As fears about the coronavirus catch up to U.S. markets, investors are watching closely to see if the outbreak freezes global supply chains and spreads far enough to be called a pandemic.
Italy, South Korea and Iran reported sharp rises in coronavirus cases on Monday as the virus’ reach continued to spread. The World Health Organization said on Monday that the virus has pandemic potential, although it was premature to declare that level of severity yet.
U.S. stocks slid more than 3% while Treasury yields tumbled and the yield curve inversion deepened – a sign that signals potential recession.
“The smart money is paying attention and positioning for that particular word (‘pandemic’) to drop,” said Wouter Jongbloed, Head of Political Risk Analysis, Exante Data. “The fear right now is focused on supply chains. If the WHO does feel the pressure to use the ‘P’ word then those supply chain fears will race to the front.”
If the virus is eventually labeled as a pandemic it would sweep fear into consumers and could impact spending, said Andrew Richman, managing director of fixed income strategies at SunTrust Advisory Services in Jupiter, Florida.
That could add another dimension to the economic damage that the virus has already wrought.
“From the perspective of the consumer, I think it would change things,” said Richman. “I think you would see another fear-induced leg down in the equities market.”
Already, companies such as iPhone giant Apple Inc. (AAPL) have warned that supply chain disruptions could lead to short-term product delays. Any further spread of the virus will likely exacerbate those problems and hurt demand, said Eric Marshall, a portfolio manager at Hodges Capital.
“The market has been too complacent with how it was pricing in those risks,” he said. “We expect to see extended impacts on the supply chain that could slow economic growth overall.”
Analysts cautioned that a dip in the yield of benchmark 10-year Treasuries – yields move inversely to prices – below its record low of 1.32% touched in 2016 would likely exacerbate the stock market sell-off.
“This isn’t just an issue of economic fundamentals, there is a lot of fear in the market now,” said Jim Paulsen, chief investment strategist at the Leuthold Group. “A break in new lows for Treasury yields would brings up a whole new host of fears of what does the bond market know that the stock market doesn’t.”
A continued sell-off in equities while the bond market continues to rally would also put an end to a synchronicated rally that had pushed both risk-on assets like U.S. stocks and typical safe-havens like the dollar and Treasuries all up by 3% or more this year.
“Especially in the bond market the fear of this becoming more pandemic in nature has really spread,” said Charlie Ripley, Senior Investment Strategist for Allianz Investment Management. “As volatility in the equity market has started to pick up it’s possible that we are seeing a divergence from what we were seeing over the previous four weeks” when both equities and bonds rallied, he said.
Financial markets on Monday ratcheted up bets the U.S. Federal Reserve will be pressed to cut interest rates to cushion a feared hit to economic growth from the spread of the coronavirus.
Jeff Grills, head of emerging markets debt at Aegon Asset Management, cautioned that further stimulus measures by global central banks may not ease concerns about the impact of the virus on the supply chain.
“Pumping liquidity into the system does a lot to support financial markets but doesn’t encourage people to leave their houses and go to work or spend money,” Grills said.