Market Watch: What To Expect Amid Coronavirus Scare, Middle East Tensions

The market has been on a 15% run since October, and the number one question on everyone’s mind is that could this trend continue? Well, the short answer was no as we saw the market fall a swift 4%.

The market began its turn-around at the beginning of October, surprisingly after economic data came in worse than expected, and corporate buy-backs went into effect again after their perfunctory blackout period. This, coupled with the ongoing trade negotiations, and the Fed cutting rates in October, aided the continued lift in markets into the new year.

If you believe markets are forward-looking, you might be inclined to say that if part of last year's Q4 swoon was market participants looking ahead to negligible profit growth in 2019. Gains logged in the final quarter of this year represent investors pricing in an improving outlook for corporate bottom lines in 2020. Earnings have turned out to be “pretty, pretty, pretty good” as Larry David would say and giving the much-needed support during a major virus scare around the world.

So what happens next?

We believed there would be a recalibration of market prices to ease the disconnect between profit growth and record-high stock prices. Corporate earnings typically validate higher stock prices, and the worry is that prices have gotten ahead of themselves versus actual corporate earnings.

Earnings season is upon us, and surprisingly the numbers aren't too bad. It looks as though we are a bifurcated earnings cycle, which investors many times find the most difficult, which is where there will be winners and losers rather than a general market direction.

With momentum in favor of the bulls, our expected recalibration most likely won't be horrendous and we predict we have seen the worst of the downturn for now. However, some call for a Tech bubble to burst, but the downturn was enough to draw the nervous headlines and market movement.

Right now, the bigger story is obviously the Coronavirus with the scare of the virus spreading to other countries and the death toll in China rapidly continuing to increase to over 1,000people.

The virus has yet to severely impact a lot of stocks (outside of obvious ones like China travel, casinos, etc.) but seeing that it is being viewed as a catalyst for selling pressure this week, and perhaps a long-overdue pullback plays to an overall recalibration.

There have already been positive showings of an expected new round of economic stimulus measures in China. The Chinese President Xi Jinping even offered reassurance saying: “The fundamental of China’s long-term economic development remain unchanged and the impact of the novel coronavirus epidemic on the economy is short-lived.” His reasoning also comes from the nation’s $10 billion in fund readiness.

Although the correction was swift and painful for some, there is reason to believe markets will find their footing and continue to march to their own beat of the drum. We also believe there will be more bumps in the road more severe but will end the year higher than where the year started. U.S. equity markets continue to look vulnerable to negative surprises, whether we find the coronavirus continuing to spread, or a progressive candidate winning Super Tuesday in March.

The primaries' effect on the market

As we continue to experience the Democratic primaries, a self-described democratic socialist, Bernie Sanders, as well as the Iowa primary’s shock victor, Pete Buttigieg, have the momentum lead, which could also be an initial shake-up for equities. This momentum has come at a cost to Elizabeth Warren who has reportedly dropped high single digits in the polls.

As the markets continue to grow worried, investors want to capture potential gains, but because the markets have experienced a slowdown, value stocks and fixed income have come back into the limelight and will continue to be of interest to investors. Value stocks can provide some security with equity (risk exposure) but typically provide a lower risk profile due to their dividend and sector representation, such as utilities and consumer staples. Whereas fixed income yields have dramatically dropped since the end of the year when many were expecting a reflation trade to take hold within the U.S. economy.

While the green shoots of economic data aren’t poor and are actually meeting expectations, they are by no means blowing the cover off. There have been some risk-off events that have kept a bid under treasuries such as missile strikes, epidemics, and a socialist primed on winning the democratic nomination.

Although the yields have dropped to signal more nervousness around growth, the bond prices have gone up in value for investors potentially offsetting equity holdings. Hedges against the uncertainties on the future like the Coronavirus, Democratic Primaries or weaker Corporate Earnings, etc. continue to give fixed income and value stocks a place in portfolios.

The impending Coronavirus’ impact

Chinese leaders are preparing for a drastic hit to first-quarter economic growth as the fatal coronavirus impacts consumption, travel and manufacturing. As of today, the virus had killed 1,000+ people and infected over 42,000, forcing authorities to impose a lockdown on a population of roughly 40 million around Wuhan in Hubei province.

Additionally, the U.S. and Japan have already conducted evacuations of foreign nationals from Wuhan. To make matters worse, airlines including British Airways announced they would be suspending all service from mainland China after the Foreign Office advised against any nonessential travel there.

With the death tolls rising, Shanghai, the financial capital, has mandated companies to remain closed until February 10, while the manufacturing center of Suzhou has delayed the return of work of millions of migrant workers for as long as a week. Suzhou is one of the world’s largest manufacturing hubs, home to the factories of companies like iPhone contractor Foxconn, Johnson &Johnson and Samsung Electronics.

Hong Kong stocks have tumbled, seeing the Hang Seng index fall as much as 3% and the Hang Seng China Enterprises index, which tracks the performance of large Chinese companies listed in the territory, was down 3.5%. The Chinese economy is expected to continue to take severe hits, specifically in areas such as retail, consumer demand and tourism. Oil has already dropped below $60 a barrel for the first time this year. According to experts from the transport ministry, railway transport fell about 42 percent compared with the same day last year. Passenger flights decreased by roughly 42% and overall transport fell by about 29% across the country.

As the coronavirus continues to spread globally, other markets will begin to feel its effects as well. Wall Street is certainly abuzz with increasing fears of the virus spreading in America. The United Arab Emirates also confirmed the first case in the Middle East and there have been reports of the virus in Singapore, South Korea, Taiwan, Vietnam, Thailand, Australia, Canada and more. The increasing global outbreaks will certainly continue to stir the markets.

Middle Eastern market tensions

Staying on the topic of international relations, President Trump’s U.S. airstrike order resulted in the death of Maj. Gen. Qassem Soleimani, the leader of the foreign wing of Iran’s Islamic Revolutionary Guard Corps. His military leader’s death is expected to raise tensions between Washington and Tehran, increasing the friction in the already capricious Middle East.

As a result of the attack, oil prices rose in Baghdad. Brent crude collected about 4% before collecting some of its gains and trading up nearly 3% at $68.20 barrel. If this move holds, it would put prices at their highest level since mid-September, following the attacks of Saudi Arabia that carved out a large portion of the kingdom’s production allowance.

Since those strikes occurred, oil’s price has retreated swiftly with the potential of the reflation trade coming under pressure and the potential for China to have a major slowdown to their travel and overall consumption. It’s only a matter of time before other industries potentially feel the extended slowdown if the pandemic doesn’t get under control.

The sensitivity of the market will continue to show itself

For now, it's entirely possible to see a modest pullback to keep prices, investors, and speculators in-check, baring no unforeseen significant macro shock to the market.

As with everything, we are only capable of expecting the unexpected. However, the sensitivity of the market will continue to show and we will see it reflected as national and global issues continue to evolve.

(Michael Lackwood is the founding principal of NYC-based Spring Delta Asset Management.)