Weekend news of a spike in confirmed cases of the coronavirus outside of China, with surges of infections in Italy, Iran and South Korea causing particular concern, has intensified the recent sell-off of equities. Fears over the economic consequences of the Covid-19 epidemic, with imminent re-categorised as a pandemic surely now only a questions of when not if, have this morning seen sharp falls in Asian and European equities markets.
The pan-European Stoxx 600 index opened the week down 2% and in Germany and France the Dax 30 and CAC 40 benchmark indices dropped more than 2.5% each. In the UK the FTSE 100 has opened the week down 1.9%. In Asia the impact has been even more severe. Seoul’s Kospi index had its worst day since late 2018, losing just shy of 4%. With several hours remaining until Wall Street’s markets open, S&P 500 futures are showing a 1.5% drop, which could still go deeper.
Over the weekend there were reports of fund managers ‘buying the coronavirus dip’. The Sunday Times detailed millions being spent to snap up shares in the luxury consumer brands being worst hit by the outbreak. The logic of these fund managers is clearly that markets are panicking and overselling, opening up an ideal buying opportunity before all the fuss dies down and stock prices rebound.
But with the weekend also seeing numbers of confirmed coronavirus cases, and deaths, rising quickly, have fund managers moved too quickly? Could the outbreak turn into a global emergency that sparks an extended stock market slump? Or even halt the record-long bull market that has now been in the ascendancy since 2009?
Should anyone investing online start to drip-feed cash into the markets between now and the eventual bottom of a temporary correction before the bull market resumes, pocketing the ‘dip’? Or could things get a lot worse before a recovery that takes an extended period of time to brings markets back to ther recent record highs?
Just How Bad Could The Coronavirus Epidemic Get?
The New York Times reports the surge of international cases over the weekend:
“On Tuesday, Feb. 18, no coronavirus cases had been reported in Iran. On Sunday, the government announced 43 cases and eight deaths. Some 152 cases (and at least three deaths) were confirmed in Italy on Sunday, up from three cases on Thursday. The number of infected people in South Korea jumped to 763 (and six deaths) in just days.
As of Monday (today), Covid-19 was detected in at least 29 countries.
In nations with few or no reported cases so far, particularly in South America and Africa, the absence of evidence shouldn’t be interpreted as evidence of absence. More likely, it reflects lack of testing”.
So things are getting worse but how bad could they get? What, as the New York Times, asks, can and can’t be done to stem the tide?
All the evidence suggests that Covid-19 is spreading like a flu virus, which means from person to person, through the air. The fact that, in contrast to other recent new virus scares like SARS, MERS and Ebola, Covid-19 can be spread by individuals before they have any visible symptoms, and even if they don’t personally become ill, makes it particularly infectious.
Each individual carrier of Covid-19 seems to spread the virus to another 2.6 people. That means that the infection would be expected to pass to 3500 new carriers within 10 five or six-day transmission ‘generations’. That a majority of cases either result in no or mild symptoms that look almost identical to those that come with a cold or flu is complicating diagnosis and accelerating the spread.
It’s still very difficult to tell just how bad the outbreak could get, but with a vaccine months away, few now believe it won’t become a pandemic.
A recent assessment by the Imperial College London warns the outbreak is likely dramatically worse than believed:
“We estimated that about two-thirds of Covid-19 cases exported from mainland China have remained undetected worldwide, potentially resulting in multiple chains of as yet undetected human-to-human transmission outside mainland China.”
However, a major spread of coronavirus cases over the next several months doesn’t necessary mean Armageddon. At least based on the evidence to date, and barring potential mutations which can’t be entirely discounted, the virus is rarely a life-threatening or even especially debilitating infection.
Australian National University infectious disease specialist Dr Sanjaya Senanayake believes it is important for countries and healthcare services around the world to be prepared. But doesn’t think there should be panic, with indications suggesting Covid-19 will prove to be disruptive but not ‘devastating’:
“While a lot isn’t known about this virus, at this stage it appears to cause mild illness in the majority of people with a low case fatality rate. So while it will cause disruption for a time to health services and economies, they will eventually recover as more and more people become immune.”
What Impact Could That Have On The Global Economy & Financial Markets?
Given the hit they’ve taken over the weekend, equities markets are clearly concerned about the economic impact of the coronavirus. Quarantined towns and cities will obviously see a pronounced slump in productivity and consumer spending. The latter is hitting China and surrounding zones of Asia hard, as populations limit the time spent in public places. Business travel between China, Asia and much of the rest of the world has been limited to trips considered of ‘absolute necessity’.
All of that is, and will continue to, have a knock-on effect for the travel and tourism sectors as well as consumer spending in Asia. If the outbreak gathers pace internationally, consumer spending will also be hit internationally.
The International Air Transport Association (IATA), the trade body for the global airline industry, has cautioned that lower passenger demand would cost the airline industry $29.3bn (£23.7bn) in lost revenues this year, with global air travel expected to fall for the first time in more than a decade.
Transport groups, hospitality chains, airlines, luxury goods makers and retailers are expected to be the sectors hardest hit. But companies in other sectors that rely on components produced in China are also feeling the effects.
Chinese manufacturing activity data is due out this week and expected to reveal a sharp drop in the factory output of the world’s second largest economy over February. Quarantine efforts to slow the spread of the virus have disrupted supply chains, which will hurt companies around the world. Jaguar Land Rover, the UK’s largest car maker, last week warned that its British factories could run out of some car parts this week.
