Globally, markets are reacting to varying degrees to coronavirus (COVID-19), but no equity market has been left unscathed. While there is little doubt that coronavirus is having a negative impact on global trade and economic growth, there are widely different views regarding two key things: (1) the extent of the economic slowdown; and (2) the subsequent recovery.
Inevitably, there will be a recovery, but will it take the shape of a V, a U, or an L? Naturally, many are looking to the SARS epidemic, which lasted for seven months – from Nov. 2002 to July 2003 — as a reference point. What happened during that time? Emerging market (EM) equities recovered quickly in a V shape, with only four months between peak and recovery. At their lowest level, emerging market stocks (including China), had fallen about 12%, on average.
How worthwhile is the comparison to SARS? That is the big question. Both viruses originated in China, spread globally and are similar illnesses in some respects. However, there are key differences, most notably the level of contagion. SARS led to the deaths of fewer than 800 people, whereas the death toll for COVID-19 is now above 2,600, largely because it has spread relatively quickly. COVID-19 has already infected more than 10 times as many people globally as SARS did over the course of the entire epidemic.
The other two key differences: Relative to 2003, China now is a much bigger part of global supply chains and GDP. China is roughly 16% of global GDP per the World Bank vs. about 5% in 2003, and its stock markets comprise about a third of the valuation of emerging market indexes. Just as important: The global economy and equity market valuations are at much different points today than in 2003. Back then, we were just beginning a multi-year economic expansion and market bull run, whereas in 2020 we are likely in the latter stages of an 11-year expansion, and valuations aren’t as attractive.
What Is Happening Now
Official data from China, which has just over 80,000 confirmed cases so far, indicate that the coronavirus is slowly being brought under control there. The daily increase in confirmed cases within China has slowed — from nearly 1,000 a day to less than 100 a day — according to Chinese authorities. However, because the virus may not show symptoms for up to two weeks and those symptoms can be confused with flu and other illnesses, it can be very difficult to assess the true number of cases and by extension the degree to which the virus has been contained.
Unfortunately, outside of China, COVID-19 seems to be spreading, with surprisingly rapid increases in Italy, Iran, and South Korea as announced at the start of the week. Yesterday, the US Centers for Disease Control warned that communities should be prepared for a wider spread of the virus in the US. While the World Health Organization and governments try to contain the situation, we’ve already seen factory shutdowns, travel bans, and instances of mandatory sequester. These necessary preventive measures will certainly have an impact on global growth and ultimately corporate earnings.
Looking Forward
In regard to investments, we are most concerned about the impact on corporate earnings. In China, automotive sales fell by 90% the first two weeks of February vs the year-earlier period. Meanwhile, trade, particularly in Asia, has dropped significantly. Given the importance of China to the global economy, we view both of these data points as indication that corporate earnings will be negatively impacted. The question is by how much and for how long.
Industry analysts and institutional investors generally expect that the hit to corporate earnings will be near term, as China’s economic growth drops dramatically in the 1st quarter of 2020 (from around 6% to perhaps 3.5%). By around mid-year, things are generally expected to get back to normal. Consider that analyst forecasts for S&P 500 profits still show an expected increase of 7% for 2020 vs. a 9% increase expected at the beginning of this year.
While no one really knows what will happen with this new strain of coronavirus, we think the above expectations could be on target, based on virus containment efforts and economic counter-measures: China providing extra support and stimulus to its economy; the Federal Reserve and other central banks ready to lower interest rates further if necessary, lending support to markets outside China that may unsettled by spreading of the virus; and finally, the coming of spring and warmer weather should also help to contain the spread of the virus.
What We Are Doing
At this point, we are not making major changes to our portfolio allocations, which are diversified globally, by region and asset class. Our allocation to high-quality fixed income, for example, has benefited from the recent drop in bond yields. The duration and severity of the COVID-19 global phenomenon may be short-lived (like SARS) or it may be a prolonged headwind. We make our short-term portfolio adjustments based on actionable data and fundamentals, and we stand ready to make changes if the situation escalates.
