U.S. equities closed lower for a second straight week led by Energy, Materials, Healthcare, Communication Services, Industrials, & Technology as the S&P 500 saw back-to-back weekly declines of over 1% for the first time since late last August. The Energy sector was the worst performing sector for a fourth consecutive week as crude fell 4.9% over the five-day period as investors continued to worry about global growth amid the spread of the coronavirus. Materials came under pressure with weakness noted in industrial metals, chemicals, as well as paper and packaging names. Healthcare lagged the broader market; however, weakness was broad-based throughout the sector while Communications service names were hit after Facebook reported earnings. Technology was in-line with broader declines; however, weakness came from a large pullback in the semiconductor group as the SOX fell 7.0% on the week. Financials fared better than expected as we saw pockets of strength in insurance companies, while banks lagged with pressure in yields with the two-year yield falling to their lowest level since September of 2017. Additionally, a key part of the U.S. yield curve inverted on Thursday for the first time since October as the spread between the 3M/10Y treasuries slipped below zero. Defensive sectors outperformed with the risk-off trade as Utilities were the best performing group and the only ones that closed higher on the week.
Coronavirus concerns continued to dominate headlines as the number of confirmed cases raced higher globally, with the number surpassing 12,000 by the end of the week. While the number of infections has surpassed the SARS epidemic in 2002, which resulted in nearly 800 deaths worldwide, there appears to be a much lower fatality rate associated with the 2019-nCov Coronavirus. Earlier on Thursday, the World Health Organization (WHO) declared the coronavirus a public health emergency, however then commended China on their efforts to control the outbreak and the actions taken. Director general of the WHO, Tedros Adhanom, said he has never seen a country mobilize like this to contain an outbreak, mentioning efforts to build a hospital in just 10 days. Additionally, the group said that curbs on travel or trade with China were not necessary, however despite the positive commentary, the U.S. State department still raised their travel alert for the country to the same level as Afghanistan and Iraq. Businesses and companies continued to announce additional closures of normal activity due to the virus, including:
- Delta suspending flights between the U.S. & China starting February 6th through at least April 30th
- United Airlines saying it would suspend flights from U.S. hub cities, Beijing and Shanghai, from February 6th through March 28th
- American Airlines suspending all flight to and from mainland China effective immediately through March 31st
- A number of global companies operating in the region continued to close stores, scale back operations and shut down production which will most likely cause a drag on both China and global growth.
Despite the volatility seen, many believe the recent moves have been exacerbated by stretched multiples and the recent run up in U.S. markets (SPX Index+10.82% over the last three months as of 1/24/20) as outbreaks have historically had a very limited market impact. According to Factset, Deutsche Bank noted in their most recent “Investor positioning and flows report” that positioning sat at the 98th percentile, just under their January 2018 peaks as:
- Equity futures long positioning continued to rise to a new record
- Call volumes are at their highest levels since 2018
- Equity funds have seen inflows of $75B over the last three months, which is the strongest flows seen since early 2018
Throughout history, markets have seemed to bounce back from pandemics especially for those investors who have long-term investment horizons. However, it is worth noting that previous outbreaks such as The Spanish Flu, Polio, SARS and the Swine Flu which all occurred near market lows. Nonetheless, had investors remained invested, global markets would overcome the short-lived impact causing the bull market to resume.
Even as the most recent virus has derailed market’s slow melt up, multiple aspects of the bullish narrative remain in place such as:
- De-escalation of U.S.-China trade tensions
- Continued dovish Fed and supportive monetary policy
- Continued expectations for earnings rebound throughout 2020
It was a big week of 4Q earnings announcements as FactSet’s latest Earnings Insight report showed that 45% of the S&P 500 has now reported results with expectations that earnings could decline to 0.3%, which is a vast improvement from the 2.0% decline anticipated at the start of earnings season. The better-than-expected forecasts come amid positive surprises in the Technology and Consumer Discretionary space as Amazon, Microsoft, Colgate, and Coca-Cola were the big winners on the week, all ending in the green.
Just as investors expected, the Fed left the Fed funds rate unchanged at 1.50%-1.75% and only made minor changes to their statement. Additionally, they announced a five-basis point increase to both the Interest on Excessive Reserves Rate as well as the Reverse Repo Rate. Chairman Powell’s comments leaned slightly more dovish and said that the Fed plans to slow bill purchases and transition to smaller “reserve management” once reserves reach ample levels, which is expected to be sometime in 2Q, however will continue to monitor money markets and make adjustments as necessary.
U.S. equities rose as all three major indexes closed higher, helping recoup some of last week’s losses after aggressive selling on Friday led by Materials, Technology, and Communication Services. While the Coronavirus continued to dominate headlines, U.S. economic data helped reverse the recent selling pressures seen as ISM Manufacturing in January hit its highest level since July, coming in an expansion territory posting a headline number of 50.9 versus expectations of 48.5. Underlying details of the report were also better than anticipated with New Orders and Prices Paid coming in ahead of expectations.
