The killing of an Iranian general by a US drone strike escalated tensions in the Middle East, yet this was short-lived and tensions between the US and Iran calmed down surprisingly rapidly.
This positive outcome, along with further signs of macro-economic stabilisation, paved the way for markets to march higher intra-month, only to take another step back following the concerning news flow of the coronavirus after it emerged in the Chinese province of Hubei.
The virus shattered the positive mood, and markets began to focus on the potential repercussions of a global pandemic and the unknown economic ramifications of China shutting down to combat the spread of the virus.
Key Points
- There has been a stock market drop following the coronavirus outbreak.
- Very little changed in the short-term following Brexit.
- A correction to markets was long overdue.
At the March 6 summit of the oil producers’ cartel Opec, Saudi Arabia wanted to extend production cuts, while Russia wanted to end constraints on supply. The meeting ended acrimoniously, and over the weekend Saudi Arabia announced its new official selling price.
The discounts offered – particularly versus Russian and North American grades that compete with Saudi Extra Light – make it clear that the Saudis are aiming to regain market share. They are currently producing 9.7m barrels a day and announced last week that they are increasing this to 12.3m bpd. This comes at a time when Covid-19 has hit oil demand growth expectations severely.
The spread of coronavirus
The outbreak and spread of the coronavirus led to significant equity and fixed income market movements with many major indices now down 20 per cent year to date. Looking back in time, the market reaction to Sars was severe because of its higher mortality rate, but fortunately it was quickly contained and the rebound was sharp, with no meaningful global economic impact for the year.
The coronavirus impact has been felt by investors but not yet integrated into corporate earnings – that comes next month. However, a slowdown in near-term growth is inevitable, with a strong impact felt in industrial, tourism and consumer discretionary sectors.
While the coronavirus appears to be less deadly than Sars, it is also less easy to contain, and critically China’s share of the global economy is four times larger than it was in 2003. China is the ‘factory of the world’, and any disruptions in its production capabilities will have repercussions on a global scale and this has not yet been factored into analysts’ expectations.
The back and forth of trade wars
The Q4 earnings season in the US started in January, with earnings 5.61 per cent above analyst estimates after 63 per cent of companies have reported.
The signing of the ‘phase one’ trade deal between the US and China on January 15 was welcome news. However, significant tariffs will remain in place and the structural issues to be tackled in the next phase are not likely to be resolved easily.
The agreement means the US will suspend its next planned round of tariffs, as well as cutting the existing tariff rates on around $110bn (£83.71bn) of Chinese imports to 7.5 per cent from 15 per cent. All this while China has committed to boost its imports from the US by around $200bn over the next two years, to allow greater access to its markets for financial services companies, enforce intellectual property protections and be more transparent in its currency management practices.
Better times ahead
The UK officially left the EU on January 31 2020. Very little will change as the UK now begins a 10-month transition period hoping to negotiate a new free trade agreement. As a result, the risk of a ‘hard Brexit’ will persist, and it may even intensify by mid-year as news-flow from the discussions hits the front pages.
The flash purchasing managers’ index releases for January were encouraging, indicating a sharp improvement in both manufacturing and services, with the composite rising to expansionary territory to 52.4 from 49.3.
The UK stock market may be poised for a comeback given the attractive yields UK stocks offer in an income-starved world. With an overall dividend yield of 4.1 per cent the UK equity market is one of the highest dividend payers.
Exposure to UK domestic equities is now seen to be favourable due to attractive valuations and the potential for currency uplift further down the line – although we should expect better entry points.
What’s to come
Heading into the new year, global stock markets appeared vulnerable to a correction, despite the recent strong momentum and frothy sentiment.
Unknown risks like coronavirus require defensive positioning in order to protect downside risk and minimise unnecessary volatility. At this stage it is unclear whether this is the start of something more ominous, or just another blip in this 11-year-old bull market.
Fears (not always rational) could lead to a further significant spike in financial market volatility. And this is long overdue: an opportunity to allocate into equities and participate in their recovery, as soon as the virus spread slows and negative news has been fully priced in.
Simon Black is head of investment management at Dolfin
