The Virus seems to be spreading further despite Chinese measures to keep under control. It is important to note that the Government reaction and prevention has been much faster this time (SARS took nearly 5 months for the 1st reported case), and prevention (overnight travel to the Wuhan Province on high speed rail was banned, etc.) has been expedited.

Data from the Chinese New Year activity are revealing the extent of the economic decline. On the first day of the holiday, there was a 41.6% decline in civil air travel, a 45.5% drop in rail travel and a 25% drop in road travel. If this negative trend continues, we will even see the Chinese GDP losing more than 1% in the upcoming quarters. Also, we should consider some spill over effects on Asia-Pacific. The most important short-term impact will be felt on travel and tourism for countries which are strongly relying on tourism such as Thailand, Australia, and Vietnam. In Thailand, for example, tourism exports are about 11% of GDP. Tourists from China also represent a large proportion of arrivals for these economies, particularly for Thailand and Vietnam, where more than 25% of arrivals are from China.

The old rule for the markets of “up on escalator, down on elevator” is good even this time. We didn’t have on the S&P a 1% drop session in 73 days and now we had already nearly 2 days in a row.

While volumes were low on the way up Ytd, activity has been hectic over the last two days. Of course derivates had a great play as the future to cash ratio yesterday was 7 to 1!

With China closed until the 3rd, and Bernie Sanders moving ahead in the polls, can see the case for price-action to get worse.

As we have stressed several times, positioning was very stretched and the Virus situation was the perfect excuse to sell/take profit.

Another reminder of the “snowball effect”,  a 1% move in the S&P on a close to close basis could result in ~$20Bn for sale from Systematic funds, while a 2% move (close to close) is near ~$80Bn and 5% move 150bn$.

The current positioning of Volatility Control funds is now at 113%, very similar to the excess they had in October 2018 where fell quickly. Is the situation of October 2018 going to be very similar to what we should see now?

Yes it is, we might possibly get a quick re-rating, maybe not that extreme but there is concrete possibility of a weight adjustment which could generate substantial equity sale on the market.

Have a look at the Cross asset volatility across Equities, Credit, FX and Gold.

In the options-space, we have seen a clear bid for skew and the idea we gave you last week of buying Puts on Indexes in order to protect the portfolios taking advantage of the low volatility and skew is working very well.

On Bonds yesterday’s risk-off environment was pretty visible in Govies, with 10-year US treasury yield dropping to 1.6%, the lowest since October and Japanese JGBs yields slumping to -5bps, the lowest in two months.

We have already flagged the extreme positive start for the year with huge numbers of bonds coming to the market. We saw the largest weekly increase in negative yielding debt, with an additional $1.16 trillion. So far the total of negative yielding debt is $12.4 trillion, up from $10.8 trillion as of mid-January (it means interest rate are trending lower).

Have a look at the chart below where global bond funds are reaching a new record taking advantage of the window given by the market. After two weeks of record volume ($210Bln borrowed so far in January), new bond issuance halted yesterday, in a pure risk-off sell-off behavior on Credit.  

At the same time, however, the iTraxx Crossover Index linked to companies with mostly junk ratings climbed  the most since early October. The cost of insuring investment-grade and financial bonds against default also rose.

An important sentiment indicator will be given this week by the equity supply given by the IPOs. This week we will have 5 IPOs for up to 2bn$ and there are further 67 IPOs on files to be done within the end of Q1. As we always stressed, it is important to see how the market could absorb this further liquidity.

On a potential positive side, we should expect that the Coronavirus could actually be the catalyst / reason for the PBOC to further ease financial conditions and we know how markets like the rhetoric.

Macro-wise, the January IFO expectations were yesterday at 92.9 vs 94.8 consensus with German business expectations falling on services and construction while rising on manufacturing. According to Finance Minister Olaf, German government spending is close to record level, after the country run budget surplus for 6 consecutive years.

In US, following the recent big upside surprise in existing home sales, analysts expected new home sales to extend gains further in December but they were disappointed significantly, dropping 0.4% MoM (vs +1.5%) and worse still, November’s 1.3% jump was revised drastically lower to down 1.1% MoM.

Today’s Macro

  • December US Retail Sales Real YoY
  • December US Durable Goods orders
  • December US Capital Goods orders
  • January US Consumer Confidence

Today’s earnings release: LVMH, Ferragamo, Pfizer, United Technologies, Lockheed Martin, Xerox, Xilinx, Maxim Semis, Ebay, Apple, Advanced Macro Devices