
  7. WHO, Haver 
  8. Bloomberg
  9. Federal Reserve Bank of St. Louis
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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