What the Coronavirus could mean for investors
Last week was the first week down in global markets this year, despite solid quarterly earnings reports on the back of Coronavirus headlines. This week looks no different, with the Virus continually dominating market sentiment and news headlines. For the moment, we conclude that these news headlines are not the cause of a correction, but only the catalyst after the recent strong market increase.
Global equity markets fell and oil prices plummeted after China warned that the spread of the deadly coronavirus would accelerate, fueling concern about the potential impact of the disease on the global economy. As travel to China is at its height around the Lunar New Year, travel restrictions combined with extended holidays could cause economic damage particularly in China, whose economy slowed its annual growth rate by 6.1% last year, the lowest reading for nearly 30 years. As a result, travel-related stocks, as well as companies with a large exposure to the Chinese market, have suffered a significant blow so far. In addition, volatility indices – an indicator of market uncertainty – have peaked north by 30% in global stock markets. In contrast, safe havens such as gold and Government Bonds have increased in value and could prove their advantage as a source of diversification.
The key take-away from past epidemics is therefore that elevated volatility and a short-term market setback do not necessarily lead to a prolonged and deep sell-off – quite the opposite.
While the lasting global impact remains very uncertain, the virus has marked a setback for the global economy and manufacturing sector, which had shown tentative signs of improvement in recent months. Wuhan, a city of 11 million inhabitants, is one of China’s largest industrial hubs and home to its steel industry. Several international suppliers and businesses are based in Wuhan. With the city technically in isolation, a significant economic effect on Wuhan is likely to be inevitable. What remains to be seen is whether the economic impact will span further. For example, if the outbreak were to become an epidemic, health care expenditure would increase and thus limit the stimulus measures aimed at shoring up a Chinese economy already under the weather due to the trade war with the United States.
While we recognise that the Coronavirus outbreak could possibly lead to near-term de-risking, we note that pandemics of the past have not lead to sustained selling, but have ultimately become buying opportunities. Looking at past epidemics (13 events since 1981) the impact on the market was minimal in most instances. Statistically, the MSCI World Index rose on average one, six, and twelve months after the outbreak of an epidemic in past instances, as the chart below shows. This, however, does not mean that such outbreaks have not lead to a short-term drawback of markets. On average, the maximum drawdown (from virus outbreak to bottom of the market) was 7.7% – before markets recovered rapidly. Furthermore, just because indexes have managed to shrug off the epidemic contagion in the past does not mean that this will happen again. The market reaction will eventually be dictated by the severity of the virus. The key take-away from past epidemics is therefore that elevated volatility and a short-term market setback do not necessarily lead to a prolonged and deep sell-off – quite the opposite.
The comparison between the Coronavirus of 2019 and the SARS epidemic of 2003 seems quite interesting. However, the world has changed significantly since 2003, so any comparison should be treated with great caution. It is worth remembering that the Chinese economy (GDP) is about 10 times bigger than it was during the SARS outbreak in 2003, which means that the disruptions will have a much bigger global impact today than they did back then. China’s weight in the MSCI world is now 3.6% compared to 0.3% in 2003. While this figure might seem low compared to US equities, which reflect a 56% share, one should also consider that many foreign companies have sites in China and that their earnings would also be affected.
While medical treatment for the Coronavirus – unfortunately – is not yet in sight, at least we have learned how the financial markets are treating the disease: as a conventional risk-off event where diversification pays off.
While medical treatment for the Coronavirus – unfortunately – is not yet in sight, at least we have learned how the financial markets are treating the disease: as a conventional risk-off event where diversification pays off. Positioning portfolios in both directions – either rapid virus containment or a fatal global epidemic – is in our view too early. To do so requires more reliable data – particularly on incubation and the infectious period, according to the World Health Organization. To complicate matters, we are in the middle of the biggest earnings week of the quarter, with reports due from Apple, Facebook, Microsoft and Tesla. Many of the large cap tech stocks are technically extended and therefore vulnerable to a correction. As a result, it is not yet clear what factors will have the biggest impact on the markets in the next days. Consequently, we are not making any significant changes to asset allocation for the time being. On the contrary, we are closely monitoring market developments, remain diversified and intervene on the basis of confirmed data rather than concerns.