Wall Street Gauges of Virus Fear, From Volatility to Dr. Copper

(Bloomberg) -- As the number of confirmed coronavirus cases surges, Wall Street is scouring global markets for clues as to how much damage the illness is doing -- and how long it will last.

Analysts and investors are turning to everything from S&P 500 options and commodities to bond spreads and monetary liquidity signals in the hunt for macro insights, trading ideas and hedging strategies.

Sure, U.S. stocks are rebounding after last week’s slump. But traders are far from sanguine, with corners of the options market on high alert as volatility marches higher. Chinese stocks tumbled the most since 2015 on Monday as the nation’s economy remained virtually shut down because of the outbreak.

Here’s a look at what some of the pros are using to gauge the situation:

Sell Mode

Aberdeen Standard bond fund manager Luke Hickmore is eyeing tourism trends and big automakers that rely on Chinese manufacturers.

I reduced exposure to supply chain-at-risk businesses on Wednesday. So VW went, GM went, InterContinental Hotels went, and APT Pipelines from Australia went. The airlines have stopped flying to China and the capacity coming out of China has collapsed. The impact will be at least through to the end of February, possibly March even if we see a peak in the short-term over the next few days.

Hickmore’s main measure of stress is global bond yields which have plunged toward August levels.

Goldman Gauge

Based on previous viral outbreaks, Goldman Sachs Group Inc. strategists George Cole and Avisha Thakkar note that risk assets tend to stabilize two weeks to one month on average after initial panic selling -- while often recovering before the full impact shows up in underlying data.

By contrast rate markets tend to stay low even when the data perks up, anchored by dovish monetary policy. They wrote in a Friday note:

This suggests that equities and long-end rates could snap back on news of stabilization in infections. But the incoming data flow could induce risk-averse central banks to shift towards a more dovish stance, such as the BoE, the RBA and the BoC. For the major markets we expect that curves will re-steepen when risk sentiment eventually recovers.

Inversion Watch

Ben Emons, managing director of macro strategy at Medley Global Advisors, is looking out for actions by the Chinese central bank. Policy makers on Monday cut rates and injected cash into the financial system as part of a slew of measures to shore up markets.

The unknown economic effects of the coronavirus have led to the plunge in the copper price. This is signaling a material global growth slowdown could be ahead. As such, global yield curves could re-invert, which can deteriorate market sentiment and completely reverse euphoria about the phase one deal.

When liquidity conditions in the onshore market deteriorate, the People’s Bank of China could ramp up liquidity injections. A gauge of large injections to come is when the difference between the implied yield of the onshore yuan and offshore yuan is significantly wide.

At a point the net liquidity in the Chinese inter-bank system has contracted, there is the potential of a PBOC liquidity wave.

Volatility Twins

Tallbacken Capital Advisors’ Michael Purves is watching the correlation between one-month risk reversals on the Korean won and the Cboe Volatility Index. The pair moved more or less together for most of 2019 as trade headlines flared. They’re still moving together, but for a different reason. “This correlation persists even though the reasons are shifting from trade to coronavirus,” Purves wrote in an email.

Curve Anxiety

The spread between one- and three-month put options on the S&P 500 is one way Yannis Couletsis gauges whether market nerves about the respiratory outbreak are reaching an inflection point. When this turns positive, it’s a sign that anxiety has reached a crescendo. The trader at Credence Capital Management describes it as a “gauge of the insurance premium investors are willing to pay for the downside.”

Commodity Fear

George Pearkes, macro strategist at Bespoke Investment Group, is watching the dynamics of the oil market where the pricing curve offers clues to demand in China.

Large declines in reported demand in China have led the market to rapidly reduce the premium paid for barrels delivered near-term -- front-month futures -- relative to out-month barrels. This decline in backwardation shows how much the shift in Chinese demand has served to loosen the physical market, which tends to be best-proxied by the shape of the futures curve.

--With assistance from Cecile Gutscher and Alex Longley.

To contact the reporters on this story: Sid Verma in London at sverma100@bloomberg.net;Yakob Peterseil in London at ypeterseil@bloomberg.net

To contact the editors responsible for this story: Sam Potter at spotter33@bloomberg.net, Cecile Gutscher

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