Like many market participants, Morgan Stanley’s Mike Wilson recently endeavored to speculate on how far a coronavirus-related selloff in US equities might go in the event the mini-panic that showed up late last month got worse.
Although it seems like a distant memory now, it was just six sessions ago when the S&P fell the most since October amid spiraling worries about the infection, which, at the least, is poised to run roughshod over the Chinese economy in Q1.
For those with a short memory (or for those who have been inebriated since then), here’s a reminder:
And yet, as Wilson rather dryly notes on Monday, efforts to speculate on how far stocks might fall proved superfluous.
“Last week, we tried to provide a thoughtful analysis for where we thought there would be strong support for the S&P given the ongoing correction that accelerated into the prior week’s end”, Wilson writes. “That analysis turned out to be needless as the bull charged straight ahead without hesitation, never challenging our 3100-3150 support level”.
(Morgan Stanley doesn’t see the virus “derailing” the global recovery, only delaying it.)
As far as why US equities on the whole only sold off a mere ~3.5% amid the scare (see visual), Wilson attributes the resilience at the index level to five things.
First, he simply notes that there’s some hope the pace of the virus’s spread has slowed. We won’t spend much time on that because the jury is still out on the veracity of that assumption.
Second, Wilson says that although the S&P didn’t drop much, the damage was more readily apparent if you just looked at growth proxies, a point we’ve made repeatedly in these pages of late. “Given already weak performances of such assets, they are now discounting a fairly negative outcome given the fact many of these measures are back to where they traded last summer when recession fears were prominent”, he notes, referencing commodities, yields, relative performance in cyclicals and the copper/gold ratio.
Next, Wilson rolls out the tried-and-true rationale for risk asset resilience in the face of macro headwinds: The hope that if things get bad enough, China and Germany will be compelled to embark on serious fiscal stimulus in an effort to reflate.
Markets have been (almost literally) begging Berlin to loosen the purse strings, and as we marveled last week, Germany continues to run a surplus despite being mired in a truly egregious factory slump characterized by 19 consecutive quarters of order book contraction. Industrial production printed the worst since the crisis on Friday.
In China, authorities have been keen to avoid delivering “too much” stimulus, monetary or otherwise, for fear of inflating bubbles and/or prompting the world to question Beijing’s commitment to de-leveraging. Now, however, the Party’s hand may be forced – and that is one heavy hand.
Fourth, Wilson cites the possibility that between the Iowa (non)results and the acquittal of Donald Trump, market participants may be less worried about the political outlook. “Last week saw the acquittal of President Trump and Iowa results that obfuscated the ultimate direction of the Democratic primary”, he writes. “On the margin, investors may think this reduces the probability of major changes”.
We spent a ton of time on all of that last week. Pete Buttigieg’s strong showing in Iowa seemed to buoy risk assets at the margins as the mayor is seen as preferable (from a market perspective) compared to Bernie Sanders and Elizabeth Warren. The technical debacle in Iowa also bolstered sentiment. Last Monday’s logistical mayhem was seen by some as helping President Trump’s re-election odds. As long as there’s still a chance that Sanders or Warren gets the nomination, anything that Trump can spin in his favor is seen as a positive for stocks.
Lastly, Wilson makes a more nuanced point about why it is that US equities were bid when they were. To wit:
The S&P 500 is often viewed as a safe haven itself because of its high quality defensive growth characteristics. In short, it is the appropriate asset to own if rates continue to fall so long as we don’t have a recession. Therefore, whenever we breach 400bps on the equity risk premium to the upside, there has been a strong bid. Two Fridays ago, when the markets had their big one-day selloff, the ERP reached 402bps, which attracted capital like a magnet.
As indicated by the right-most annotation, Wilson thinks that with the ERP having come back in, and realized vol. having been pulled higher, the buffer for additional macro shocks may now be limited.
Ultimately, Morgan’s equities team says the S&P has “strong support” at 3100 to 3150. Of course, with SPX perched at 3338 as of this writing, that’s small comfort for anyone who’s newly-long.