Investor focus will remain on earnings as it continues to be another busy week with more than 90 additional S&P 500 companies expected to report 4Q results. Additionally, politics will be another key area of focus as Iowa, New Hampshire, Nevada and South Carolina all have caucuses in the coming weeks in what remains a very tight race for the Democratic nomination. Senator Bernie Sanders has recently gained momentum in polling numbers, and initial indications show that he is the leader in Iowa as we await confirmation after it was announced there were irregularities in numbers, causing a delay in final results. Also polling better than expected within the state were Pete Buttigieg and Elizabeth Warren, while initial favorite Joe Biden appears to be in a distant fourth place lagging behind expectations severely and suffering a blow to his campaign. Furthermore, RealClearPolitics is currently showing Senator Sanders leading in New Hampshire, which is the next caucus on February 11th. If Sanders were to win both states, Senator Biden and the rest of the field would have to clear a significant hurdle, as no Democrat in modern times has lost races in both Iowa and New Hampshire and gone on to claim the party nomination according to The New York Times. While many have debated Sanders’ policies and their threat to investors as well as markets, many in both parties believe his extreme ideals would be easier for President Trump to beat on the national stage compared to a more moderate candidate such as Biden.
Crude ended 4.28% lower to start the week, continuing its decline to start the year as the beaten-up commodity has fallen 18.33% to start 2020 and has entered bear market territory, falling 20% from its January 6th peak. Investor fears surrounding global growth and the impact of the Coronavirus continue to weigh on oil as Chinese demand has fallen 20%, the sharpest drop since September 11th.
THIS WEEK INTERNATIONAL:
APAC – Chinese market’s closed mixed on Monday with equities experiencing their worst loss since the 2015 crash amid ongoing fears of the Coronavirus. The Shanghai Composite fell 7.72%, Shenzen closed down 8.41%, and the Hang Seng finished positive 0.17%. All CSI 300 sectors sold off led by Technology and Telecom names as mainland indexes reopened after being closed for the Lunar New Year Holiday. More than 2,600 stocks fell by 10% as 21 provinces, municipalities and other regions within the country have told businesses not to resume work before February 10th. China continues to take steps to help stem the selling pressure in the region such as:
- Restricting stock sales by prop traders at brokerage firms, instructing them that they cannot be net sellers of equities and were only allowed to sell to meet investor demand
- Barring brokerage firm clients from selling borrowed securities
As countries continue to battle the virus, some estimates call for the Chinese economy to grow as much as 1.4% slower than originally thought according to Bloomberg Economics. With experts racing for a “safe cure”, one that Thomas Breuer Chief Medical officer of GlaxoSmithLine says may not come for an additional 12-18 months,the most recent figures continue to grow. The country has confirmed another 57 deaths related to the virus as well as another 2,830+ cases bringing the total number of cases in China to 17,205 with over 350 deaths.
Europe – European markets followed other global peers and closed the week lower with the coronavirus outbreak in China continuing to weigh on investor sentiment. We continue to see industries who have heavy exposure to the Chinese market such as auto manufacturers, luxury brands and travel & leisure stocks continue to be the hardest impacted by the outbreak.
While many have compared the most recent virus to the SARS outbreak, there remain stark differences in capital markets such as:
- China accounted for 2% of global luxury goods in 2003 vs 35% in 2019
- China now accounts for 15% of global GDP, which is four times more than in 2003
With that in mind, those industries that garner most of their demand from Chinese consumers continue to underperform broader markets as analysts believe this could be a promising buying opportunity valuations remain attractive. Luxury names such as Salvatore Ferragamo, Burberry, Prada, Hermes and SMCP have all declined anywhere from 4%-20% over the last month.
Elsewhere, the Bank of England voted 7-2 to leave their policy unchanged after taking a more optimistic assessment of recent developments. The Central Bank noted the recent upturn in PMIs, business sentiment and consumer confidence then as expect to see growth of 0.2% in the first quarter. The statement accompanied with the decision was left more open ended as than many would have liked saying “if the economy evolves as it expects, modest tightening will be needed” however they also were open to lower rates if growth and inflation did not pick up. Additionally, the UK formally left the EU on Friday after the EU Parliament ratified the Withdrawal Agreement. Focus will now turn to the ongoing negotiations regarding the future trade relationship between the UK and EU, which Prime Minister Boris Johnson would like to agree on by year end. PM Johnson is expected to say next week that he is ready to accept the free trade agreement that EU Brexit negotiator Barnier originally offered Prime Minister May.
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