… Or were they overbought and due a correction?
The last week of January has seen a marked pick up in equity market volatility, seeing indices falling sharply from recent highs as concerns over the Coronavirus hit markets. The question is whether markets were long overdue a correction and the virus concern was merely the catalyst, or whether there is justification in pricing in a significant slowdown in global trade and therefore earnings?
The charts below suggest that the market was looking for a reason to correct.
MSCI World Index Relative Strength Index
VIX index (Chicago Board Options Exchange Volatility Index)
Source: Bloomberg
The first chart illustrates that global markets were significantly overbought (bottom window) on the Relative Strength Index RSI and that the market had become complacent with volatility, as measured by the VIX Index in the second chart, reaching lows not seen since Q3 2018 just prior to the sharp correction in equity markets in Q4 of that year. For most of 2019 global investors had, in aggregate, taken a cautious approach to risk according to a number of investor surveys. It was interesting, therefore, to read the Bank of America/Merrill Lynch December Investor Survey which confirmed that positioning in equity markets had shifted significantly from underweight in Q3 to overweight by year end.
On the topic of the Coronavirus, it is very difficult to see this as an investible driver for markets except that it does create uncertainty which markets do not like. Widespread global contagion of the virus will clearly have serious ramifications for global movement, trade and consequently economic activity. Once again, the bond market rally over the last week or so has, to some extent, come to the rescue for stocks and we would expect central banks to react quickly should the situation deteriorate. One would hope that any economic slowdown as a result of the Coronavirus would merely create pent up economic activity further down the road when the crisis has been contained, as was the case following the SARS outbreak.
Therefore, without wanting to sound complacent in the very least on the potential impact on global growth and consequently risk assets that the virus could cause, as markets drift into oversold territory and volatility increases to levels last seen in the middle of last year we would view this as a good buying opportunity. The fundamentals have not changed. Monetary policy remains very loose and fiscal balance sheets are likely to support the global economy further. While not particularly cheap, equity markets are fairly priced. The ever decreasing stock of publicly traded equity means that any technical sell off, like the one we are experiencing now, should be taken advantage of.
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