There is light at the end of the Covid-19 tunnel for China, however aftershocks around the world remain. Investment sentiment has been pushed into an ultra-cautionary mode due to rising uncertainty about the novel coronavirus’s spread around the world and the economic impact this will have.
Until last week, global investors may have been too complacent about the coronavirus. Despite the coronavirus rampaging through China, there was strangely little impact on global markets. The final week of February saw the S&P 500 having its single biggest daily decline since 2008 and overall dropping 13%, while the US 10-year Treasury yield plunged from 1.46% to 1.13%.
Market participants have certainly woken up and are now pricing in global recession, but have they overcompensated?
Uncertainty remains high
We have seen a rapid and dramatic correction as a result of the news flow around the Covid-19 outbreak. This appears to be an overreaction, although we would not be surprised to see the sell-off continue as uncertainty remains high on key issues: ease of contraction, length of time a person can be infected and contagious without showing symptoms, mortality rates, and length of time before the infection rate stabilizes globally.
However, for many other countries, the number of infected is rising rapidly. And while there are various measures being employed to slow the spread of Covid-19, in general they are likely to be less effective than the actions taken by the Chinese government.
For most major economies, depending on how the virus develops, we see the risk of a significant negative impact on growth through the second quarter of 2020 and possibly longer. We believe some countries’ economies will experience a V shaped recovery while others will experience a U-shaped recovery, depending on the length of time the contagion spreads without stabilization, as well as the policy response of each respective country. At this juncture, we believe it is more likely that the US experiences a V shaped recovery given favorable economic conditions in the country.
In order to remediate the health crisis, Chinese authorities have sacrificed the majority of Q1 economic activity. After posting a 50.0 reading in January, China’s manufacturing PMI dipped to 35.7 in February1. When compared to consensus expectations at 45, the market certainly underestimated the coronavirus and the economic impact from the government’s related policies to stem the spread.
Although market participants can continue to expect very negative economic data points to come out of China for the near term, initial indications suggest that the worst is behind us. The epidemic is no longer in its escalation phase, as measured by the number of new daily infections and the government is restoring economic order outside Hubei. A sense of normalcy is starting to take shape in many parts of China.
In terms of earnings, we of course expect an earnings recovery in Chinese equities first. It will take longer for an earnings recovery for other major stock markets given where they are in the contagion cycle.
As the outbreak worsens outside of China – we are closely watching whether the coronavirus will impact global supply chains and international trade. Attention is now shifting to the economic impact on China’s most important trading partners in Asia and whether these governments will take as aggressive actions to curtail the spread of the coronavirus.
While we are unsure of the timeline of this contagion, we believe it will be relatively short term in nature. At this juncture, we expect it will not have a substantial impact on the global economy beyond 2020.
We expect an adequate policy response from most major economies, although it will likely be primarily monetary for developed countries. China is continuing to provide significant stimulus, both monetary and fiscal, to help support its economy. Fed Chair Jay Powell issued a statement of reassurance on Friday: “The fundamentals of the US economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook.” This indicates the Fed stands ready to act and provide monetary accommodation if needed.
Asset class implications
In this environment, we believe in continuing to favor risk assets, especially stocks, but ensuring that exposure remains well diversified.
- Within stocks, we favor Chinese equities and global equities with significant revenue exposure to China, given our view that earnings will likely recover first in China given the trajectory of the disease. We also favor lower volatility, higher dividend-paying stocks or income generating risk assets in developed markets, which should exhibit lower volatility in this environment. While we are not calling a bottom, we think that there will be many buying opportunities to take advantage of.
- Within fixed income, we continue to favor credit over sovereign debt. This is particularly so given falling rates.
- We think adequate exposure to alternatives, including real estate and gold remains important.
Additional coronavirus commentary:
Our Global Market Strategist team has been closely tracking the coronavirus since the beginning, monitoring the new infection cases in China and around the world along with the overall death rate.
We argue here that the coronavirus death rate and the number of deaths are the important statistics that market participants should focus on. While the coronavirus has vigorously spread across China and in places like South Korea, Iran and a few communities in Italy, evidence shows that many of the cases have been mild and will primarily affect older patients who have pre-existing conditions2. According to WHO data, the coronavirus mortality rate hovers around the 3.5% range3.
Comparatively, the US flu tracker shows this year’s flu to infect 15 million Americans and 8,200 associated deaths4. From a statistics point of view, we don’t think that the coronavirus is a repeat of the 1918 Spanish flu. A more recent comparison of global health pandemics is the 2009 H1N1 swine flu – that infected 60mn Americans and 12,500 deaths in the US alone5.
Although the coronavirus trajectory is still uncertain in the US, there has so far only been two reported coronavirus-related deaths in the US as of March 1. The 2009 H1N1 pandemic had a relatively subdued market impact caused little economic damage because the CDC announced – within 2 weeks of the first reported case in the US – that the mortality rate was around the same as the seasonal flu6.
The death rate from Covid-19 is noticeably higher than the seasonal flu and market participants continue to mistrust the clinical data coming from China. When compared to the handling of SARS back in 2003, the Chinese authorities this time around have been much more transparent and taken more aggressive action to stem the spread.
However, the market has instead focused on the uncertainty caused by the initial muddying of coronavirus by the local authorities – even Chinese President Xi Jinping in a speech during the last week of February to party cadres acknowledged the “obvious shortcomings exposed” by the coronavirus7.
Even if market participants do not trust the medical data coming out of the China, the coronavirus has spread to other parts of the world and market participants now have medical data that they can compare with. Most recently on March 1 the UK Health Secretary Matt Hancock said that the “very best assessment” was that the mortality rate was “2% or, likely lower.8”
Kristina Hooper is Chief Global Market Strategist at Invesco, David Chao is Global Market Strategist (APAC) at Invesco. Paul Jackson, Global Head of Asset Allocation Research, also contributed to this piece.
^1 Source: National Bureau of Statistics of China, March 2, 2020.
^2 Source: Vital Surveillances: The Epidemiological Characteristics of an Outbreak of 2019 Novel Coronavirus Diseases (COVID-19) — China, 2020, China CDC Weekly, Feb. 17, 2020.
^3 Source: World Health Organization, Invesco. Data is daily from Dec. 31, 2019 to March 1, 2020.
^4 Weekly U.S. Influenza Surveillance Report, US CDC, last updated Feb. 28, 2020.
^5 2009 H1N1 Pandemic (H1N1pdm09 virus), US CDC, last updated June 11, 2019.
^6 H1N1 Flu (Swine Flu): General Information, US CDC, last updated Dec. 22, 2009.
^7 Coronavirus is China’s fastest-spreading public health crisis, President Xi Jinping says”, South China Morning Post, Feb. 23, 2020.
^8 “Coronavirus: What are the chances of dying?”, BBC, March 1, 2020.