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Coronavirus: global panic or the opportunity to earn?

US, WASHINGTON (NEWS OBSERVATORY) — The epidemic of a new type of coronavirus swept the entire planet and overshadowed almost all the important events in the world of politics, economics and finance.

After some time, the panic spread to the stock exchanges. The global economy has been paralyzed: work in factories stops, people are advised not to leave their homes, production and transportation are reduced.

The PRC Purchasing Managers Index (PMI) has completely collapsed to historic lows. It is not surprising that investors began to dump shares and play to lower the value of commodity assets. A sharp decline in demand is coming.

World regulators are hurryingly pouring money into the economy. The Federal Reserve could not resist, on March 3, he did not wait for the next meeting, scheduled for March 18, and reduced the rate, and immediately by 0.5%. An emergency meeting is not an ordinary event, the last time the regulator had to take such measures more than 10 years ago was in the midst of the 2008 crisis.

However, the Fed started talking about it a little earlier, when US stock indices made the fastest descent in their history . True, they were waiting for rate cuts on March 1, but the regulator decided to introduce an element of surprise.

Separately, it is worth noting that Fed Chairman Jerome Powell actually did what Donald Trump asked almost every two weeks. Now the United States will be easier to finance its prohibitive budget deficit. Yields on treasury bonds are near historical lows.

The rule worked: buy on rumors, sell on facts, and at first the decision of the Federal Reserve System was perceived negatively, but there is another unwritten rule – don’t fight with Fed. Indeed, the decision of the Federal Reserve offers good opportunities for making money. As John Rockefeller said: “Buy when blood is pouring in the streets.”

Most likely, large players began to form long medium-term positions, while others emptied their portfolios. The main purchases, apparently, were made as early as “black Friday” on February 28, when sales reached their peak. A colossal trading volume may indicate this. In addition, according to Western financial media, $ 125 billion of pension money entered the US stock market.

At the end of the month, they rebalance their portfolios, sell some assets and buy others. Do not forget that the value of financial assets is determined by the value of money. Under the conditions of ultra-soft monetary policy, markets have existed for more than 10 years, and have long since lost some connection with the real state of affairs in the economy.

A striking example is the expectations of global economic growth and the dynamics of stock indices in the period 2013-2015. Economists and analysts cited fair factors that pointed to a downturn, but markets continued to grow.

This happened for one simple reason – the money was cheap, and the Fed rate at minimum values. The collapse in late February quickly made stocks in the US and other markets attractive. The Federal Reserve sharply reduced the rate by half a percentage point to 1-1.25% per annum – the minimum since 2017, and the shares not only fell significantly in absolute terms, but also look very attractive for various models, taking into account the risk-free premium, Igor Stremoukhov, senior Partner FP Wealth Solutions SA.

Bonds of the US Treasury Department are considered a risk-free asset. It is on this that all financial models are built. If this rate is too low, financial institutions opt for more risky assets, in particular stocks: either because of dividend yield, which is higher for them, or because of expectations of growth in value. In both cases, money is transferred from bonds to stocks, since the risk-free premium is too low.

Now, 10-year Treasury yields have fallen below 1%. Given the drop in value, the dividend yield on individual shares is now quite high. For example, at Exxon Mobil at the peak of the fall, it even reached 7%.

By the way, the Russian market also has a lot of securities, on which the dividend yield approaches 10%, and in some cases even higher. For example, in Alrosa, the dividend yield is now about 8.5%, Bashneft – about 9%, VTB – also about 9%. Igor Stremoukhov said that he had already bought these papers for himself.

Large investors work in the market to earn money and are unlikely to be very interested in the epidemic of the virus when it is possible to make good profits, moreover, the Federal Reserve is literally pushing bidders to make purchases. In addition, it cannot be ruled out that in the coming months, rates will be reduced yet.

Goldman Sachs, for example, has already stated that it expects two more rate cuts of 0.25 at meetings in March and April. In the medium term, the probability of an uptrend is high. Until the summer, stocks can grow significantly, and then the market can begin to win back other stories. From the outside, such a view may seem overly optimistic. After all, such a strong fall could not have happened just like that, so there are serious reasons.

There really are reasons, says Igor Stremoukhov, Senior Partner at FP Wealth Solutions SA, but they have their own nature. This is not panic in the usual sense of the word, and one should not think that global investors were so afraid of the coronavirus and the economic slowdown. Now is not the year 1929 and not even the year 2000, and there are no so-called “stock pits” where brokers run around and place applications.

Funds and banks have been using trading robots for a long time, they account for more than half of transactions on the exchange. They work on certain algorithms. The speed of movements increases, but there is also a side effect: when falling, a kind of self-destruction mechanism is launched, which could already be observed in action at the end of 2018.

Traders during the rally actively sell put options, but at the moment when the indices begin to decline, they have to reduce risks and hedge positions by selling futures or stocks included in the index.

Robots do this purely on mathematical models, they are alien to emotions and other thoughts – there are only numbers. And the stronger the decline, the more they increase sales to minimize risk on options. Confirmation of these words can be easily found on option desks, where the volume of trading in American stock options is almost equal to the volume of trading in basic securities, and the option / underlying ratio has become the maximum for 14 years.

Thus, each decline provokes even greater sales and an even greater drop in quotes. At some point, more passive funds trigger risk management signals and they already begin to sell their portfolios.

All this leads to what we saw last week. But at some point, passive funds end liquidation of portfolios, and the situation on the trading books of active traders is stabilizing. Now the Federal Reserve is giving a helping hand to the markets, and fresh money cannot be in the system just like that, it will go into financial assets.


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Article is written and prepared by our foreign editors from different countries around the world – material edited and published by News Observatory staff in our US newsroom.