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Asset correlations not making sense


20 February 2020

US and European equities are at record levels and US Treasuries are trading close to their October highs; meanwhile, gold prices have climbed to a new seven-year high. It seems investors are simply buying everything and that could be worrying…

Investors who were sitting on the sidelines anticipating a 10-20% correction in stocks after the coronavirus outbreak have been left behind. What is driving this rally? It is monetary policy expectations, pure and simple. The US Federal Reserve and the European Central Bank are committed to keeping interest rates low, and extra liquidity may still come from reviving bond-buying programs. The Bank of Japan is ready to cut rates even further, while the People’s Bank of China and other emerging market central banks are already in the process of further loosening their monetary policies. 

While valuations are extremely high, we’re not yet near the highs of the late 1990’s dot.com bubble. However, the ‘FOMO (fear of missing out)  rally’ may soon lead markets to the euphoria stage.

Investors buying equities at current levels are not anticipating better economic conditions or higher corporate earnings. In this scenario, US Treasury prices and gold too, would be much lower . When assets perform in such a way, it is clearly an environment that suggests irrational behavior by investors. They still want to participate in the equity bull market, but at the same time, buy safe haven assets to protect their portfolios from a potential downturn.

What we are clearly missing in this equity rally is solid fundamentals. The impact of the coronavirus on the global economy may well be underestimated. A drop in newly infected cases doesn’t immediately translate into an end of this pandemic. Many factories in China remain closed and the global supply chain has been disrupted already.

Apple has been one of the few large companies which issued a revenue warning and market participants should expect many more to follow. Similarly, expect to see global growth and the earnings outlook revised lower for the first quarter of 2020. When equities are priced to perfection, it’s hard to escape a market correction.

#source

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