Stocks are surging in part because investors expect a central bank response to the coronavirus

Market Insider

Analysts caution there’s likely to be more negative headlines on the spread of coronavirus as well as a deeper economic hit to the Chinese economy, but they also say any further impact could also be cushioned by central banks.

“The news is going to get worse, but you have to juxtapose that against the stimulus response. That’s what we’re living through right now,” said Art Hogan, chief market strategist at National Securities. “You don’t know how long China is going to be closed. You have to make a guess about how much of that activity does not get caught back up … It hits us in multiple ways.”

Stocks were higher Wednesday, but off their highs in midday trading. The S&P 500 has recovered most of its losses since the market began reacting to the spread of coronavirus two weeks ago. The S&P 500 briefly rose above its record Jan. 17 close of 3,329 but backed off and was still up 0.9% on the session and 3.1% for the week so far.

Global stocks rallied for a third day, as investors reacted to a lack of new shocks about the virus. The growth of new cases continued, but it exponentially has slowed, and authorities continued to report on how they are dealing with the outbreak. There is also speculation that there may be existing or developing drugs that could treat or prevent the virus.

Investors have been betting on more than one rate cut from the Federal Reserve this year, based on activity in the fed funds futures market, but the fed’s projections show no cuts, and it remained on hold at its meeting last week. The People’s Bank of China has added liquidity and eased some regulations, including reportedly easing up on its crackdown of shadow banks.

“There is some sense of relief as well that the Chinese have been very quick with the stimulation. The liquidity injections have been massive. The economic consequences have not been fully grasped,” said Paul Christopher, head of global market strategy at Wells Fargo Investment Institute. “You could see firms on the street come out with downward revisions to GDP. There are people asking how well protected are U.S. supply chains.”

Christopher said Wells Fargo expects Chinese gross domestic product growth of 5.5% this year, down from an earlier forecast of 6%. Macquarie revised its growth outlook Monday for China’s first quarter to just 4% year-over-year, from 6% in the fourth quarter, but said it should then rebound. For the entire year, it expects growth could fall to 5.6% from 6.1% last year.

Goldman Sachs economists expected a 1 percentage point hit to Chinese GDP growth in the first quarter, and a 1 percentage point spillover to global growth. The spillover includes reduced exports to China, equal to about 0.3 percentage points and a 0.6 percentage point hit from Chinese tourists, traveling abroad.

But the impact should be short-lived. “Our baseline assumption is that the aggressive response from the authorities in China and elsewhere will bring the rate of new infections down sharply by the end of Q1. If so, global economic activity should normalize in subsequent quarters, with positive GDP growth effects of about 1½pp in Q2 and ½pp in Q3 (both qoq ar),” the economists wrote. “For the year as a whole, this would imply a modest hit to annual-average global GDP growth of 0.1-0.2pp but still allow for a slight reacceleration from 3.1% in 2019 to 3¼% in 2020.”

Hogan said the fed funds futures market is responding to concerns that the hit to China could be bigger than expected, and spill over to the U.S. “Now the market has two [cuts]. that’s just trying to extrapolate out to how much economic damage is done and what that would do to monetary policy domestically and globally,” said Hogan.

The PBOC on Tuesday said it was injecting 500 billion yuan, about $71.5 billion, into its economy after it injected 1.2 trillion yuan on Monday, through its repurchase operations. After an initial plunge of nearly 8% on Monday, the Shanghai market steadied and was up 1.3% Tuesday and higher by another 1.3% Wednesday.

Analysts say stocks were also helped by the fact that there was no clear front runner in the Iowa Democratic caucuses Monday, and the progressive candidate, Vermont Sen. Bernie Sanders, came in second behind Pete Buttigieg.

“To me, the market seems to be more driven by liquidity than anything about the coronavirus … but it’s also like we saw with the U.S. confrontation with Iran,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “The markets tend to exaggerate non-economic variables, and what I think the markets have decided is that Asia is going to be hit hardest because of its ties with China.”

He said, for instance, Korean car companies Kia and Hyundai are having problems already getting parts from China, and those types of impacts could increase.

Analysts said while the worst may not be over, there are expectations that Chinese authorities are taking every step to stop the spread of the virus.

“A lot of this stuff comes back to the idea that if you can show the market is under control, and you’ve got some containment going on, and we don’t sees it spreading out of control, to me that’s the key to restoring confidence in this market,” said Jack Janasiewicz, portfolio manager with Natixis Investment Managers Solution.

Hogan said there has been no all-clear on the virus, which has infected about 25,000 individuals, mostly in China. He said there are still events that could spook the market. “First, it would be if there’s hard economic damage. That could cause an eye popping reversal,” he said.

Another surge in the number of cases could also send stocks reeling. “It’s the order of magnitude. It’s still increasing but at a slower pace,” Hogan said.

On the plus side, the market has been responding to talk about potential drugs that could slow the spread or help symptoms. “We don’t have a vaccine now,” said Hogan, adding there are dozens of companies working on it. “Gilead is the most famous because they actually are using a current drug to see if it’s effective.”

Analysts said it was encouraging that health officials have said the virus has not mutated, and that the percent of those dying from the virus has not increased. Hogan said the market is awaiting signals that the virus has peaked, and that will remove some of the concern but when that might happen is impossible to tell.

So far, economists are not expecting much damage to the U.S. economy, and models show a rebound by second and third quarter.

Chandler said many central banks are not likely to cut, but the Chinese central bank will continue to move.

“China later this month will for sure. People expect them to cut their loan prime rate by more than 10 basis points. Yesterday, they cut the 7-day repo rate by 10 basis points,” Chandler said.

Chandler said the way China could hit the U.S. economy is through slower imports of U.S. goods. That would hurt U.S. exports, which are just 15% of the U.S. economy.

“We’re not seeing a big downgrade of the U.S. economy. So far, the markets have decided it is Asia that is going to be most affected,” said Chandler.

In the U.S., traders point to improved ISM manufacturing data, which was better-than-expected and showed expansion when it was reported Monday. They also are waiting to see January’s jobs data Friday, but it is not likely to show any virus impact.

“China is four times bigger than it was when SARS broke out … so in some ways, China represents a downside economic shock. Countries will have to respond with fiscal policy or monetary policy or accept slower growth,” Chandler said.

Articles You May Like

Introducing StockTracker Master Class Volume 1