From late December 2019 a new virus outbreak, officially called Covid-19 (a.k.a. “coronavirus”), emerged out of Wuhan, China.
To date this outbreak was focused on China which accounted for 96.7% of 80,423 confirmed cases and 98.4% of 2,708 reported deaths (as at February 26)
However, in recent weeks we have seen notable growth in cases particularly in South Korea and Italy as well as Japan, Iran and elsewhere in Europe.
Why did the outbreak affect markets?
Investors fear that the outbreak will further weaken the global economy not just China.
Fears of spreading elsewhere into Europe would further weaken an already weakly growing European economy.
There are now substantiated fears that this may upset global supply chains with companies such as Apple calling out revenue misses and potential difficulty in getting iPhones to market given factory shutdowns in China.
Markets had arguably been rallying in recent weeks despite virus concerns on the assumption that it would be contained. This had seen share market valuations become stretched which heightened the damage we have seen in the last week when investor sentiment weakened.
Implications for your portfolio
Defensive assets like bonds and defensive subsectors such as property have benefitted.
We take a long-term approach to investing with the allocation to growth assets in line with target levels of risk. Clients are not exposed to undue loss as a result.
You will see more alarmist headlines such as “global markets lose $x trillion” or “the ASX falls $y billion”
These headlines are literally true but are unhelpful and misleading. By triggering fear, they help news websites generate traffic and ad sales.
However, negative daily or even weekly returns in markets can happen often.
Taking a longer-term perspective is key. Holding for longer periods of time substantially improves the likelihood of a positive return as the below shows for the Australian share market over the longer term. Day to day there is only a 54% chance of a positive return, however this increases to 100% when a ten your horizon is used.
Ongoing Monitoring and action
Our base case was for the outbreak to be gradually contained in the near term with its impact on the economy limited to weakness in the March quarter and potentially the June quarter of this year.
Authorities also stand ready to commit to further stimulus with announcements of new Chinese fiscal stimulus being flagged while the US Federal Reserve has announced its willingness to be proactive should the US economy soften.
As a possibility we raised in our previous update, news on the virus did contribute to higher market volatility. The scale of the economic shutdown is also likely to see poor economic data with early warning signs in “flash” Composite PMIs for the US (reflecting the weakness in trade and production as activity has softened).
Currently Australian equity market volatility is at 12.6% (annualised) while portfolio composite proxies (using market index benchmarks) are also low. Periods of heightened volatility tend to coincide with share market corrections as shown below. Today’s levels are below SAA thresholds and longer-term historical averages. All else being equal this would suggest leaving portfolios unchanged.
The John Hopkins CSSE using a mix of Chinese, WHO and other data sources has reported 80,423 cases with a total of 2,708 deaths and 28,035 recovered at the time of writing (26 February 2020). Within this total there have been 2,666 cases confirmed outside of China and 43 deaths at the time of writing. These cases and deaths outside of China were initially limited to a spate of infections on the Diamond Princess cruise liner.
However as noted above this has changed with spikes of cases in South Korea and Italy over the past week. These have sparked fears of a lack of containment globally. Iran has also seen a spike and it stands as a test case for countries with poor health infrastructure and how poorly the might fare when faced with such a threat. Separately we have seen a small number of cases reported in other European countries such as Spain, Switzerland and Austria.
The below charts illustrate first the confirmed cases from major regions on a log scale. This means an increase from 1 to 2 for example implies 10 times as many cases e.g. An increase from 1 to 2 is an increase in reported cases from 10 to 100 and an increase from 2 to 3 is an increase in cases from 100 to 1,000.
Importantly as we highlighted in the previous update mortality rates remain well below those of China which has seen a greater proportion of the reported cases. In Australia for instance half of the 22 reported cases have already recovered with no deaths yet recorded. The concern has been the growth in reported cases outside of China which has seen concerns grow globally amongst investors and policymakers.
We note that there are reports of potentially higher infection rates that would see material proportion of the global population infected. While this has not occurred (and we hope that it will not) this is a possibility that would increase the likelihood of not only human cost but would also have flow-on impacts to the broader global economy and markets. We will continue to track the outbreak in the interim and we may see it labelled as a pandemic similar to the 2009 swine flu (Pandemic is a term used to describe an infectious disease that threatens many people around the world simultaneously).
We explored potential scenarios here earlier in February. At this stage we are seeing initial signs of weakness
outside of China with the US “flash” Services PMI falling into contractionary territory during February. This is a sign suggesting weaker US economic growth in the near term. In China we have seen the resumption of factory activity at a staggered pace. 70% of larger businesses in the manufacturing hubs of Guangdong, Jiangu, Shandong and Liaoning have resumed production. In addition, the Chinese Politburo has signalled more fiscal stimulus will be forthcoming which should be supportive of growth.
On balance, we continue supporting our base view of eventual containment with economic damage limited to the first half of 2020.
Factors in favour of this view are:
Slowing growth rates of cases within China and still limited spread outside of China (relatively speaking),
Outside of the epicentre in Hubei province, death rates remain relatively low, and
Economic activity is slowly resuming within China, a large part of the global economy. Factors supporting more extreme outcomes include:
The potential for asymptomatic cases (people spreading the virus without being affected),
Containment being reached only after prolonged shutdown and quarantine efforts. We have seen these efforts increase in several European countries with greater potential to slow European growth and perhaps tip it into negative growth.
In that instance the economic damage on countries such as Australia is likelier to be substantial including perhaps our first recession in several decades. This would, should it transpire, see a mix of further rate cuts by the RBA and ultimately fiscal stimulus by the Federal government. Efforts to date have been more focused on public health
initiatives including travel bans on foreign nationals who have visited China recently. Such efforts would help to dull the economic damage but are unlikely to offer complete relief.
Implications for markets
We noted before that spikes in cases could trigger episodes of market volatility. This has occurred in the last 2 weeks. Beyond this however a lot will depend on government policy both in public health (how well is the outbreak contained) and fiscal stimulus (to counter any economic slowdown).
The present setting is likely to pose challenges for risk assets. Much will depend on the willingness of investors to “look through” the economic and consequently profit damage that reduced activity will cause. Until the most recent spike in cases, share markets had shown some willingness to overlook it with weakness concentrated in the Australian dollar and, globally, a bid for perceived safe haven assets such as the US dollar, bonds and gold.
Subsequently we have seen a sell-off in share markets although we note the extent of market falls is within historical norms and slightly less than the last notable correction in the December 2018 quarter. This can be seen in the below chart that tracks a combination of market benchmarks and daily fund NAVs to assess portfolio volatility depending on proportion in growth assets e.g. G70 means the portfolio is 70% invested in growth assets such as shares.
General Advice Disclaimer: The information in this report is general advice only and does not take into account the financial circumstances, needs and objectives of any particular investor. Before acting on the general advice contained in this report, an investor should assess their own circumstances or seek advice from a financial adviser. Where applicable, the investor should obtain and consider a copy of the prospectus or other disclosure material relevant to the financial product before making any investment decision to acquire a financial product. It is important to note that the price or value of financial products go up and down and past performance is not an indicator of future performance.