150419 Chart of week M 150419 Chart of week M 150419 Chart of week M

EM equities go red on 2019-nCoV, Italian election result lifts sentiment

Equities 5 minutes to read
Picture of Peter Garnry
Peter Garnry

Head of Equity Strategy

Summary:  In today's equity update we argue that investors should tactically be on the short side of equities respecting the unknowns and nonlinearities related to the Chinese coronavirus. For longer term investors being strategically long equities should consider reducing exposure somewhat or hedge market risk with options or futures. The most sensitive sectors to the Chinese coronavirus and potential economic impact are materials, energy, industrials, IT and consumer discretionary. Italian equities are responding positively to the weekend's result which is positive for our positive call on Italian equities which have an attractive equity risk premium.


Equities are finally beginning to contemplate the possibility that the virus 2019-nCoV in China will have significant economic impact as the lockdown is now affecting 56 million people. China has imposed travel bans, school closings in major cities and is extending the Lunar New Year. The market reaction already started Friday with the US equities declining as more news disseminated, but in today’s session Chinese related markets are hit hard. Emerging market equities are down 4.1% and cyclical sectors are leading the declines with especially travel, luxury goods, semiconductors and mining related stocks being hit the hardest. IFO survey numbers from January also shows this morning that the economic rebound in Germany is not a straight line as we have seen in previous rebounds since 2008. It all adds to uncertainty.

We are not and do not pretend to be experts on viruses but it is important to understand that viruses are independent of each other and that comparisons to previous outbreaks like SARS in 2003 are poor risk management. China is very different from 2003 with significantly more high-speed rail network and the virus is spreading during incubation period which makes it more difficult to contain. China’s health commission has said this morning that the epidemic is becoming more complicated to battle. Our view is to respect the unknowns of viruses and that it comes with potential ugly nonlinearities. From a tactical side traders should be on the short side in equities and the large gains from last year will likely be attempted to be locked in creating downside liquidity effects. For investors with a longer term view we believe reducing exposure somewhat or hedge market risk is a good precautionary step.

27_PG_1
Source: Saxo Group

Our tactical asset allocation model Stronghold, which clients can invest into through SaxoSelect on the platform, had increased its exposure to emerging market equities in the last couple of weeks as the expected returns had improved with improving conditions in Chinese equities. But today’s reaction in emerging market equities is causing the portfolio’s risk measures to flash red and as a result the portfolio will half the exposure to emerging market equities. It is during times of elevated volatility that our tactical asset allocation should react better to risk and outperform more static asset allocation models.

Adding to risk-off sentiment we observe the VIX Index is close to 18, the highest level since October, which means that the equity market is shifting in a different state with lower expected returns and higher volatility. Remember as we have said many times in the past that the 22 level is the magical level where equity markets downside dynamics become very ugly. So stay alert and pay attention to news out of China and watch the VIX.

27_PG_2
Source: Bloomberg

Investors were nervous about Italy going into the regional elections in Italy this weekend with consensus fearing Salvini winning in the long-standing leftwing region Emilia-Romagna. But Salvini’s rightwing coalition failed in the election and investors are heaving a sigh of relief with Italian equities being the best performing equity market in Europe this morning only down 0.9%. With this political risk lower for now Italian equities should perform well on a relative basis. The equity risk premium remains very attractive compared to many other equity markets driven by long-term profit growth rate of 4.9% and a fat dividend yield of 4.5%.

27_PG_3
Source: Saxo Group

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.