
Markets and Economy The market impact of coronavirus has begun to spread
Companies issue warnings that the epidemic will impact their revenue and earnings.
We have seen a rapid and dramatic market correction as a result of the news flow around the COVID-19 outbreak. This appears to be an overreaction, in my view — but I would not be surprised to see the sell-off continue as uncertainty remains high on key issues: ease of transmission, 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.
The situation in China in terms of contagion already appears to be improving, as new infection data is being driven by cases outside of China. Having said that, economic data is poor — especially the February Purchasing Managers’ Indexes (PMIs) just released this past weekend. China’s official manufacturing PMI dropped to 35.7 — from 50.0 in January — while the services PMI dropped to 29.6 from 54.1 in January.1 However, that is to be expected given the extreme measures taken by the Chinese government to lock down travel and commerce in order to stem the tide of infection.
I suspect the data for February will represent the bottom, and that March data will indicate improvement. If this is the case, it suggests the greatest impact on Chinese economic growth will be felt in the first quarter of 2020. In China, we expect a V-shaped economic recovery, with a sharp rebound quickly following the first-quarter fall.
However, for many other countries, infections are 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, with a rebound taking longer to get off the ground. The path of economic recovery depends on the length of time the contagion spreads without stabilization, as well as the policy response of each respective country.
At this juncture, here is what we anticipate in terms of the impact and the policy response:
At a tactical level, we believe investors should continue to favour risk assets, especially stocks, but ensure they are well-diversified.
We believe that this is still a secular bull market potentially favouring stocks over bonds and credit over Treasuries. Nonetheless, investors should be prepared that, in the near term, volatility in markets is likely to persist, and equities and credit may fall under additional pressure. The good news is that the 10-year US Treasury yield and the copper-to-gold ratio seem to already be pricing in close to worst-case scenario outcomes.
Within stocks, we favour Chinese equities as well as global equities that have significant revenue exposure to China, given our view that earnings will likely recover first in China due to the trajectory of the disease. US stocks could also perform well, given our expectation that the Fed will provide adequate policy support. While we are not calling a bottom, we believe investors should be ready to take potential advantage of buying opportunities as they present themselves.
Within fixed income, we continue to favour credit over sovereign debt. This is particularly so given currently falling rates.
We continue to encourage adequate exposure to alternatives, including real estate.