The Virus, the Bernie Factor, and the Europeans

It’s been a crazy week. The major U.S. equity indices puked their guts up, mostly over the spread of the coronavirus, COVID-19. With the Chinese economy stuck in a very low gear and new outbreaks happening in South Korea, Italy, and Iran, it looked like it was just a matter of time before the nasty bug washed up on our shores in a meaningful way.

Then staff from the Centers for Disease Control and Prevention (CDC) said as much, noting it’s not a matter of “if” we have an outbreak in the U.S., but rather “when.” Well, that’s just awesome…

But that’s not the only thing driving the stock markets into the ground. That little thing called the presidential election is heating up, and the Democratic race for the nomination took a not-totally-unexpected turn when the candidates took turns punching Mike Bloomberg in the face during his first debate appearance.

Bloomberg’s performance was largely panned, though it did have one big positive: he can only improve from here.

The ugly outing sapped the power from the notion that Bloomberg would swoop in on his billions and secure the nomination as an adult moderate, friendly to business and yet nodding to social concerns. Mike’s loss was Bernie’s gain, which was punctuated by the results of the Nevada caucus, where Sanders picked up almost 50% of the vote.

There’s now an avowed socialist at the front of the race, and it’s scaring the hell out of investors.

If you’re not sure about it, take a look at United Healthcare Incorporated (NYSE: UNH). The stock lost 6.3% on Monday, then 6.4% on Tuesday, and was responsible for more than 15% of the drop in the Dow. Bernie has pledged to destroy private insurance, and he’s leading in the polls.

Just to drive the point home, the latest Reuters poll shows Sanders beating Trump in a head-to-head race among all likely registered voters, 47% to 40%.

But there is a caveat. If Sanders takes the nomination and gathers national support, he would likely repel voters in Trump country who sent Democrats to the House in the midterms. Those seats could flip back, giving the Republicans either more voice, or perhaps even a majority, in the House of Representatives.

Gridlock would be a friend to the markets if Sanders sits in the White House, but it’s not a solid wall. With the presidential pen he can still enact many regulations and call for interpretations that favor a socialist agenda. After all, that’s why his supporters would be sending him to the Oval Office.

And then there are interest rates.

The rush to safe havens as COVID-19 spread drove up the dollar and flattened interest rates, but there’s more to it than that.

If the knock-on effects of the virus put the Chinese economy into recession and drag Japan and Europe down with it, then it’s a sure bet that the Bank of Japan and the European Central Banks will respond with a flood of new cash, sopping up equities and anything else the can find in Japan and buying government bonds across the euro zone. The moves will drive interest rates further into negative territory in those markets, eventually pulling U.S. rates down as well.

The only question left will be, “When will the Fed lower rates?”

If the sell off continues and the economic pain increases, the pressure will mount on the Fed to fix the inverted yield curve by cutting the overnight rate.