The light at the end of the equity tunnel could yet be a train
US and European indices have rebounded since the coronavirus sell-off
A peek at global stock indices will tell you that all is well in the world. US and European stocks are at record highs after their coronavirus-induced wobble at the start of the year, while the benchmark indices in Hong Kong and mainland China have also started to recover. Diehard optimists can point to a number of reasons to be cheerful: rating agency Moody’s said that for Europe and the US, at least, the epidemic should have a “muted” impact on economic activity. Investment bank Goldman Sachs says the markets’ appetite for riskier bets is rebounding as “virus concerns fade”. By some measures at least, the pace of new infections appears to be slowing. Remember the rise in tensions between the US and Iran? The brief flurry of alarm that sent oil prices rattling higher and hit stocks? That was just over a month ago, and most investors have not given it a second thought in at least three weeks. With luck, this virus outbreak will prove to have a similarly short shelf life. The talk is of light at the end of the (fairly short) tunnel. But as any good pessimist can tell you, that light can turn out to be a train.
In fairness, broad equity market indices are a bad gauge of investor nerves. Some of the pick-up in China’s equity markets may be seasonal. Nomura says that, on average, mid-February delivers a good patch for Chinese equity sentiment, which means the latest mini-rebound “may be no more than a shortlived fake-out”. Recommended Markets InsightJames Kynge Investors’ hunt for coronavirus rebound stocks is not simple Double-digit drops in some China-focused stocks and a rally in the safest portions of the bond market also serve as signs that fund managers are taking sensible precautions. “Markets are not as complacent as they look,” analysts at Barclays said in a note to clients this week. Still, it is easy to imagine a scenario where that level of concern proves nowhere close to sufficient. “There is enough of a probability that the coronavirus becomes an unusually large disruptive market event that it warrants portfolio managers taking a close look at potential hedges,” said Alan Ruskin, an analyst at Deutsche Bank. Buying US government bonds or amping up dollar exposure is a good way to take cover, he suggests.
Taking out (very cheap) protection against a rise in currency-market volatility is also a good option. After all, Mr Ruskin points out that already historically low currencies volatility is highly unlikely to sink meaningfully lower if the virus passes. Nor is the dollar likely to crash if the news turns more positive. By contrast, the virus-induced weakness in base metals could very easily turn round quickly if the news improves, making negative bets on that market a risky strategy in itself. Failing to take this outbreak seriously, however, is likely to be the riskiest bet of all.