Updated: Feb 4, 2020
By Imran Lakha
Risk markets began the year in exuberant fashion making new highs as investor consensus seemed to be extremely optimistic. The equity markets even managed to shrug off geopolitical tensions between Iran and the US which resulted in air strikes by both parties after the US killed a top Iranian General causing people to fear the beginning of World War 3. Despite de-escalation, this confrontation did however trigger some extreme volatility in oil prices and reignited the gold rally, taking the precious metal briefly through 1600 on the upside.
We had also seen quite parabolic upside moves in stocks like Apple and Tesla over the last few months which have definitely felt bubble like and caused some concerns of too much too fast. After hitting peak euphoria some time in mid January, the market has had a ‘not so healthy’ dose of reality. The US market has given up all of its gains after being up around 3% whilst European markets are now down 2% on the month of January. The main culprit being the outbreak of Coronavirus (2019-nCoV) originating in China which is sending shockwaves across the globe due to the potential impact it could have on the Chinese economy and hence the global economy. The Chinese stock market is down 13% from its January highs and showing no signs of bouncing since reopening after Chinese New Year. Initially global stock markets had been relatively un-phased by the outbreak and had been comparing it to the SARS virus which had very little lasting market impact. However, that was not at a time where markets were seemingly overvalued, positioning was extremely bullish and global supply chains were as tightly linked as they are now.
If China sneezes, the world will definitely catch the cold! Oil prices have tumbled a massive 15% since the outbreak as markets factor in the impact on oil demand from the travel bans that countries have begun imposing to China. The World Health Organisation(WHO) recently declared the outbreak an international emergency due to the growing cases outside of China and the exponential rate at which this can spread if left un-contained. One saving grace seems to be that fatality rates are relatively low for now, but many of the statistics out of China are regarded unreliable so time will tell.
Currency markets have been quite insulated from the concerns over the virus so far and we have seen EUR trade within the 1.10-1.12 range since the beginning of the year. GBP had a brief downside test of 1.2950 but has managed to trade back up to 1.32 on relief that Boris did actually ‘Get Brexit Done’ and the Bank of England saw fit to leave UK rates unchanged. We would expect GBP to fade as we start to get into the trade deal negotiations which will inevitably bring more challenges and UK growth will likely be hampered by a general reluctance from business to invest until the terms of the deal are known.
We had been advocating Gold and Long dated bonds as important risk mitigating assets to the portfolio and so far they have been exactly what the doctor ordered. We continue to see multiple scenarios that work well for owning precious metals and see no reason to change our view here. In our previous outlook we had said that we felt that Q1 would be challenging for equity markets given positioning, sentiment and valuations. It seems this virus(2019-nCoV) has given the ammunition needed to begin a correction. Another potential cause for concern is the Democratic primaries, where polling suggests Bernie Sanders as the frontrunner to go up against Trump in the November US election. This would be very negative for markets and may prolong the correction if it was felt that he might actually win.
Overall, we still think the dip will get bought at some point over the next couple of months once these latest fears reach their climax and the various ‘big guns’ get called in to support markets (think FED rate cuts and Global QE). For anyone trying to navigate an investment portfolio in these times, diversification and optionality remain a must.
Good Luck out there.