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Week Mar 02 - Mar 06, 2020

Coronavirus: Impact on market volatility

The ongoing worldwide scare due to the Coronavirus has raised concerns over an already slowing down global economy. China's contribution to the global economy is immense while the ongoing lockdown there has threatened to decelerate the global economy further. Crude, as a macro indicator of global demand, has moved to three-year lows despite a sharp production cut by Opec. Central banks across the globe trying to give a cushion by providing a stimulus in the form of a 50 bps emergency rate cut by the US Federal Reserve can be seen from that perspective. The money flow is evident in safe assets as US bond yields have moved to life-time lows.

 

Developed market equity performance

Source: Bloomberg, ICICI Securities

Emerging market equity performance

Source: Bloomberg, ICICI Securities

Commodity market performance

Source: Bloomberg, ICICI Securities

The recent outbreak of Coronavirus has increased panic in the global markets. On an average, developed and emerging equity markets have fallen 15% in just over a month. This has increased the panic, which is measured in terms of volatility. The volatility indices have seen a sharp spike to multi-year highs in recent times. Industrial commodities have also seen a correction of an average 15% while Brent has moved to three-year lows amid growth concerns. Money flow has shifted from risky assets to safe havens like bonds and gold, which have given positive returns.

Indian markets had bottomed out when volatility surged to 40% before 2015 

Volatility, which is a measure of panic in the market, had made a top near 40% before 2015 on occurrence of four major panic scenarios. This was the time when the lower levels of volatility used to be 15%.  

 

Source: Bloomberg, ICICI Securities

Indian markets have bottomed out when volatility surged to 30% after 2015

Post 2015, as the markets have started trading at lower volatility levels of 10%, the sharp panic levels in volatility have seen top formation near 30%. Currently, volatility has seen a surge from 10% to 25% already. It is expected to see a cool-off from 30%, which should ideally form the market bottom.

 

 
Source: Bloomberg, ICICI Securities

 
Nifty has taken 1-5 months to recover after sharp volatility spikes
 
Source: Bloomberg, ICICI Securities

Out of nine panic situations seen in the last 10 years, the Nifty has bottomed out within a month or two in six instances after posting an average decline of 11-13%. In three out of nine times, the Nifty has seen bottom formation in four to five months after posting average decline of 17%. Currently, the Nifty has already fallen by 10%. Hence, the Nifty has important level of investment at 10800 and worst case scenario seems to be close to 10400.

 
US volatility index has topped out at 50% since 1997 barring 2008 crisis

 
 
Source: Bloomberg, ICICI Securities

US equity markets respond to its volatility surge

 
Source: Bloomberg, ICICI Securities

US equity markets have seen the bottom formation within 1-3 months in all major crisis situations in the last 10 years. In 2008 US equity markets volatility had risen till 90%. However post 2008 crisis, the volatility in US markets has topped out at 50%. Their equity markets have seen an average decline of 15-20% on these panics. Currently, their equity markets have already fallen 16%. It seems they are coming closer to their value area.

Nifty has generally seen recovery when FIIs' net short positions have reached beyond 1 lakh contracts 

 
Source: Bloomberg, ICICI Securities

Since 2015, whenever FII's short exposure has increased and net short positions have reached beyond 1 lakh contracts, the Nifty has come closer to the bottom. Currently, net short positions of FIIs have reached 1.5 lakh contracts and markets seem to be coming to the oversold zone.

The comparison of previous panics in the Indian and US markets suggests that certain levels of volatility act as reversal points in most unforeseen events. In the US, barring 2008, all panics have ended at volatility levels of 50% while in India volatility has topped out at 30% since 2015. Reversals from these high levels of volatility result in base formation for equity markets, thus providing good investment opportunities.
 
 
 
 
 

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