Investor complacency sets in while coronavirus spreads


While the coronavirus crisis spreads and deepens, threatening to damage supply chains and economies for months to come, many investors are falling back on a tried and tested response: count on central banks to fix the mess, and buy the dip.

Key stock markets are hovering close to record highs even while the death count from the China-centred virus rises and travel in, out and around the country remains heavily restricted, hurting the outlook for domestic and international companies. Regardless, stumbles in stocks are quickly reversed.

To some traders, this is proof that investors believe major central banks will pump more stimulus into the financial system. While that will not cure the virus, it would probably bolster asset prices, and expectation of this support is fuelling complacency among fund managers.

“Markets are ‘stoned’, after [a] long heavy dosage of monetary injections,” said Francesco Filia, head of London-based hedge fund Fasanara Capital. “[The] reality is that they don’t care about valuations a tiny bit, it’s only a big momentum market. Only the global liquidity tide matters.”

Europe’s Stoxx 600 equities index hit all-time highs this week, as did the S&P 500 in the US. In Asia, the virus’s epicentre, the market reaction has been greater but still not dramatic: China’s Shanghai Composite is 6 per cent down from its mid-January high, while Hong Kong’s Hang Seng is down 4 per cent. Commodity markets, too, have recovered some of their losses this week, with Brent crude rising about 5 per cent.

That mood differs from economic forecasts. Analysts at Citi cut their expectations for China’s first-quarter GDP growth to 3.6 per cent from 4.8 per cent and trimmed their annual forecast to 5.3 per cent from 5.5 per cent.

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The bank expects copper prices to fall to $5,300 a tonne from about $5,790 currently and Brent crude to $47 a barrel, from $57 now.

“The nCov outbreak continues to have a massive human and economic impact . . . disrupting supply chains and creating major short-term headwinds for Chinese demand and imports that have barely been priced into global commodity markets,” analyst Max Layton at the bank said.

Investors’ optimism on asset prices is not without foundation, given central banks’ ability to soothe stock markets, where bull runs are now well into their second decade. Over the course of 2019, 49 central banks cut rates for a total of 71 times, according to JPMorgan data.

Line chart of S&P 500 index showing US stock market continues upswing as virus spreads

Betting on sharp market falls has rarely been a winning tactic for hedge fund managers against that backdrop of rate cuts and plentiful liquidity. The market has quickly recovered from sell-offs such as February 2018 and the fourth quarter of that year to press on to fresh highs.

Investors have been repeatedly conditioned to treat shocks, such as the US assassination of Iranian general Qassem Soleimani this January and the damage to Saudi oil facilities last September, as “containable, temporary and reversible”, said Mohamed El-Erian, chief economic adviser to Allianz.

“This has deeply embedded a ‘buy the dip’ mentality that has proven profitable for investors time after time,” he said. Reinforcing this “is the strong confidence they have central banks will act as a safety net for markets”.

Some also fear that investors are too readily drawing a parallel with the 2003 Sars outbreak, which, while also deadly, was contained.

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MSCI estimates that global equities could lose slightly more than 5 per cent if China’s weakening economy causes a sustained flight to safe assets, according to the index provider’s stress test. It said that the impact was likely to be bigger than Sars because China’s share of global trade had grown from 5 per cent in 2003 to 11 per cent in 2018. The country also now accounts for a far greater portion of MSCI’s emerging markets index.

Chinese ecommerce group Alibaba’s chief executive Daniel Zhang characterised the widening coronavirus crisis as a “black swan event” on Thursday, warning that the outbreak had potentially global implications.

Should infection rates or economic data suddenly worsen, then markets could be left exposed.

“Markets are far more vulnerable to economic shocks when they are expensive than when they are cheap. Today, on almost any fundamental measure, equities are expensive,” said Tony Cousins, manager of Nedgroup’s Global Cautious fund. He said that the worst-case scenario for coronavirus “has definitely not been discounted in markets”.

The Cboe Volatility index — known as the market’s “fear gauge” — suggests that some traders are bracing for sharp moves. The Vix has climbed from a low of about 12 points in mid-January to 15 as stock markets hit record highs. That has happened only in 2007, 2000 and 2015 “right at the top of bull markets”, said Stephen Aniston, president of vixcontango.com, a volatility trading analytics provider.

Colby Smith and Henry Sanderson contributed to this article

laurence.fletcher@ft.com and jennifer.ablan@ft.com



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