In the last post (Market Thinking February) we noted how the traders were anticipating an interest rate cut, which duly arrived to much ‘surprise’, but that we were nervous about a shift in sentiment by long term investors who would flip from a recent history of buying dips to selling rallies regardless of how bad (or indeed good) the economic data turns out to be. We remain of that view.
The spread of Covid-19 to Europe has not been as dramatic as the spread of the policy intervention. Being based in Hong Kong (though coincidentally not at the moment) we have already seen this script play out with the precautionary principle raised to extreme levels in terms of closing schools, banning large gatherings and so on. We even see repeats of the hoarding of toilet roll and the panic buying of face masks even though all advice says they offer no protection. Interesting that Hong Kong now seems to be getting back to some semblance of normality – they even had a small protest the other day (!) As another early indicator, it is worth noting that the Baltic Dry appears to have bottomed in early to mid February and is now up 30% on the month. Meanwhile, the ratio of precious metals to industrial metals or Gold to Copper, that we discussed recently as a proxy for economic negativity appears to have topped out for now.
The net result of all of this will nevertheless be a meaningful slowdown in activity, which will present a working capital problem for a number of firms, particularly those with weak balance sheets, making a focus on quality and balance sheet strength important. Meanwhile, the Fed response to the ‘crisis’ has capped the US$ on a trade weighted basis and particularly against the Euro, where there was clearly a lot of interest rate spreads in place that no longer make sense now that US rates are approaching zero as well. The Yen, Swiss Franc and Gold are all prospering on a similar basis. Looking further out, dollar weakness could become an investable theme pointing asset allocators back towards emerging markets, but experience suggests that those trades will wait a while yet. The first clue will be in how the March options expiry plays out in two weeks time. This has proved to be a powerful indicator of positioning in the past, either hedges are rolled or they are allowed to expire and that can set the tone for the rest of the year.
