Huge week for markets, as UK Budget, oil price, ECB meeting and Chinese data are in focus

The coronavirus has dominated the global news headlines once again this weekend, as the number of cases outside of China continues to rise and the death toll increases. The northern half of Italy is on lockdown for the rest of the month, which will no doubt have huge economic ramifications for the Italian economy, and now it looks like Saudi Arabia is starting an oil price war with Russia just as the oil price has tumbled to $45.50 per barrel, after falling more than 9% on Friday. At this stage of the coronavirus outbreak, the future is deeply uncertain, and while the world seems to be going mad for loo roll the chief beneficiary has been Kimberley Clarke Corp, its share price rose 2.2% on Friday bucking the trend of global indices that fell sharply. Is this what peak lunacy looks like? 

Have markets made a bottom yet? 

As we move into another week, the markets have to digest a 17% collapse in China’s exports for February, after the drastic action taken by Italy over the weekend, we can expect similar size falls in economic output there in the coming months. While the collapse in some risky financial markets shows no sign of abating, one has to ask, is the recent price action the financial market equivalent of empty shelves in supermarkets across the world? Is this unnecessary panic? The market is incredibly sensitive to the increase in the number of new Covid-19 cases, thus, until we see the number of cases start to level off in Europe and the US, we can assume that pressure will remain to the downside. Since the number of cases outside of China is unlikely to peak for the next month, then one could argue that stock markets may not have hit their bottom.  However, two things make us cautious about looking for a deeper sell off: 1, Italy has been the epicentre of the outbreak across Europe and other parts of the world; thus the action taken to lock down all of northern Italy, is, hopefully, an effective way to try and halt the spread of the virus in Europe and beyond, thus we could see markets breathe a sigh of relief that such drastic action has, finally, been taken, even if it does have a devastating impact on the Italian economy. 2, Coronavirus fatigue. We expect that the public will soon become de-sensitised to the news media’s blanket coverage and updates every time a new case is discovered. This could allow cooler heads to prevail, and for markets to take a calmer approach, which may see equities embark on a tentative recovery, and US Treasuries to sell off - yields to rise - after falling to record low levels in recent weeks. 

Business as usual, not that fast … 

Of course, for a market recovery to take place we would need a few things to happen: for the outbreak not to get any worse than what is currently expected, i.e. for the death rate not to jump, and for the peak in cases to come in the next few weeks/ month, and not to last well into the summer. Also, it will require that no long-term economic damage is done that is greater than what is currently expected, for example, no mass corporate bankruptcies, no sovereign debt issues caused by the lockdown in Northern Italy and no prolonged impact on the global growth rate. As you can see, there are many uncertainties around the impact of the virus, how long it will last and also what the economic impact will be, this is why stocks have tanked along with the oil price, and why Treasury yields have sunk to record low levels (yields fall as bond prices rise). However, as the market gets used to the virus and becomes less sensitive to the news flow about the number of new cases, as we mention above, then the speed of the sell-off may slow. We may not have reached the depths of the stock market sell-off, however, last week’s whipsaw price action may have been the peak of the volatility (famous last words…). 

At the start of a new week, there are a few things to look out for which we list below. Overall, risk management is key in this type of market, and holding onto losing positions in the hope that the market turns around may not be a good strategy. 

1, FTSE 100: winners and losers 

Last week, the clear winners in the FTSE 100 were the supermarkets, Tesco, Sainsburys and Morrisons. This is no surprise as news reports of panic buying and empty supermarket shelves hit the newsstands. Other notable gainers last week were utilities and industrial cleaning companies like Rentokil. We expect these companies to continue to do well as long as the panic among investors remains high. However, we do urge caution, as sentiment in the stock market could switch sooner than it does among the general public. Firstly, if the UK is put on lock down, or if supermarkets have to switch to a ‘feed the public at all costs’ mode, then supermarket profit margins could become depressed, eroding earnings power and ultimately weighing on their share prices. Also, IAG – the owner of British Airways – which has seen its share price fall by a third during the coronavirus outbreak, saw its share price rise by 2% on Friday, even though the broader market continued to sell off. This could be a sign of bargain hunters picking up stocks on the cheap, or longer-term investors expecting that the cut to flights will ultimately give airlines more pricing power later in the year. Either way, watch IAG, if it continues to recover then it could be a sign that the market has bottomed out. 

2, Oil: Saudi vs. Russia 

The oil price could be in for further downside this week, as Saudi Arabia vows to increase production in an effort to squeeze Russia into agreeing to an Opec-led production cut. It’s likely to be a case of which oil producing nation blinks first, and at this stage we wouldn’t be confident to put money on either side. However, the worry is that this will push the price of oil down even further at the start of this week. Brent crude slid 9% on Friday to $45.50, since downward pressure is likely to remain high then $40 could be on the cards. This is bad news for the oil majors and could weigh further on the likes of Shell and BP, which are large components of the FTSE 100. It is also bad news for the shale producers in the US, which are mostly located in the Russel 2000, the index of smaller companies in the US. With the oil price at this level, it is not cost effective to produce shale oil, so some shale oil companies could go bust. This is also bad news for US and global banks, who are large funders of the oil industry. Thus, we could see the energy and banking sector fall further in the UK, Europe and the US at the start of this week. 

3, UK Budget 

We will talk more about this mid-week, but for now, the new chancellor’s budget is likely to be dominated by money for the health service and businesses to help them cope with the coronavirus. We expect the chancellor to be generous in the fight to contain the virus and limit the economic damage. Other initiatives including scrapping entrepreneurs tax relief, a small tax cut for the lowest paid, potential changes to stamp duty or a housing tax, and money for the regions could also be announced. Coronavirus is likely to steal the limelight from this government’s showpiece budget, which could limit the market impact. The pound may be impacted, but only if the market believes that the budget doesn’t go far enough in tackling the coronavirus or in limiting the economic impact. Right now, we expect the chancellor to over-promise support for the economy, which could be neutral for financial markets. But if the maths doesn’t make sense then we may see some downward pressure on the pound. GBP/USD had a decent performance last week, and rose back above $1.30, it has also opened this new week on a high and is extending recent gains as it attempts to target $1.31. Part of the reason for the pound’s upsurge is the dollar’s decline, we have already seen the euro benefit from dollar weakness in recent weeks. The dollar is declining because of the Fed’s extraordinary rate cut last week and the dramatic fall in Treasury yields. Since the market is still expecting the Fed to cut rates, and there is limited scope for the BOE and ECB to follow suit, we expect there to be further upside for EUR/USD and GBP/USD in the next few days. Key resistance levels to watch including $1.32 for GBP/USD and $1.1490 for EUR/USD. 

We will analyse the implication of the UK budget, China’s inflation data and also preview the ECB in our mid-week note. Until then, good luck trading.