By Philip Lawlor, managing director, Global Markets Research
The coronavirus outbreak and subsequent market panic has turned investors into Donald Rumsfelds—attempting to price the ‘known unknowns’.
A few weeks ago—even as news of coronavirus spread—equity investors were celebrating as stocks powered to new highs, driven by the performance of US tech stocks. Since then, every equity market has fallen, and fear-stricken investors have fled to haven assets.
Chart 1: asset class returns since February 19, 2020
Source: FTSE Russell, Refinitiv. March 9, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
It is extraordinarily difficult to price an unprecedented event, but we can say is that the bond market has been more alert to the economic impact of coronavirus. In contrast to the initial resilience of equity markets, fixed income markets were quicker to treat the epidemic as an extended threat, rather than a short-term economic shock.
This is illustrated by the early contraction of government bond yields before the recent spectacular falls (Chart 2), while corporate bonds have been the canary in the coalmine, with investment grade heading sharply downwards, as US High Yield bonds heading in the opposite direction (Chart 3).
Chart 2: government bond yields have broken to record low levels
Source: FTSE Russell, Refinitiv. March 9, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Chart 3: corporate bonds—the canary in the coalmine
Source: FTSE Russell, Refinitiv. March 9, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Significantly, bond markets are also pricing in a fall in the US ISM, a purchasing managers index summarizing economic activity in the US manufacturing sector (Chart 4). The market prices in a plunge in ISM to 40, which as Chart 5 illustrates, implies -2% US GDP Growth, and near certain recession.
Chart 4: The bond market thinks US ISM will plunge
Source: FTSE Russell, Refinitiv. March 9, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Chart 5: ISM at 40 implies -2% US GDP growth
Source: FTSE Russell, Refinitiv. March 9, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
We have previously noted the optimism bias in EPS forecasts (chart 6). As well as watching out for improving 2nd derivative in infection rates, and concerted fiscal and monetary policy support, bond markets appear to be an accurate indicator of the path ahead.
Chart 6: FTSE All-World Consensus EPS estimate trails (USD)
Source: FTSE Russell, Refinitiv. March 9, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
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