Too fast, too soon?

US and European equities regained early January’s highs. The S&P 500 and Nasdaq even recorded new record highs. Over the week, the S&P 500 index gained 3.2% while the Stoxx Europe 600 was up 3.3%. US Treasury yields edged up but were far off their pre-health crisis levels. The same applies to commodities, especially oil, whose prices remained very low.  

Is it reasonable?

On Friday, major stock market indices lost some ground again as investors continued to try to assess the impact of the coronavirus. That said, last week's rebound was remarkable in its scale, but also in its timing that has been much earlier than in previous pandemics.

This leap in confidence stems from a number of factors. After measures of massive quarantine were taken two weeks ago (the incubation period of the virus) and travel bans, we should see the first results in the next few days. Official figures show that the number of new contamination cases is already growing less rapidly, the spread outside of China does not appear to be accelerating and various sources have announced progress in the search for treatments and vaccines, although the WHO (World Health Organization) has been more cautious on this point.

The markets were also encouraged by the Chinese central bank's liquidity injection into the financial system. There is talk of a rate cut soon. China also halved customs duties on a portion of imports of US products. After Brazil, Thailand and the Philippines, Russia followed suit by cutting policy rates on Friday. Singapore and Mexico might do the same this week.

While it is reasonable to think that the impact of the virus will be temporary and a catch-up effect may occur thereafter, this impact will be significant and the duration of the health crisis remains unknown.

The ISM and the US jobs report surprise positively

The US economy is doing well. After the rebound of the ISM manufacturing index from 47.8 to 50.9, the ISM services index nudged up to 55.5 (a figure above 50 means expected growth).

In January 225,000 jobs were created. This number is more than the 165,000 expected and the 147,000 created in December.  The trend remains robust with an average of 211,000 over the last three months. The unemployment rate rose from 3.5% to 3.6% due to a higher participation rate (measured when people who are neither unemployed nor job seekers join the labour market). Average hourly wages rose 3.1% year-on-year.

In Europe, the manufacturing recession continues 

Industrial production in Germany (-6.8% y/y) and in France fell short of expectations. Orders registered by German industry declined and the eurozone ISM manufacturing index remained in a contraction zone (47.9). The contrast between the health of Europe and the US has pushed the dollar higher.

Conclusion

The two major crises at the beginning of the year, namely the intense tensions between the United States and Iran and the health crisis linked to the coronavirus, highlight the resilience of equities. There has been no massive profit-taking despite their good performance in 2019. This reflects some confidence in equities for 2020. It also proves that there are still a lot of cash reserves, that can been readily invested at any downturn.

This is surprising because valuations are not cheap. The latter point, however, needs to be put into context, because the overvaluation of equities is mainly concentrated in the technology-media sector in the United States. This is an area prone to some vulnerability. But so far, earnings from broader technology stocks in the fourth quarter have lived up to high analyst expectations. So there are no worries there in the immediate future.

The coronavirus pandemic is far from under control and signs of slower growth in new cases need to be confirmed over a longer period. The markets may have bounced back a bit too rapidly and fears may resurface. This means that volatility is likely to remain high. But in view of current information available, we do not change our conclusion: it is better to take advantage of troughs to top up equity positions than to do it the other way round.