If equity markets are nervous, they’re not showing it  

Brian Nick

The last week’s market highlights:

Quote of the week:

“Nearly all men can stand adversity, but if you want to test a man’s character, give him power.”  – Abraham Lincoln
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.

Equities say, “Go!” Other asset classes say, “No!”   

Educator William Arthur Ward once quipped, “A pessimist complains about the wind; the optimist expects it to change.” We thought that line accurately describes the way financial markets have reacted to the coronavirus outbreak: some have shown great concern, while others—stocks in particular—have largely shrugged it off.
Last week, investors maintaining a glass-half-empty standpoint likely latched on to a February 9 statement from the World Health Organization that the number of confirmed cases of the coronavirus outside of China could be just “the tip of the iceberg.” That assessment was followed a few days later by news that Chinese authorities were changing their diagnostic criteria for counting new cases of the virus, leading to a surge in the number of people confirmed to be infected. In short, the true scope of the human toll remains unclear.
But while it’s impossible to predict the path of the disease or the total number of people it will ultimately affect, certain economic headwinds are coming into focus. Among them:
  • Tourism will tumble. Airline carriers around the world have canceled flights to and from China. And it’s not just the travel industry itself that stands to lose. Chinese tourists like to open their wallets while vacationing. According to the Wall Street Journal, they spent about $275 billion abroad in 2018, with a healthy chunk of that total going toward luxury items. Destinations like Japan may be particularly hard hit, as the country was counting on a heavy influx of Chinese visitors for the 2020 Tokyo Olympics, scheduled to begin in July.

  • Global supply chains will suffer. Closing Chinese businesses and ports to curb the spread of the disease will hurt companies and economies worldwide. Wuhan, the epicenter of the virus, is a hub for manufacturing and foreign investment. Beyond the manufacturing sector, drug companies are also likely to come under pressure. India, the world’s biggest exporter of generic drugs, depends on China for around of 75% its raw pharmaceutical materials.4

  • Calendars will see “cross outs.” One key example is the cancellation of Barcelona’s annual Mobile World Congress, a major European telecom conference originally scheduled for February 24. This conference creates about 14,000 temporary jobs and generates around €500 million (about $540 million) for the Spanish city, according to the Financial Times.

  • Consumer spending will contract. Malls in China have emptied out as major retailers such as Levi Strauss, Ikea, H&M, Nike and Starbucks have closed many of their stores.  Since China accounts for about 11% of global imports, this drop in consumption will ripple through the global economy.5
Against this backdrop, which financial markets have been accentuating the negative? U.S. Treasuries, for one. The yield on the 10-year note, which tends to fall when the outlook for U.S. and global growth weakens, finished at 1.59% on Friday, unchanged from the end of the prior week and well below its 2019 close of 1.92%.
Prices on a number of commodities, including oil, have also declined. While Brent crude, a global oil price benchmark, rallied last week, it remained 19% below January’s $70 high.6 Moreover, oil prices may struggle to rebound. That’s because China, a major oil importer, is projected to use less fuel as its economy slows. Indeed, the International Energy Agency now anticipates that global oil demand will contract in the first quarter of 2020. If that happens, it will be its first quarterly drop in more than a decade.  
Then there’s copper, often referred to as “Dr. Copper” for being a bellwether for the global economy due its use in everything from car wiring to plumbing. Its price has nose-dived over the past month.7
In contrast to Treasuries and commodities, stock markets have been much more sanguine in the face of the coronavirus. Last week, global equities advanced for the second week in a row, with the S&P 500 and Europe’s STOXX 600 Index each notching fresh record highs by midweek. For the year to date, these benchmarks have returned 4.6% and 3.5% (in local currency terms), respectively.
Why have stocks been in favor amid this global pandemic? There are several reasons, in our view:
  • Investors may have become complacent about the virus and its impact on growth. They expect global central banks to remain accommodative and China’s government to unleash a wave of stimulus.

  • The dividend yield of the S&P 500 Index currently exceeds that of the 10-year U.S. Treasury note, making stocks a more attractive vehicle for generating income.8  This is a relatively rare phenomenon.

  • Equity markets have become adept at quickly dismissing bad headlines. (Think of how equites kept rallying last year despite the uncertainty over a U.S./China trade deal.)
Of course, equity investors may change their tune if U.S. economic data releases for February and March disappoint. We think that’s a distinct possibility, although we don’t anticipate the U.S. will slip into recession. But if stocks were to slide, we believe investors would be well served by tuning out the noise generated by the inevitable barrage of negative headlines. History has shown that sticking to a long-term investment strategy, implemented through a well-diversified portfolio, is the most prudent course of action.

Mr. Powell goes to Washington

In his semiannual monetary policy report to Congress, Federal Reserve Chair Jerome Powell stated that the Fed was closely monitoring the risks from the coronavirus outbreak. While admitting there will very likely be “some effects” on the U.S. economy, Powell added that “it’s just too early to say” whether the impact will be material, or how long it may last. We agree.
But for now, he’s still confident about the U.S. economic expansion—well into its 11th year and the longest on record—thanks to the healthy labor market, solid household spending and an upturn in residential investment.9 All three of these factors helped the U.S. “remain resilient to the global headwinds that had intensified last summer,” mostly around trade.
Powell also provided his views on inflation, which has consistently undershot the Fed’s 2% target, as measured by its preferred inflation barometer, the PCE Core Price Index.10 Over the next few months, he expects year-over-year inflation to move up closer to that threshold, as unusually low readings from early 2019 drop out of the 12-month calculation. Last month saw little movement in another price gauge, the Consumer Price Index (CPI). Headline CPI edged up to 2.5% on an annualized basis in January, and core CPI, which excludes volatile food and energy costs, held at 2.3% for the fourth consecutive month.
Complicating matters for the Fed on the inflation front: a stronger U.S. dollar. (A rising dollar helps tamp down inflation by keeping a lid on import prices.) The Wall Street Journal Dollar Index, which tracks the dollar against a basket of currencies, has moved steadily higher in 2020, reaching a four-month peak last week.11
Why the more muscular greenback? Amid the coronavirus fears, foreign capital has shifted to safe-haven assets such as U.S. Treasuries, which continue to offer far higher yields than sovereign debt offered by other developed nations such as Japan or Germany. For those investors willing to tolerate more risk, U.S. investment-grade corporate bonds offer an even greater payout. Also supporting the dollar’s rise has been the Fed’s willingness to maintain its current monetary policy stance while its major non-U.S. counterparts, such as the European Central Bank, remain in easing mode.
  1. S&P, STOXX 600 data (Haver, MarketWatch, Bloomberg)
  2. Treasury data from Haver
  3. Wall Street Journal
  4. Pharmamanufacturing.com, Financial Times, Indian Express
  5. Chinapower.csis.org
  6. Haver
  7. Haver
  8. Bloomberg
  9. Transcript of Jerome Powell Congressional testimony 
  10. Inflation data from Haver 
  11. Haver
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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