The impact of the coronavirus on the major US indices has been devastating. The major US indices are very close to bear market territory, which means they have declined 20% since hitting their recent highs. All three major indices are in correction territory as of the second week of March, which means they have declined more than 10% since hitting a recent high.
What is so shocking is the rate at which prices have declined. On February 12, less than 1-month ago, the Dow Industrial Average hit a fresh all time high. Fear has quickly penetrated, which has pushed the VIX volatility index to a fresh decade high above 50%. While the major indices have been punished, they have faired better than some of the sectors which have been decimated.
Why is the Coronavirus Affecting Major US Stock Indices?
The process of selling took a while to occur, following news that the coronavirus was spreading throughout China. Initially investors sold Chinese stocks and purchased US shares and bond. US yields started to move lower, but strong inflows into the US buoyed the dollar as well as riskier US assets. It was not until it was clear that the coronavirus was spreading globally and into the United States that US Indices started to sell off.
Energy shares and travel companies were the first to crack putting downward pressure on the US major index trading. Investors began to realize that consumers where unlikely to travel or get on a cruise when an infection disease could quickly move through a ship. The lack of potential future travel started to put downward pressure on energy shares, as oil prices started to decline. As investors saw how the virus affected Chinese economic data, the realization that the US could experience a recession started to dawn on investors who started to sell US stocks.
The selloff in the major US indices started to accelerate as the VIX volatility index exploded. The VIX is an index created by the Chicago Board of Options Exchange that measures the “at the money” implied volatility of the S&P 500 index. Implied volatility is the component used by option traders to price put and call options. The VIX surged from levels below 20% to 50%, which was the highest close on the VIX since the 2008 financial crisis. The surge in the VIX represents fear. It also tells investors that traders are paying up to hedge their portfolio.
How Has the Coronavirus Create Fear?
The fear related to the VIX and the major US indices is driven by the potential lack of economic output. People are so fear full that they are not going to the malls to shop or a concert to be entertained. Schools are beginning to close, and colleges in the US are sending kids home. In the US the lack of test kits is one of the major causes of fear. People don’t know if they have coronavirus, because there are no test kits available. The US is well behind the curve and until kits become available and the number of infections start to decline, the major US indices will likely remain under pressure.
The bottom line is that investors are looking for a sign that the coronavirus has stopped spreading in the US, which will help economic activity regain traction. With the US administration behind the curve this process will take some time. Once traders see a light at the end of the tunnel they will begin projecting where stocks could be if economic growth begins to gain traction.
