Investment Risks Increased by Fear-Driven Capital Movement
Global markets have slipped into a correction status following the novel coronavirus outbreak in multiple countries.
In an intensely risk-averse market environment, investors are scampering out of the stock markets. The MCSI All Country World Index (ACWI) which shows the movement of global equity markets as a whole has fallen 11% over the week on February 24-28. The Dow Jones suffered 3583-point drop within a week, setting a historical record. The correction in the U.S. share markets has set a historical record and wiped out over US$3 trillion in market value. In the European markets, concern over the novel coronavirus has caused investors to pull out of equity markets comprised primarily of tech stocks, wiping out over US$1.1 trillion in market value, even exceeding the annual GDP of the Netherlands. The SPDR S&P ETF Trust SPY with US$257 billion in assets has experienced US$13 billion in capital outflows within a week, the largest weekly capital loss in 2 years. This caused the fund asset value to fall to levels last seen in October 2019. In Asia Pacific, the Nikkei 225 index fell by 9.6% while South Korea’s KOSPI fell by 8%. Chinese A-shares fell by 5%, Hong Kong’s Hang Seng Index fell by 4%, and markets everywhere experienced severe capital withdrawals. Within a week as much as US$6 trillion in market value evaporated from global equity markets.
Investment funds are shunning risky assets, and risky bonds are not being exempted. The U.S. Intercontinental Exchange (ICE) data shows that high yield bonds’ spread over U.S. Treasuries on February 28 widened to 5.21%, increasing 1.38 percentage points in a week and exceeding 5% for the first time in the past year. Two largest junk bond ETF’s also experienced record capital outflows. IBOXX High Yield Corporate Bond Fund and the SPDR Bloomberg Barclays High Yield Bond ETF experienced losses of $5.2 billion over the previous week. Global bond issuance markets in recent times are effectively closed as risk premiums soar forcing creditors to stay on the side-lines. The U.S. Federal Reserve statistics show that U.S. corporate debt and loan balances as of September 2019 stand at US$16 trillion, a historical high. With the withdrawal of funds, default risk of financially fragile companies will increase.
Investors aggressively selling high-risk assets causes assets to flow to market safe havens such as U.S. Treasury Securities. The U.S. 10-year Treasury yields continue to set new historical lows. Due to the combined effect from purchases by investors seeking safe havens and interest rate cuts, U.S. 10-year treasury yields fell to a record low of 1.11% on February 28. Bond market trends signal a more pronounced economic recession. In the U.S., 10-year treasuries (1.11%) are lower than 3 month Treasury yields (1.29%), showing an inverted yield curve widely known as a precursor to an economic recession.
Additionally, capital is flowing back to the previously volatile Japanese yen. In the U.S. markets on February 28, Japanese yen exchange rates increased to ￥107.4-107.6 per dollar. Judging from the latest situation on March 2, as China’s novel coronavirus epidemic gradually goes under control, foreign capital begins to flow into the corrected Chinese A-share markets. Following the increase in A-share values, the Shanghai-Shenzhen-Hong Kong stock exchanges experienced a net capital inflow of 6.8 billion yuan in renminbi.
Due to increased investor concerns over risk, international capital is scrambling to seek safer assets thus increasing the imbalance in global financial markets. According to ANBOUND researchers, at a macro level, although the stock market decline has wiped out some wealth, the global capital surplus situation has no improvement. While the COVID-19 epidemic is yet to be under control, and investor risk appetite has yet to see improvement, international capitals will still flow in different markets leading to increased asset price volatility and imbalances in market liquidity. Such a risk aversion has aggravated asset differentiation. On one hand, there is a shortage of low-risk assets, and on the other hand, various risky assets face a capital shortage and lack of attention. This marks an intensification in market distortion and an event of a stoppage in capital inflows will cause market collapse.
Central banks such as the Federal Reserve could support the market by implementing expansionary monetary policy. The Bank for International Settlements pointed out that major central banks worldwide continue to keep expansionary policy positions and some large emerging market economies have further relaxed their policies. This shows that global liquidity excesses will increase. Researchers at the Bank of International Settlements said that market participants are enveloped by serious concerns and uncertainty and expectations for a V-shaped recovery in the economy now seem very unrealistic. As previously mentioned by ANBOUND, this will exacerbate the formation of a low-interest rate currency environment as well as decrease overall investment returns. With the COVID-19 epidemic still expanding it remains unclear as to what extent easing policies can reverse capital flow trends.
Final analysis conclusion:
Affected by the spread of novel coronavirus, investor capital is moving away from risky assets and into safe havens. Against a background of overall capital surplus, the surge in capital flows in different markets will increase bringing unprecedented shocks to countries and different asset markets. Large fluctuations and adjustments will be a new normal for future financial markets and will increase investment risks in the financial markets.
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