Credit vs Equity Market as Pandemic Risk increases

It is not the first time that, at the beginning of a financial crisis, the credit and equity markets have been sending different messages. The divergence between‧‧‧

It is not the first time that, at the beginning of a financial crisis, the credit and equity markets have been sending different messages. The divergence between high yield CDX and US stocks, although narrowing, it is still quite noticeable. CDX spreads are at their highest levels in the last 12 months, having had its biggest daily widening last week since 2015, whereas S&P 500 was only slightly negative in the same week. Last time such kind of divergence happened it was at the top of the 2018 markets before the rout in risk assets.

To add some more perspective to it, for the first time ever the 10-year Treasury yields are trading below 1%, with a decline resulting in over four standard deviation below its six-month average. This is unprecedented! Treasuries are trading like an option approaching expiration. We have also experienced an extremely high correlation state for equity markets, which hasn’t happened since 2011.

According to a very interesting analysis by Bloomberg Economics, the coronavirus could cost then World nearly $3 Trillion. In China, automobile sales have plunged 80%, passenger traffic is down 85% from normal levels, and business surveys are touching record lows. The economy, in other words, has practically ground to a halt. For the rest of the world, China matters as a source of demand, a source of supply, and a focus of concern for financial markets. If China can quickly get the outbreak under control, and the world’s factory rumbles back to life in the second quarter, then the impact on the rest of the global economy could be contained. If that happens, a severe shock in the first half would be followed by recovery in the second. In an alternative scenario, considering a more severe shock to South Korea, Italy, Japan, France and Germany and a smaller shock to countries such as U.S., India, the U.K., Canada and Brazil, global growth for 2020 slides to 1.2%. The euro-area and Japan go into recession, and U.S. growth drops to 0.5%.

In the most severe scenario of a global pandemic, the analysis assumes that all countries face a severe shock—equivalent to the drop in growth China is suffering in the first quarter.

If that happens, global growth for the year goes to zero. The U.S. joins the euro-area and Japan in contraction—potentially changing the dynamic of the presidential election. China’s economy expands just 3.5%—the slowest in records back to 1980. Worldwide, lost output hits $2.7 trillion.

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    As an Investment Consultant and Specialist, Pompeo Pontone is a Professional Investor with 25 years’ experience in the fields of Investment Management, Quantitative Finance & Derivatives Trading and Data Science.

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