Coronavirus
should snap investors out of ‘buy the dip’ mentality
The coronavirus outbreak amplifies two
vulnerabilities: structurally weak global growth and less effective central
banks.
Updated Feb 4,
2020 — 11.33am,first published at 11.30am
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Last week’s fretting
over the coronavirus was a good illustration of a tug of war
that has been playing out in financial markets for a while: between favourable
sentiment and mounting longer-term
economic uncertainties.
Until now, at least, that contest has been resolved in
favour of ever-higher stock prices. But investors need to decide if they want
to opt for more of the same, by continuing to implement an investment playbook
that has served them well, or if they want to treat the viral outbreak for what
it is — a big economic shock that could
derail global growth and shake markets out of their
“buy-the-dip” conditioning.
If investors still insist on
immediately buying dips, they should do so in a much more differentiated manner
by favouring higher-quality issuers that are underpinned by strong balance
sheets. AP
Entering 2020, investors faced the challenge of balancing
favourable short-term market technicals with weaker fundamentals, and doing so
with government bonds providing little protection given the very low — and, in
some cases, negative — level of yields in advanced countries.
The coronavirus outbreak amplifies two vulnerabilities:
structurally weak global growth and less effective central banks. It is
becoming harder for markets to treat such fragilities as being beyond the
immediate horizon, especially with a host of other uncertainties not far
behind, including the recurrence of trade
tensions, growing realisation of the impact
of climate change, technological shocks, political polarisation and
changing demographics.
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Retail, trade and travel are simple
ways to illustrate what is going on in China. Stores are facing dramatic
disruptions involving a virtual halt in traffic, while suppliers are finding it
harder and slower to move their merchandise, both within and in and out of the
country. And there is a huge
drop in travel to China, dealing another blow to economic activities
undermined by less internal mobility.
This virtual stoppage of economic activities is cascading
throughout the second-largest economy in the world, and one with considerable
regional and global ties. It is fundamentally weakening the country’s services
sector, at a time of considerable challenges for manufacturing.
With both engines of growth now sputtering, internal and
external, China will also find it harder to navigate its transition from a
middle-income economy. The country’s increasing “sudden stop” economic dynamics
also involve adverse spillover effects, first and foremost for emerging Asian
economies with strong economic and financial linkages with China.
A weakening China is also a problem for Europe, where the
European Central Bank is effectively out of productive ammunition and
politicians are yet to implement a comprehensive pro-growth policy package. And
with the virus affecting the movement of people and goods, there is an
increased risk of a multi-year process of deglobalisation that neither the
global economy nor markets are wired for.
The coronavirus also has the potential to constitute a
structural break for markets: that is, a big enough shock that fundamentally
shifts sentiment. Previously, markets had been underpinned by the belief that
central banks were always willing and able to repress volatility and boost
asset prices. That fuelled investors’ fear of missing out on a seemingly
never-ending rally.
Until Friday last week, when US stocks dropped about 2 per
cent, markets’ inclination was to respond to sell-offs by deploying a game plan
that worked well in 2019 and early 2020, including in response to shocks such
as the US missile attack that killed a top Iranian general and the disruption
to half of Saudi Arabia’s oil production.
For the previous year, traders and investors quickly bought
every dip in the belief that the latest shock would prove temporary, contained
and reversible.
Now, the multi-year gap between elevated asset prices and
weaker economic conditions is becoming increasingly unsustainable. The global
economy and markets are getting closer to the neck of a T-junction. What comes
after that involves a stark contrast, depending on how policymakers respond.
One way involves recession, financial instability and even more complicated
politics; the other, a genuine growth process that validates elevated asset
prices in an orderly fashion and opens the way for more constructive politics.
If investors still insist on immediately buying dips, they
should do so in a much more differentiated manner by favouring higher-quality
issuers that are underpinned by strong balance sheets. They should also avoid
swapping US assets for more international exposure, which — although more
attractively valued — is much less resilient to global economic weakness.
For the remainder, which is probably most investors, they
should consider that this latest shock to fundamentals could prove severe
enough to dislodge for a while the bullish market conditioning that has been so
critical to this historic stock rally.
Given that the negative economic effects of the virus are
yet to be sufficiently absorbed by markets, this also calls for much greater
immediate attention to potential vulnerabilities in portfolios, in the form of
equity and liquidity risk.
The writer is Allianz’s chief economic adviser and
president-elect of Queens’ College, University of Cambridge
Financial Times
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