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Are financial markets close to breaking point?


It has been a bumpy old week in financial markets, and commentators are getting more hysterical all the time. The coronavirus has captured everybody’s imaginations, and this is translating into panicked reactions which are causing financial markets to veer from one extreme to another.

The VIX Index, the key measure of fear in the market, is trading at record levels, beating its highest points reached in the midst of the Great Financial Crisis. We are seeing some truly amazing fluctuations and asset prices dropping from their all time highs into the depths.

Gold is dropping in a way you would not expect. Bitcoin has been crushed today. Most asset prices are in free fall (unless you were long the USD Thursday, in which case congratulations).

Going forward, this remains an extremely fluid situation with markets driven in the short-term by sentiment and news flow pertaining to the coronavirus outbreak. We continue to expect the effects of COVID-19 to be largely temporary in nature; however, the speed at which financial markets regain their poise will depend on how quickly authorities are able to arrest the spread of the virus and the extent to which the global economy is impacted.

Traditional markets have bounced back this morning, with European markets between 2-3% higher and US futures indicating a 4% firmer open. This has to be seen in perspective though as markets have sustained such heavy losses over the course of the week and it’s difficult to see what the rally is based on.

Could it be stimulus hopes? The recent swathe of rate cuts and government spending have not staved off the selling pressure as yet. It is possible that central banks continuing to pump in liquidity could be the start of a turnaround or, in the absence of any reduction in new cases across Europe and the US, this could be a relief rally before another leg down.

It is at times like this that it is worth traders and investors taking a deep breath and taking stock, rather than panic selling. For those with spare cash we may be about to see a once in a generation buying opportunity over the next few weeks.

Here’s our view on what is happening:

  1. Reporting of the coronavirus epidemic is getting hysterical. Information we are receiving from traders in Asia, especially in China and Hong Kong, is that the virus looks largely under control there and life is beginning to come back to normal. The situation in Italy, however, seems to have shocked many governments, not least the American one. But we think the coronavirus is being oversold as a story in the press.
  2. The real danger is what this over-reaction could do to the global economy. We were due a correction in the markets and many investors were looking for a reason to sell. A herd mentality has once again prevailed, as it did in 2008, and the market has become the story. But ask yourself, did those S&P 500 valuations look realistic? Was the Trump Balloon really going to sail upwards forever?
  3. The coronavirus story is eventually going to run out of steam: firstly, news rooms get bored. Look at newspapers in World War Two: yes, the war made it on to the front page every day, but there were eventually days when it stopped being the lead story. It became part of the background for many ordinary civilians. The coronavirus is either going to become part of the scenery, and we’ll learn to live with it, or, more likely, the hotter weather will see it off. In the latter case, this is potentially only a few weeks away.
  4. We are soon going to reach a point where asset prices are not going to reflect the reality and there is going to be a fantastic buying / turnaround opportunity. Many successful hedge fund managers made their reputations because they had the courage to launch their funds into the teeth of a financial crisis – I’ve met several – and the first few years of the aftermath is when they made most of their money.

At The Armchair Trader we are going to be looking at some turnaround opportunities across a variety of markets over the next few weeks, shares and sectors we think are being oversold. It will soon be time for investors to load up on some very cheap stocks before all the panic has leaked out of the market.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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