Insights   •   Volatility

Putting the Virus-led Volatility in Context

  • Coronavirus-led global growth concerns have wiped out $4 trillion of market cap over the past five days, leading to a rush into safe havens and out of risk-on exposures1.
  • The difference between this growth shock and prior ones is that the Covid-19 epidemic is affecting consumption and consumer behavior, the bulwark of the global economy.
  • The price action over the past two days is somewhat rare: since 1927 there have been only 36 times with two days with a greater than 3% decline in the S&P 500 Index. Note the S&P 500’s average return on the third day has been +1.28%2.

Putting the Virus-led Volatility In Context

Coronavirus-led global growth concerns have impaired sentiment, leading to a sizeable rush into safe havens and out of risk-on exposures. Major equity indices that were once at all-time highs have now broken through traditional resistance or support trend lines3, as $4 trillion of global market capitalization has been wiped off the books in the last five days alone. The VIX futures curve is inverted – a typical phenomenon during a panic driven selloff – and US Treasury 10- and 30-year yields were pushed to all-time lows, given the demand for safety.

Source:Bloomberg Finance L.P. as of 02/26/2020

These market reactions are emblematic and consistent with the violent microbursts of volatility fueled by exogenous variables that we have become accustomed to over the last few years. Why have these microbursts occurred? The current bull market’s foundation is not overly strong, as fundamental and economic growth rates are already low and slow. An exogenous event, like rain pooling in the basement, only serves to weaken the walls – creating a cause for concern that something more serious may be afoot. Policy, either fiscal or monetary, has lately come in to shore up those walls and keep the good times going. This is why we have seen Federal Reserve rate cut expectations increase to three for 2020, up from just one over the last few days.4 It’s the typical playbook.

Consumer Led Growth Shocks

If we have seen these events before, why the panic in the past few days? The difference between this growth shock and the one from last year surrounding trade is twofold:

  • First, the path to resolution is uncertain. Trade tensions can be calmed by resolutions and new deals. A growth shock fueled by an epidemic creates uncertainty and fear, leading to debate over whether the impact will be transitory or long-lasting. 
  • Second, this growth shock is affecting consumption and consumer behavior, the bulwark of the global economy. Trade was more of a manufacturing and industrial event. Covid-19 is impacting how citizens around the world, and in particular China, are conducting themselves on a daily basis – socially and at work. This is a consumer impact first, then business. Trade was the other way around.

With the consumer at the crux of this growth shock, it has naturally led to a reduction in global growth GDP estimates and weaker guidance from companies that rely heavily on global supply chain logistics and consumer spending habits. With growth being revised lower, prices paid for that growth have naturally fallen.

Here is a short list of growth impacts so far:5

  • Economists have rushed to downgrade Q1 China GDP growth to just 3%, down from a 5.9% forecast earlier this year. 
  • Q1 US GDP growth has been similarly downgraded to just north of 1%.
  •  Europe was forecasting a paltry 0.3% GDP growth rate before the virus hit, and those numbers have since been revised down to indicate a contraction of growth.
  • U.S. business activity shrank in February for the first time since 2013, as the coronavirus hit supply chains and made firms hesitant to place orders.
  • Diageo Plc and Danone SA warned the virus outbreak will hit their sales in China.
  • Apple announced earlier in the month that the coronavirus was posing a bigger hit to sales and production than previously expected.
  • Earnings estimates have also started to leak lower, as the three-month earnings revision ratio for S&P 500 firms has fallen as of late.

Market Reaction

With such dour news and uncertainty over when the volatility may abate, investors have been quick to shed risk assets and seek out areas of potential downside protection. One narrative that has not been prevalent in this selloff, however, is the all-too typical tail wagging the dog argument we’ve refuted in the past that ETF trading exacerbated stocks falling.

In this latest selloff installment, trading volumes on Russell 3000 stocks over the past three days have totaled $900 billion.6 Gross primary market activity (absolute value of creation and redemptions) for any ETF tracking a US market has been $25 billion.7 That equates to a similar level of ETF primary to stock level volume we have seen in other selloff events of 3.9%. If we only take redemptions, that figure drops to 2.8%.  So once again, ETFs escape blame.

Source: Bloomberg Finance L.P. as of 02/26/2020, calculations by SPDR Americas Research. 

The flows in and out of ETFs, while not the cause of the declines can foretell shifts in sentiment and reversals of direction, like a driver making a hard U-turn to avoid a traffic jam.

