Morning Notes — Short-Term Forecast

History: It’s still too early to judge the ultimate size and scope of the coronavirus outbreak but we’re using the 2003 SARS outbreak as a market forecasting template nonetheless. At this point, the mortality rate of the Wuhan coronavirus is much lower than what occurred during the SARS outbreak (~3% vs ~14%), so the comparison should provide a conservative baseline. The SARS virus started in China’s Guangdong province, which borders Hong Kong and made the Hang Seng Index the most sensitive benchmark as a result. The first confirmed case of SARS occurred on November 16, 2002. As you’re probably aware, the PBOC was very slow to notify the WHO, but ultimately did so on February 10, 2003. The Hang Seng (HSI) started responding to the outbreak in mid-March and declined ~9.7% before reaching a bottom on April 25, 2003 coincident with decelerating rates of confirmed cases and the snap-back in the HIS was rapid. It’s reasonable to assume mainland China markets will be the most-sensitive markets to the current outbreak. As we know, those markets are closed for the Lunar New Year holiday, which was extended by one business day to include next weekend. In the meantime, we’d keep an eye on yen as a reasonable proxy.

Volatility: A the moment, the direct risk to US markets is probably an associated uptick in volatility. Some systematic funds (‘gamma hedging’) use volatility measures to program sales. The most recent example of volatility-induced systematic selling occurred in October 2018, but positioning among systematic funds today is far lower than it was back then. The VIX is a simple, easy to find measure of equity volatility and it’s recent uptick thus far, is about half the move from 10/18.

Still good: On Friday, January 17, we called attention to some SPX price trend deceleration and the potential for a resulting ~2-4% correction. We followed up last Thursday (1/23) with the following: ‘Last Friday we noted some price deceleration in the S&P 500. That trend has continued this week and comes at a time of ‘elevated’ short-term bullish sentiment in the AAII polling data. Sentiment indicators tend to be reliable contrarian indicators only at extremes. We’re not there yet, but with the recent price deceleration, we see an increased probability for a near-term pull-back of maybe 2-4%. Picking a round number midpoint, we could see short-term SPX consolidation to ~3200 before a resumption in trend.’ This short-term forecast still feels accurate.