As the Covid-19 outbreak that began in China spreads deeper into more countries globally, the primary message from markets couldn't be clearer: volatility is back, and risk assets are falling out of favour. But look more closely and there are some signs of counterintuitive strength, too.
US stocks fell more than 6% amid a two-day sell-off at the end of February and the 10-year Treasury yield touched a record low, as investors pare risk exposure and seek safe-haven assets. Gyrations have returned to stock markets after a long period of relative calm, with the CBOE Volatility Index surging to a 14-month high.
Complacency dislodged
In our view, the volatility isn't as surprising as the fact that it took so long to rear its head. However, the recent swings indicate the complacency that appears to have settled over markets during the earlier stages of the outbreak has been dislodged.
The general response in recent sessions has been mostly predictable. Commodity prices took a hard hit amid concerns that the epidemic will curb global demand. Crude oil led declined by about 6%, while copper and rubber also lost some ground. A rush to safe-haven assets, on the other hand, pushed gold prices to a seven-year high, and the Japanese yen has rallied too.
Pockets of resilience
But there have been some perhaps unexpected pockets of resilience. Stock markets in mainland China held up relatively well amid the global sell-off. Investors appear to be hoping the worst is over for China, as the daily tally of new Covid-19 cases outside of the locked-down province of Hubei continues to decrease from hundreds per day in early February.
Markets have rebounded, with onshore funds seeing robust inflows in the weeks since trading resumed following the Lunar New Year holiday - sectors including e-commerce and tech startups have been outperformers. Alongside onshore equities, both the Chinese currency and the Asian high-yield bond market also look to be performing better than expected.
What's going on here? In addition to the slowing number of new confirmed cases in the mainland, investors may also be anticipating additional monetary and fiscal policy support from the Chinese authorities. But there's another factor at play - namely, the valuation cushion that already existed in these assets before the Covid-19 outbreak.
During times of short-term market panic, it can help for investors to re-focus on fundamental factors with some longevity, as these are what will prove to be more important to long-term returns. Along these lines, a bias against sectors and companies with over-extended balance sheets and towards those with higher cashflow visibility can also help mitigate market volatility.
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