In the past five days:8

  • Equities have lost more than $12 billion, but remain positive on the month, given the strong uptrend sentiment prior to the recent selloff.
    • The $1.8 billion of outflows in single-country funds has pushed the month-to-date totals to -$3 billion, a reversal of the positive uptrend of four consecutive months of over $1 billion of inflows.
    •  Financial sector ETFs continue to be hit hard as a result of the flattening of the yield curve and the reduction in long-term yields, posting outflows over the past week, month, year-to-date, three months, and trailing 12 month periods.
    •  Other cyclicals like Materials and Industrials have lost over $500 million, a reversal from trends earlier in the year when positivity from the China-US trade deal led to inflows.
  • Fixed income flows were $1 billion – sending the monthly total to over $17 billion (this would be the fourth highest ever total for fixed income flows in a month but close to the second and third by only a few million).
    • Safe haven, interest rate-sensitive Government and Aggregate funds saw the greatest inflows. 
    •  Risk-on equity sensitive credit exposures, however, lost almost $4 billion in the past week – a reversal from the trend we saw in the past three and twelve months.
  • Gold-related ETFs took in over $700 million, raising the February total to nearly $2 billion and the 2020 total to more than $3.2 billion (5% of their AUM)  – a two month reversal after gold funds had outflows to conclude 2019 as the market was more risk-on.
    • An indicator of both trend (% of days with positive inflows) and magnitude (notional amount of inflows) has reached its highest level ever for US-listed gold-related ETFs, as shown below.
    • There have been inflows on 90% of the last 30 trading days (100% percentile ranking historically, so most ever for our consecutive trend indicator) with $4 billion of inflows over that time period (96% percentile ranking – the most for a 30-day period was $7 billion back in the financial crisis)
    • Taken together, the two average a 98%-tile ranking for our trend and magnitude score, indicating overwhelmingly strong sentiment for gold


Source: Bloomberg Finance L.P. as of 02/26/2020, calculations by SPDR Americas Research. 

Looking Ahead in a Sea of Uncertainty

Stocks are risky, hence the equity risk premium. But it’s worth noting that the price action we have witnessed over the last two days, in particular, is somewhat rare. Since 19279, there have been only 36 times when there have been two days with a greater than 3% decline in the S&P 500. There have been only four times when a 3% decline extended into a third day – all of which happened prior to 1933. As shown in the table below, in the 36 instances where there have been two consecutive days of more than 3% declines, the average return on the third day has historically been 1.28% with returns typically skewed positively (61% of the time returns were positive on this third day). The subsequent one-month return has historically been 2.8% (with a 64% hit rate for positive returns). The return dynamic when considering consecutive -2% or more declines is shown below.

Historical Performance on Similar Volatility Days Since 1927 Days Avg. 3rd Day Return Avg. Subsequent 1 Mth Return
# of Times with 2 Days of -3% S&P 500 Daily Return 36 1.28% 2.76%
# of Times with more than 2 Days of -3% S&P 500 Daily Return 4    
% of Days Positive   61% 64%
  Days Avg. 3rd Day Return Avg. Subsequent 1 Mth Return
# of Times with 2 Days of -2% S&P 500 Daily Return 94 0.80% 1.06%
# of Times with more than 2 Days of -2% S&P 500 Daily Return 18    
% of Days Positive   62% 56%

Source: Bloomberg Finance L.P. as of 02/26/2020, calculations by SPDR Americas Research. Past performance is not a guarantee of future results.

So why the turnaround historically? Well, if we use the more recent cases, policymakers stepped in and activated stimulus measures to calm fears. August 24th, 2015 was the most recent episode of more than a 3% decline in consecutive days, and shortly thereafter the Federal Reserve revised down rate cut expectations for its September meeting. Currently, we have already seen fiscal policymakers, notably in China, discuss and commit to spending plans to offset the impact the coronavirus may have on consumption. With breakeven inflation rates declining in the US, and inflation already slow outside the US, this may lead global monetary policymakers to strike a noticeable dovish action plan for 2020.

Given the risks in today’s marketplace, seeking to harness the equity risk premium in 2020 requires working overtime to limit the impact of any volatility. The likelihood of stimulus to offer support, combined with growth uncertainty, may require investors to balance the upside (growth fears lessen = rates may rise off historic lows, equity markets perhaps resume their uptrend) with the downside (growth fears increase = equities possibly decline with rates likely continue falling). As discussed in our Outlook, investors may want to focus on equity strategies that offer upside potential but limit downside risk, while pursuing non-correlated strategies to mitigate shocks such as the Coronavirus in this new microburst volatility regime.