Only a month ago, the chatter in the markets around the impact of the coronavirus was limited, with only a few articles writing about the potential for large-scale disruption.
Fast forward to today, and the negative risk sentiment in the stock market has clearly been felt by everyone from retail investors like me to large institutional fund managers.
With the impact of the virus likely to linger for some time (more cases are being confirmed in the UK each day, currently standing at 85) the affect on the FTSE 100 index will likely remain for a while too.
While I think there are some great buying opportunities in this market, it is important to look at some of the ways the virus is already impacting the index and the stocks within it.
A hallmark of an unsettled market is higher volatility on a daily basis. This box has definitely been ticked over the past couple of weeks. Now while there is no specific volatility gauge for the FTSE 100 index, I keep an eye on the VIX index, which measures volatility on the US stock market. Given the similarities between the two at the moment, I see it as an acceptable proxy.
As of Wednesday, the VIX index traded at 33.85. Without getting overly technical, this is just a relative number, but the point is that it is the highest level of volatility recorded since 2011!
What does this mean for stocks within the FTSE 100 index? Well large volatility can entail large gains/losses, often over a short period of time. For me, it is a warning against trading stocks with leverage at the moment due to the large swings. It also suggests to me that if you are a risk-averse investor, then it is best to sit on the sidelines until the volatility calms down.
Fair value dislocation
I wrote about fair value dislocation briefly when arguing that the short-term impact of the virus scare has caused fear to overtake fundamental values. FTSE 100 companies have experienced the sell-off, regardless of whether they are in a sector that will be affected by the outbreak.
In some cases this has led to firms trading well below their fair valuations. Home-builder Barratt Developments has seen a share price dump of around 13%, even though it has a strong financial position and is in a sector which should see little impact.
If you do some more research, there are plenty of other firms in this boat. For examples, see the recommended shares for March from my colleagues and me. The index can experience a dislocation from a fair value in the short term when we see this type of large-scale uncertainty.
If we look at history, these dislocations have always reverted back to a fair value. The difficulty is calling exactly how long this can take, given that the risk sentiment behind the dislocation is still very much prevalent.
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Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.