Stock rally faces major test as China virus spreads

  • Markets
  • Tuesday, 28 Jan 2020

stocks US NYSE

NEW YORK: The latest rally in U.S. stocks is facing a serious test, as the S&P 500 heads toward its worst loss in months on concerns over how the coronavirus will impact the global economy.

So far, the selling has been measured, with most investors confident the U.S. economy remains in good shape and the Federal Reserve stands ready to provide stimulus if the situation deteriorates.

Still, worries have grown that months of placid trading may have left stocks primed for an upsurge in volatility.

"Markets hate uncertainty, and the coronavirus is the ultimate uncertainty," said Alec Young, managing director of global markets research, FTSE Russell, New York. "With the markets overbought to begin with, this is now a sell first, ask questions later situation."

On Monday, the benchmark S&P 500 stock index broke a streak of 71 days without a 1% move, the third such longest stretch since 1995. The index registered its biggest one-day percentage drop since October on news that the death toll from the virus grew in China while more cases were reported abroad.

Past runs of quiet trading in U.S. stocks have tended to culminate in periods of turbulence: for instance, an unusually calm period from September 2017 to January 2018 preceded a sharp sell-off in February 2018, fueled by an implosion of bets volatility would stay low.

The Cboe Volatility Index touched a three-month high on Monday and ended the session 3.67 points higher at 18.23, after having traded near its lowest levels over the past year earlier this month.

"Positioning in the equity markets... had gotten a little bit out of hand. That creates a lot of kindling for a fire in risk asset prices," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott.

There have been few tests of the bull market's most recent leg higher, which before Monday's losses has seen the S&P hit numerous fresh highs after the preliminary U.S.-China trade deal was announced in mid-December.

Growing confidence in the rally's durability had pushed investors to increase their exposure to equities: Allocations to global stocks stood at their highest level in 17 months, while cash levels shrank to a seven-year low, a Bank of America Merrill Lynch survey of fund managers showed last week.

Until last week, options also reflected muted concerns about a sharp pullback.

Persistent low volatility would usually prompt greater demand for puts, which offer downside protection, in comparison to calls, used to participate in further upside, said Stacey Gilbert, portfolio manager for derivatives at Glenmede Investment Management in Philadelphia. But skew, a measure of interest in puts versus calls, for the S&P 500 rose only modestly in relation to the plunge in volatility.

Investors may take comfort from the market's reaction to the 2003 SARS (Severe Acute Respiratory Syndrome) outbreak, when the S&P rallied more than 10% from the start of the outbreak to the announcement of its containment.

A few investors have gone against the grain in recent weeks, buying insurance against a jump in volatility while prices for most such bets have been relatively discounted. At least one investor bought 225,000 calls earlier this month that would require the VIX to hit 22 by late February in order to be redeemed. The index traded as high as 19.02 on Monday.

"People are nervous because the market has been going up for such a long time and done so well recently," said David Kelly, chief global strategist at JPMorgan Funds. "I think this coronavirus may be more of an excuse than a rational estimate of its effects."

Reuters also reporte

U.S. stocks suffered their worst day in over three months on Monday as China extended the Lunar New Year holiday due to a virus outbreak, fueling worries about the economic impact of containment efforts in the world's second largest economy.

The benchmark S&P 500 suffered its worst weekly performance since September last week as China locked down several cities and curbed travel, reminding investors of the deadly SARS virus that killed nearly 800 people in 2002-03 and cost the global economy billions.

Still, some investors viewed any long-term economic impact as unlikely, given past experiences with viral outbreaks.

"This whole thing is way overblown," said Stephen Massocca, senior vice president at Wedbush Securities in San Francisco.

"It seems to me the Chinese are doing a much better job of containing it than with SARS and what did SARS ultimately lead to? Did it lead to some sort of economic catastrophe - no."

After the 2003 SARS (Severe Acute Respiratory Syndrome) outbreak, the S&P rallied more than 10% from the start of the outbreak to the announcement of its containment.

Travel-related stocks, including airlines, casinos and hotels, were among the hardest hit on Wall Street, while shares of sectors exposed to China's growth, including technology, materials and energy, pressured the markets.

Adding to downside pressure was the sluggish start to corporate earnings season with indexes near record levels.

Earnings are now expected to show a decline of 0.5% for the fourth quarter, according to Refinitiv data. Of the 87 companies that have reported though Monday morning, 67.8 have topped expectations, below the 74% rate from the past four quarters.

The Dow Jones Industrial Average fell 453.93 points, or 1.57%, to 28,535.8, the S&P 500 lost 51.84 points, or 1.57%, to 3,243.63 and the Nasdaq Composite dropped 175.60 points, or 1.89%, to 9,139.31.

The Dow and S&P has their biggest one-day percentage drop since Oct. 2 while the Nasdaq's fall was its largest since Aug. 23. Wall Street's fear gauge, the CBOE Volatility index, reached 19.02, its highest since Oct. 10.

Technology and internet heavyweights that have powered the recent rally including Apple Inc, Microsoft Corp, Alphabet Inc and Inc, which account for about 15% of the S&P 500 weighting, lost at least 1.6%.

Wynn Resorts Ltd, Melco Resorts & Entertainment Ltd and Las Vegas Sands Corp, which have large operations in China, plunged at least 5%. The NYSE Arca Airline index dropped 3.32%.

Yum China Holdings Inc tumbled 5.27% after the company said it had temporarily closed some of its KFC and Pizza Hut stores in Wuhan, the epicenter of the outbreak.

The rush to safe-haven assets sank U.S. Treasury yields, with the benchmark 10-year note falling as low as 1.603%, its lowest since Oct. 10, and the yield curve between the two-year and 5-year inverting for the first time since Dec. 4, putting pressure on lenders. The S&P 500 banks index was down 1.42%.

The S&P energy index dropped 2.76% as crude prices settled down about 2% on fears the outbreak would dent demand.

Fourth-quarter earnings will kick into high gear this week with 141 of the S&P 500 companies, including Apple, Microsoft Corp and Boeing Co, reporting.

Declining issues outnumbered advancing ones on the NYSE by a 3.63-to-1 ratio; on Nasdaq, a 3.25-to-1 ratio favored decliners.

The S&P 500 posted 20 new 52-week highs and 12 new lows; the Nasdaq Composite recorded 42 new highs and 92 new lows.

About 8.11 billion shares changed hands in U.S. exchanges, compared with the 7.31 billion daily average over the last 20 sessions. - Reuters

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