10 Mar 2020
The core issue – Coronavirus – continues to be the focus of market attention and volatility and has caused the lack of demand for oil in Asia that has led to the recent collapse in the oil price. There will be continued economic impact on a wide variety of sectors as the number of cases increases in the West. So far, there have been over 111,400 reported cases with around 3,892 reported deaths, mostly affecting the younger and older end of populations plus people with pre-existing medical conditions. These are significantly larger numbers than the 2003 outbreak, but the fatality rate is significantly lower, as the rate in 2003 was closer to 10%. The 2003 outbreak was mainly focused in China and other parts of Asia, but this new outbreak, although originating in China, has become more global with an increasing number of reported cases outside Asia, most notably in Italy and Iran.
The economic impact of the virus is far wider than the number of reported cases in terms of lost man hours, and it will of course have knock on effects on economic activity, reducing global GDP figures in the first few quarters at least. Unfortunately, at present there is no sign that the intensity of new cases in the developed world is anywhere near the peak. In fact, the pace of the spread seems to be increasing and it could be argued certain Western governments have been lax in putting in place measures that are likely to contain the rapid spread of the virus. Currently, such measures would probably have been more impactful on markets than the improvement in the rate of disease spread in China, or even improving economic data from that region. A further concern is that the virus spreads to Third World countries in Africa and Latin America – we have already seen a far higher mortality rate in countries where healthcare is less well developed, such as Iran. The contagious nature of this virus with carriers spreading the disease before symptoms appear, is at least weeks or more likely months away from its peak with the potential for deeper and more prolonged negative economic effects.
China is central to this outbreak and its economic consequences. While there is always concern about how robust Chinese data is, it does appear outside of Hubei there is a downtrend in the number of new cases and some recovery in activity in manufacturing, although firms are still operating well below full levels of output because many employees still face restrictions on travelling back from the Chinese New Year holidays. Last week Foxconn, which is one of the world’s largest electronic companies and a key supplier to Apple, announced it expected its huge Shenzen facility to be back at full production by the end of March. If correct, and not a politically inspired statement, it is a promising sign. Furthermore, J.P. Morgan’s daily tracking data of goods movements through ports also point to some uplift in economic activity in China, as do increased domestic flights. Another positive factor is that the spread of the virus may slow down, with the arrival of warmer weather in the northern hemisphere. Sunnier weather is known to build up immune systems via higher levels of Vitamin D and a study by a team at the University in Guangzhou has suggested that the virus is less effective at spreading in warmer countries, whilst the opposite is true in colder climates.
The collapse in the oil price as a result of the outbreak is another deflationary blow to the global economy, at a time when it is least needed. Over the weekend, crude oil suffered its biggest one day fall since the end of the 1990s Gulf War. There is a lack of agreement at OPEC, with the Russians seemingly taking the view that marginal US shale production could be permanently closed by not adopting production cut backs, and on Friday (6th March) we had the news that talks between OPEC and Russia about reducing production had fallen through. OPEC responded by removing limits on its own production, which led oil prices lower. On Saturday (7th March) Saudi Arabia announced their intention to increase production and sell at a discounted price, which was the catalyst for the much larger price fall. This affected equity markets, with the UK and US markets opening over 7% lower than Friday’s close and oil-related stocks and sectors seeing large stock price falls. As well as concerns over the credit worthiness of businesses exposed to the oil sector, especially in the US, some countries are highly commodity export dependent and there are, quite rightly, concerns about contagion spreading from these areas through the global economy. Commodity exporting countries will see a significant deterioration in their terms of trade as occurred in 2015.
The Coronavirus has a number of concerning features, it appears to be extremely contagious and can be transmitted by people showing no symptoms (asymptomatic), as has been seen with the rapid rate of spread in countries such as Italy and Iran. These characteristics mean that there is the potential for a prolonged and severe hit to economic activity globally, in other words a recession. As a result, it is impossible to rule out significant further falls in stock markets notwithstanding the sharp declines to date. Shorter term equity markets are oversold but valuations in absolute terms are not yet at bargain basement levels, especially with so much uncertainty as to what corporate earnings will actually be.
Markets hate uncertainty as was seen during both gulf wars and also the more recent Brexit process. An outcome affording some sort of visibility on corporate earnings and the lower discount rate applied to these earnings (even if not appearing to be good news) is necessary for a sustainable market rally both regarding the impact of the Coronavirus and the fall in the oil price.
For the time being we will have to accept that higher volatility in markets will continue and we will have to be prepared to face further unpredictable outcomes (such as the oil price collapse) caused by the virus outbreak.
For those with longer term investment horizons, our view is that this is not a time for significant portfolio change and clients should not assume that they have the skill to time entry into or out of markets to maximise returns.
RSMR
March 2020
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