Global stocks sold off sharply over the last week on news that the coronavirus has spread to countries beyond China, with the US S&P 500 index dropping more than 7% from its recent all-time high.
We are buying the dip in our multi asset funds, moving to a high conviction overweight position in stocks. While it is impossible to know how much economic damage will be caused by measures to contain the virus over the next few months, markets have a strong tendency to overreact to bad news in the short term and our contrarian investor sentiment indicator is once again registering a buy signal (chart 1).
Chart 1: RLAM Composite Investor Sentiment Indicator with global stock prices
Source: Refinitiv Datastream as at 21/02/2020 Note: RLAM composite sentiment indicator includes factors relating to market volatility, private investor behaviour and US company director dealing in their own companies’ stocks
As longer-term investors we find it usually pays off to look on the bright side when others are panicking. Virus disruption is very unlikely to force the world economy into recession. We expect to see a large but temporary hit to economic activity followed by a bounce back later in the year that additional stimulus could make stronger than it otherwise would be.
Growth lead indicators were turning positive in early 2020 before news of the virus emerged (chart 2). We expect the drop in energy prices in response to the crisis to take the steam out of inflation, moving us from a tentative Overheat reading on the Investment Clock model that guides our asset allocation back to the equity-friendly Recovery phase (chart 3).
Chart 2: RLAM Global Growth Scorecard as a lead indicator for JP Morgan’s global purchasing managers index
Source: Refinitiv Datastream as at 15/01/2020. Note: RLAM global growth scorecard includes factors related to central bank stance, OECD lead indicators, business confidence and consensus economic forecasts; it is pushed forward six months on the chart
Chart 3: The Investment Clock is likely to move back into equity-friendly Recovery
Source: RLAM as at February 2020. For illustrative purposes only. Note: Red dot marks the current reading of indicators we use to tell the time on the the Investment Clock; the trail shows the progression of the readings over the last 18 months
While confidence will drop in the near term in response to the virus shock, this could trigger additional fiscal and monetary ease in the US and around the world following China’s lead where such policy moves are already under way. If it becomes clear the virus has reached the US, we may see the Federal Reserve cut rates again and the drop in treasury yields to a record low will lower mortgage rates and boost an already strong US housing market. In an election year President Trump may also promise additional fiscal stimulus if a US pandemic is declared.
We are not complacent about the risks. We expect markets to remain choppy for weeks or perhaps months as investors weigh up good and bad news on the outbreak and its impact. We will look to trim equity exposure on rallies and buy on dips during this period. With inflation low, the longer term prospects for the world economy and stock markets remain positive, especially if additional stimulus is in the offing.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice. Portfolio holdings are subject to change, for information only and are not investment recommendations.