The beginning of the year for financial markets was a positive start as improving economic data led to a further uptick in investor sentiment. However, markets have been jilted as the recent Coronavirus outbreak causes caution heading into H1 2020, further lowering expectations for global growth recovery. The 10-2yr U.S. Treasury yield curve narrowed on Monday morning as stock markets priced in renewed recession fears as new cases of Coronavirus erupt in Europe. Nonetheless, amid a backdrop of uncertainty and increased volatility, stock markets overall have stood not too far from all-time highs. Although global stock markets are now starting to feel the brunt of Coronavirus, as investors flee to safe-haven assets such as Gold, in the long term the sell-off in equities will be a great buying opportunity as the backlash from the Coronavirus passes.
Coronavirus continues to weigh in on economic activity across China as coal consumption, retail and construction remain remarkably subdued due to national shutdowns in efforts to contain the virus. The IMF lowered its 2020 Chinese GDP forecast from 6% to 5.6%, further highlighting the impacts the outbreak will have on the slowing economy. Although the full effect of the virus will not be felt until the virus disruption dissipates, incomes have already taken a hit as China’s urban workforce who are self-employed have seen income plummet over the course of a month. However, the vast majority of firms in China have enough funds to pay creditors and employees for at least a couple of months, minimising any significant fallout on employment figures from the Coronavirus outbreak. Though a contraction in China’s economy this quarter appears all but certain, a sharp rebound that allows much of the loss in output to be made up in the remainder of the year has not been completely ruled out. The graph below reiterates following a sharp decline in activity, in fact it is starting to stabilise, indicating there is still a window for economic activity to bounce back.
China Daily activity indicators
Stock markets have now started to react to the impacts of the virus on the Chinese and the global economy, as the Shanghai Composite finished 8 points lower on Monday, amid fears of a rapid spread of the virus outside China. However, the speed of the infection in China has slowed as reported deaths have reduced, indicating restrictive measures in containing the virus are taking effect. Furthermore, China has pledged to implement a more effective stimulus package despite a widening fiscal gap, as the virus continues to weigh in on an already slowing economy. The aim is to implement measures, which will reduce corporate taxes and budget government expenses therefore boosting business sentiment and diminishing further headwinds of the virus on the Chinese economy in the medium-long term.
As it stands, the downside risks are prominent of the Coronavirus, however it isn’t quite a pandemic and the magnitude of the impact depends on containment of the virus. There are two possible scenarios either the outbreak is limited to an Asia pandemic, which may result in a fall in 0.5% of GDP in 2020 or the outbreak results in a global pandemic, which may result in a 1.3% fall in GDP over 2020. Nonetheless, developed economies are preparing for an exacerbated subdued economic environment, looking closely into monetary policy stimulus. FTSE 100 was down 3.5% in addition to European shares on the Stoxx 600 also pushed down as trading opened on Monday morning, with investors pricing in a direct hit to European economic growth which would negatively impact company profits, however the European Central Bank is watching carefully, with the ECB tipping towards a more dovish stance in order to ease Coronavirus pressures in the medium term. This sentiment is also felt across the globe, with the Fed assessing the risks to global supply chains from production shutdowns in China, with no signs of monetary tightening. This further supports our view that the downside risks for long term impacts of Coronavirus will be limited, with stringent measures to support the global economy.
At this point, the most accurate indicator of potential economic and stock market impacts as a result of the Coronavirus outbreak are historical pandemics with similar characteristics. The SARS outbreak in 2003 killed 1 in 10 people that were infected with the virus, however Coronavirus is seen as less deadly with a fatality rate at 1 in every 50 people infected. As a result, the Coronavirus is less likely to cause a severe impact on the global economy in the long term, with sharp declines short-lived. Historically, markets have recovered soon after a virus outbreak, as shown below, and the expectation is equity markets will behave in the same way on this occasion with a short-term decline in markets followed by a recovery further into 2020. As uncertainty continues on the potential impact of the virus, there are other factors to consider, such as China’s 15.4% contribution to the global economy in comparison to the 4.4% during the SARS pandemic and its impact on global growth this year, which we will continue to monitor.
S&P 500 Real Index vs Exponential Growth Trend
How are portfolios positioned
Financial markets are weighed in by uncertainty surrounding the Coronavirus and how this will play out on the global growth outlook in the short-medium term. However, with room for the Chinese to implement both monetary and fiscal stimulus following 2 years of restrictive policy and other global central banks leaning towards stimulus packages to support fallout from the virus outbreak if necessary, our portfolios remain positioned to minimise substantial downside risks with diversified asset exposure. We expect growth to edge higher in 2020, helped by more comfortable financial conditions and improved company probability, which will benefit equities further on in the year. Although the magnitude and duration of the Coronavirus pose downside risks to the current economic backdrop, we remain diversified across all asset classes, with quality equity and investment-grade bonds supporting significant swings in market movements.