Over the weekend, China’s president Xi Jinping warned the outbreak would have a “relatively big impact on the economy and society”.
However, Xi also added that the effects of the coronavirus would be short-term and controllable – a belief also shared by IMF boss Kristalina Georgieva, with the caveat that things could still take further, unpredictable turns for the worse.
Yesterday, U.S. Treasury Secretary Steven Mnuchin said that it would be another 3 or 4 weeks before the economic impact of the coronavirus could be accurately assessed:
“Although the rate the virus spreads at is quite significant, the mortality rate is quite small. It’s something we’re monitoring carefully, one of the discussions we’re having here is that countries should be prepared, but I think we’re at a point where it’s too early to either say this is very concerning or it’s not concerning.”
Should Investors Be Buying or Selling?
In early February, the Financial Times said that the coronavirus epidemic represented:
“a big economic shock that could derail global growth and shake markets out of their ‘buy-the-dip’ conditioning”.
The opinion piece, written by Mohamad El-Erian, Allianz’s chief economic adviser and president-elect of Queens’ College, University of Cambridge, went on to explain:
“The coronavirus outbreak amplifies two vulnerabilities: structurally weak global growth and less effective central banks. It is becoming harder for markets to treat such fragilities as being beyond the immediate horizon, especially with a host of other uncertainties not far behind, including the recurrence of trade tensions, growing realisation of the impact of climate change, technological shocks, political polarisation and changing demographics”.
The argument is that the coronavirus outbreak’s impact on China’s economy may well be severe enough for it to halt, at least temporarily, the country’s transition from a middle to high income country. With Chinese growth representing the single strongest catalyst to global growth over the last 2-3 decades, and particularly in the last 10 years, that would ripple out internationally to an extent that could change the course of international financial markets:
“The coronavirus also has the potential to constitute a structural break for markets: that is, a big enough shock that fundamentally shifts sentiment. Previously, markets had been underpinned by the belief that central banks were always willing and able to repress volatility and boost asset prices. That fuelled investors’ fear of missing out on a seemingly never-ending rally”.
El-Erian argues that asset prices have run ahead of weaker economic conditions for a number of years now and that the coronavirus outbreak may well accelerate the arrival of the global economy and markets at a ‘T junction’. The two roads forward are either recession and financial instability for a period or growth that justifies high asset prices.
Source: The Times, data from Refinitiv
How investors might approach the prospect of a temporary, which could evolve into a sustained, bear market will depend where they are in their investment cycle. Historically, as the graphic above from The Times newspaper shows, markets have rebounded strongly from wobbles induced by international epidemic/pandemic fears.
The current case may be complicated by markets being considered by many to as more generally fragile. But if global economic slowdown fear do not, in the end, come to pass, the return to a bull market could, when it comes, be a strong one.
But the level of uncertainty is enough that investors who may need to cash in investments for an income at some point over the next few years might want to consider increasing the allowance to cash and/or safe haven assets such as bonds in their portfolio. That will act as a safety net, protecting against the need to sell of investments at a steep loss in the worst case scenario.
Investors further away from retirement or any other scenario that they would expect to mean them drawing an income from investments can see the current dip, or even a future bear market, as a buying opportunity.
Nick Train, manager of the £6.7 billion Lindsell Train UK Equity fund has bought millions of pounds of share in fashion retailer Burberry, French spirits-maker Rémy Cointreau and Diageo, the London-listed owner of drinks brands including Guinness, Johnny Walker and Smirnoff.
In the last month, Rémy Cointreau’s share price has fallen 13%, Burberry’s 11% and Diageo almost 6%. Other luxury goods companies, such as Estée Lauder and LVMH, have fallen too, by as much as 5%.
All three brands are growing quickly in China and the Far East, with Burberry’s success particularly tied to the Chinese market, which now accounts for 40% of the company’s sales. Train explained his contrary approach with:
“We took advantage of the panic to add to [Burberry, Rémy Cointreau and Diageo]. We did so not because we have any insight into the severity and duration of the epidemic, but because we have been rewarded more often than not during previous unsettling episodes by treating them as buying opportunities. We hope we are right again on this occasion and that the distress and suffering the virus has already caused will soon dissipate.”
Other fund managers are doing the same. But also, like Mr El-Erian, there are those that are less optimistic on how short lived the coronavirus’s impact on markets will prove.
But even if the situation does usher in a longer term bear market, investors who are several years or more from cashing in investments could decide to keep on investing, or even up their activity as prices drop. This is done on the basis that the best investment returns are made during the recovery from a market crash. And as it’s impossible to know exactly when the bottom will come, a good approach is to drip feed money into assets at regular intervals.
If buying individual stocks, rather than indices, it makes sense to opt for those with strong balance sheets. These companies shouldn’t find themselves in any existential danger during a prolonged downturn and can often use such periods to also take advantage of other companies in trouble, or whose stock is trading cheaply, to make acquisitions. That can see them come out of a downturn in an even stronger position than when they entered it.
In conclusion, how the coronavirus epidemic, evolving into a pandemic, will play out for the world economy and equities markets is hard to predict. There is a good chance recent falls will be a short-lived to few months-long blip. It could, however, spark a more serious market downturn. But investors shouldn’t panic. It could be a great buying opportunity for those with a longer term outlook. And for others with shorter term horizons, fattening up their cash buffer to potentially dip into without selling off other assets before a recovery takes hold, should mean there is little reason to panic.