The market can withstand the Coronavirus if it remains a one-off, however there are other concerning signs for the economy, like the yield curve, reports Adam Button.
Markets deepened their losses Friday on traders' reluctance to hold on to gains ahead of potentially more virus-related revelations over the weekend.
Ashraf Laidi tells me to watch the 3202/05 support on the SPX, which is around its 55-day moving average, a level last reached in Oct 2019.
If you thought Friday’s 's market fall was ugly, then how bad would it have been without the FAANG— (Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and Google (GOOG)— stocks? Their contribution to the overall index has been among the biggest in over 20 years. The market is struggling to price in what's happening in China. There was a clear effort Thursday to 'buy the fact' as the World Health Organization (WHO) declared an emergency after a week of wavering.
One main reason for the initial rally (in addition to the Amazon earnings) was that the WHO did not force any nations to restrict travel. Markets care about travel, transportation and demand but known unknowns could be in store. It's been a strong month all-round for the U.S. dollar except against the Swiss franc (CHF), but the dollar struggled late last week, especially as Chicago PMI hit a five-year low.
Remember the Yield Curve?
And what about the yield curve. Two out of the main four measures are inverted.
In the big picture, it's important right now to emphasize the difference between a one-off hit to growth and a structural change. Right now, the market is treating Coronavirus as a one-off event. So, whether it curbs Chinese growth by one percentage point this year or five percentage points, it will eventually disappear. It's like an 'ex-items' line in an earnings report or an unscheduled one-time plant shutdown. Eventually it's fixed and the business gets right back on track. The equity market is powerful for pricing past those kinds of events, and is trying to do the same with Coronavirus, while bonds and FX remain underpinned by U.S. yields and scope for policy inflection points.
Other events can be lasting, structural changes. One of them is an increasingly clear stance at the Federal Reserve indicating they will allow inflation to run hot to make up for shortfalls. Fed Chair Powell said Wednesday that they're “determined to avoid” the downward spiral in inflation and inflation expectations like in the Eurozone and Japan. That's led to a growing belief the Fed will institutionalize that kind of thinking in its policy review. The result is lower rates overall for the foreseeable future via inflation averaging.
Another example is the 5% deficit-to-GDP numbers in the United States. A few years ago, we might have expected some path to a balanced budget – and the associated growth drag – but now there's almost no pretense of fiscal responsibility and nothing on the horizon. Eventually the bill will need to be paid but Japan has shown you can push that off for a generation if you have a global reserve currency.
The Fed said last week it may be more than bulls versus bears -- this might be a case of some positive structural factors pushing back against one-off items.
The thing is those one-off items can expose other faults. You see that time and time again in the stock market where some bad revelation is followed by a series of others. So aside from the Coronavirus risk itself, there's the chance it exposes something else, like the large debt overhang in China or unseen political frictions.
Path of two-week Incubation Period
This week should be key regarding the spread of the Coronavirus. Since we know that the incubation period is 14 days and that Wuhan had been quarantined since Jan. 23, then the spread of infections should likely peak by middle of next week. If that is not the case, then the ominous conclusion is that either the quarantine was not effective, or that the incubation period may vary at the risk of the outbreak of further cases.
Adam Button is co-owner and managing director of ForexLive.com and a contributor at AshrafLaidi.com. You can see Ashraf’s daily analysis at www.AshrafLaidi.com and sign up for the Premium Insights. Ashraf's Tweet on indices here.
