Tatton News Archive

New article from Tatton Investment Management: Markets show no fear - should they?

10 February 2020, 12:00am

January is behind us and what a year itâ€™s already been. Investors have been bounced around from WWIII fears between the US and Iran, the formal Impeachment of the US president and the prospect of a global virus pandemic. Against this backdrop, it is not surprising that our January 2020 asset returns overview has quite a lot of red across equity markets and solid black across the lower risk bond sectors (see table at the bottom).

Yet it was only the last week of the month that led to this end result. For most of the month the tallies had been positive for equities â€“ maintaining the somewhat extraordinary run for global risk assets since last September. Then the Coronavirus scare gripped investors and provided the reason for the more speculative end of the markets to start taking profits.

Readers may be pleased to hear that it took just the first four trading days of February to turn the tide in favour of equities once again. It must seem bizarre that stock markets recovered so swiftly from the virus scare, while the wider global public is still being bombarded with distinctly scary stories from China. Market participants came around fairly quickly to what we noted here last Friday â€“ not only that there was not much evidence to suggest that this new coronavirus from Chinaâ€™s Wuhan was different to most other seasonal flu viruses but also certainly not as likely to become a global emergency as had originally been feared.

So, all clear for investors then. Does this mean we go back to the previous narrative of gradually improving economic growth numbers interspersed with the occasional comedy intermezzo from Donald J. Trump and his unconventional and unpredictable actions?

Well, not so fast. By the end of the week â€“ at the time of writing â€“ it may have dawned on more than just us that the fear of the virus may have more wide-reaching consequences. Chinaâ€™s decisive, if not draconian, actions to limit infections spreading further may have been lauded by the World Health Organisation, but they leave a vast number of Chinaâ€™s workforce displaced relative to their place of work. Ironically, the Coronavirus outbreak coinciding with the Chinese Lunar New Year celebrations has meant that the virus spread much more than would have been the case during other periods when people do not travel. However, for Chinaâ€™s economy it has so far been a blessing since factories are all but shut during this two-week celebratory period anyway. So, while the domestic and some of the international tourism sector has taken a hit, Chinaâ€™s manufacturing sector has not â€“ so far.

The next two weeks will be crucial, not just for Chinaâ€™s people and economy, but the global economy at large. Should the rate of new infections not decline, then the Chinese authorities will be unable to lift the travel bans next week as envisaged. That means that factories will not reopen as planned and the global supply chain dependencies will begin to bite. Since the China Lunar New Year is a reoccurring event, manufacturers elsewhere will have held increased inventory levels in order to bridge this period â€“ up to the end of February if they planed prudently.

We expect a return of market volatility over the coming fortnight, as the world watches with bated breath whether China returns to work or remains quarantined.

The overwhelming noise of the viral news has had many miss the fact that the other worry point for markets has quietly gone away. The US central bank â€“ The Fed â€“ has not ended its ongoing liquidity support as had been feared. Despite this reassurance from central bankers that market supporting liquidity conditions are here to stay for longer, another bond market monster has reared its ugly head once more: the inverted US yield curve. Only at the very short end between cash and two-year maturities, but enough to reawaken another â€˜fear of fearâ€™ dynamic.

We do not expect the Fed will allow itself to be bullied into straightening out the yield curve slope by lowering rates â€“ especially as it is likely to regard the market rally that followed the introduction of its liquidity support measures last autumn as a negative not positive side-effect. With the humongous volume of government bonds at the Fedâ€™s disposal, it could aim some attention to the cash end of the yield curve and reinvest enough of maturing stock of treasuries there. This would allow for a straightening of the yield curve by slightly less conventional means.

So, the jury is out on whether the fragile balance between growth and stagnation, or disruptive bond markets and highly valued stock markets, continues and becomes more stable or whether it all morphs into even greater volatility over the shorter term.

The broad consensus is that the Coronavirus disruption will depress data flow, sentiment and put a dent into the first quarters economic progress. Against this, neither we nor the research partners we regularly discuss these matters with have changed our view, that 2020 will witness an improvement in the global economy. Indeed, the Coronavirus episode has increased our conviction that the economy will take a turn for the better, given that the Chinese leadership will now be forced to unleash a far more substantial stimulus program than had been expected for this year. Unfortunately, this may well come at the price of a one quarter delay for the pick-up in global economic growth.