Monthly Market Review – Coronavirus Widespread was the Main Focus

Unfortunately, if in January the global stock markets were not significantly affected by the diffusion of Coronavirus, in February, a widespread in Italy and in western countries led to a strong correction of the main financial markets in the last week of the month.

Such a correction in a short period of time had not been seen since the Lehman Brothers case in 2008. Main indices have suffered double-digit losses only in one week, for more than 14%. These are movements that have seriously challenged any statistics. The coronavirus (COVID-19) outbreak replaced trade and any economic data as the main focus of the markets.

In light of recent events, it appears quite evident that the economy of the main developed countries is preparing to suffer an imminent recession. China peaked after the spread of Coronavirus about two months after the outbreak and is still in a difficult phase.

The official China Manufacturing PMI, released by China’s National Bureau of Statistics, had already been either in the doldrums or in outright contraction for the past 14 months. In January it was at 50.0, the stagnation point. In February it collapsed to a previously unfathomable 35.7.

But it’s even worse than it looks, as the index was likely distorted to the upside, due to the way a sub-index, “supplier delivery times,” is figured into the headline PMI, according to Lu Ting, chief China economist at Nomura Holdings in Hong Kong. These data are showing the mindboggling extent to which China’s economy has been disrupted by the coronavirus-containment methods in February.

In the meantime, observers of the Chinese economy are anxious to understand if the industrial production of the main Asian economy is about to recover, but even if China immediately resumes producing goods for export, we have to keep in mind that now demand is contracting in Europe and the United States. So the matter becomes more complicated: on one hand, hopefully, speedy recovery of Chinese manufacturing activity, but on the other side of the world, the demand for these goods is stopping due to the effects of Coronavirus.

The imbalance between supply (Chinese production) and demand (Western consumption) does not seem ready to be bridged and risks creating serious problems for the world cycle, therefore the settlement of the cycle will be somewhat laborious and complicated. I believe that the year 2020 is now seriously compromised and any rebounds in the business cannot be lasting until the mismatching between production, stocks, and consumption has settled.

The Coronavirus, therefore, risks being the “black swan” that will bring an economic crisis through a new financial crisis. Triggers have the characteristic of hitting the system at the peak of its historical risk. When you expose yourself to high systemic risks, statistically the so-called “triggers” multiply exponentially even if they are not seen: any negative event can, in fact, turn into the feared “black swan”.

The recent weakness of the Dollar begins to price this scenario. Gold has undergone an unexpected correction due to interventions aimed at preventing that, the systemic risk indicator for excellence, accentuate panic.

However, if the dynamics that await us are those illustrated, such correction should be quickly reabsorbed and the Gold will resume its upward trend that has started since last year, confirming our target price of 1750/1850 within end of the year.

Expectations of expansionary monetary policies aside from the Fed and the possible opening of a phase of the weakness of the dollar bills are an additional supportive argument to that scenario. Another event that should make you think, and that emerges in these days of the crisis, is that the main platforms the United States online, which handle stock market orders for millions of customers have had “technical problems” and, in fact, have blocked millions of sales orders.

Another confirmation that in a market where you are induced only to buy what you cannot ever sell and the “profit-taking” cannot be activated for all but only for a few. We believe the current downturn, albeit rather violent, has not yet seen its lows and uncertainties economic and political issues that probably lie ahead put an end to a long period characterized by low volatility and high-risk appetite.

Gold

It’s been interesting to monitor gold, which in 2019 increased more than 15%, despite the fact that the equity markets were recording new historical highs. Big institutions, in the face of geopolitical uncertainties and instability, had been cumulating gold reserves expecting big drops on the stock markets.

Historically, in similar situations investors would have preferred to move away from stocks to bond markets, but when you have such liquidity on the market, there is no benefit to be invested into government bonds or to park liquidity in the banks (counterparty risk has increased from 2008).

With the sudden contraction of the equity market, gold prices have been benefiting during the last part of the month trading up to 1,680 area, with an exception the 29^th of February when institutional investors and hedge fund managers had to intervene severely, liquidating gold positions in order to cover the positions on the equities which were on margin call. During that single day, the precious metal dropped more than 90$, giving interesting long entry positions in March. We could look at a gold target price of 1,750-1850 in the medium term.

Forex

On the currency markets, we have finally seen an increase in volatility on the EURUSD in February. The main pair has experienced a slow drop of 2% during the first half of the month, driven by slightly worse economic data in the Eurozone and by carry trade logics (given the negative interest rates in Europe) which brought the euro at 1.08 low against the greenback.

During the last week of the month though, in a risk-off situation due to coronavirus, the US dollar has significantly decreased in value, losing its role which is typical in risk-off periods: on one side the market started pricing interventions from the FED to cut interest rates (expected three interventions in 2020) and on the other side realized carry trades from bigger investors. We at Mayfair Brooks, after the more than expected comments from President Trump and consequent emergency intervention of the FED, could expect the pair to invert the long term trend if closing above 1.13-1.1350 level.

YEN has been behaving as safe haven during the last weeks, bringing the USDJPY from 112 to 107.50 in the last week of February. Obviously the safe-haven role of the yen, combined to the above-mentioned dynamics of the US dollar, are leading the pair to lows of the period. We can expect in the short term the pair to be trading around the psychological level of 104.50, which could be broken in the case of a further escalation of the coronavirus.

Particular attention has to be dedicated to the Australian dollar, as it is one of the most affected currencies in the last weeks, recording new lows during February and breaking the previous monitored levels of 0.67 down to 0.6450 after the worst manufacturing Chinese data ever expected.

The article was written by Rosario Pisana, Chief Trader and Analysist at MayfairBrooks