Stock Markets May Struggle Even If Coronavirus Fears Subside

STOCKS, CORONAVIRUS, US DOLLAR – Talking Points:

• Charts warned that stock markets were vulnerable before coronavirus outbreak
• Assorted risks more worrying with slow growth, limited scope for policy support
• US Dollar may benefit as uneasy backdrop, low rates boost demand for liquidity

Technical cues warning of ebbing upward momentum – a frequent precursor to topping – were flagged across multiple major stock indexes recently. These signals have proven to be prescient. Equity benchmarks in the US, Eurozone, Japan, Australia, mainland China and Hong Kong have since plunged.

The coronavirus outbreak emanating from China’s Wuhan province has been pegged as the nominal catalyst for the selloff. A rapidly growing docket of cases reported at home and abroad along with Beijing’s sweeping containment efforts have stoked worries about the epidemic’s impact on global growth.

Chart created with TradingView

This is, to be sure, a fair concern. And yet, the appearance of those topping cues preceded the virus’ emergence as a driving narrative. That suggests that it may amount to a trigger for forces that were already conspiring to sour sentiment rather than a standalone catalyst inspiring recent turmoil.

MARKETS LOOKED VULNERABLE BEFORE CORONAVIRUS OUTBREAK

The markets’ anti-stress defenses looked diminished at the start of 2020. Global growth appeared to steady a bit in the fourth quarter and the flow of incoming economic data brightened relative to baseline forecasts. Nevertheless, activity growth remains near the lowest levels in three years.

As noted last week, this is “problematic in that it would not take too much stress to bring recession back into view. That makes assorted risks like the US presidential election, the lingering threat of a no-deal Brexit, violent escalation in the Middle East, and now the coronavirus, appear relatively [more potent].”

Meanwhile, “comments from bigwigs at the World Economic Forum in Davos, Switzerland...flagged worries about the dual risk posed by fiscal dysfunction and central bank impotence whenever the next downturn invariably arrives.” The ECB conspicuously launched a comprehensive review of its mandate in tandem.

Finally – as pointed out soon thereafter – “late-2019 successes appear priced in. Building on the ‘phase-one’ US-China trade deal, [which tellingly landed with a thud ], seems unlikely for at least a year and failing to secure an EU/UK trade deal before 2021 may yet [make for a messy divorce].”

US DOLLAR MAY ADD TO RECENT GAINS AS INVESTORS SEEK LIQUIDITY

All this means that containing the Wuhan virus is unlikely to give stock markets a lasting lift. It is unclear if it will be enough to smother the nascent upturn in the global business cycle. If it is not, it will nevertheless diminish the markets’ immune system further, making the next bump in the road more dangerous.

The ultra-loose setting of worldwide monetary policy means the opportunity cost of owning liquidity – i.e. cash – looks rather low. Against this backdrop, defensively-minded investors may continue to push capital into the US Dollar, which accounts for a commanding 88 percent share of global FX market turnover.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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