In the last few days, the Chinese authorities have taken drastic measures to ensure that the latest corona virus is contained and does not spread further across China and other countries. The global media are taking no such measures and keep on producing stories about this new “killer virus” using pandemic terms to describe the dangers ahead for the world. Financial markets have responded to the avalanche of news reports, no longer caring about messages from Davos but focusing on news coming from Wuhan.
SARS and MERS
In the last few decades, we have already experienced 6 different corona viruses. Some of them are still endemic, mostly causing flu-like symptoms and in some severe cases pneumonia. The best known are SARS (November 2002) and MERS (September 2012), the first one infected a confirmed 8,000 people globally, while the estimate for MERS is about 2,500 patients. The most recent number for the Wuhan corona virus stands at about 6,000 people, which number will probably increase considerably in coming weeks, taking into account the relatively long incubation time for this specific virus. Global health authorities have learned a lot from previous corona outbreaks and are cooperating to limit a further spread of the virus and work on a vaccine.
The direct effect of the previous health crises on the global economy was extremely limited, with a temporary dip in Hong Kong growth early 2003 as business and tourist travellers avoided the region for several months. Global stock markets did sell off by more than 10% in the winter of 2002, but this was mostly linked to the aftermath of the burst of the internet bubble in 2001. Sentiment in stock markets was already weak when SARS hit the China region in 2002 and this was one more reason to depress stock prices further. When the MERS virus caught the headlines in September 2012, the European economy was still in the middle of the sovereign crisis, which resulted in the Greek default and rescue packages for other periphery countries. This was the main cause for depressed equity prices in the first half of 2012, the MERS virus did not move the needle for global equity markets however. Based on these examples, we conclude that health crises by themselves have rather limited effect on equity markets, but they can exacerbate negative equity market performance if sentiment is already depressed. For specific sectors such as travel and hospitality, the impact will be more significant and visible in earnings numbers, as it will take quite some time for tourists to want to visit the affected region again.
In the last few month, we have seen some improvements in global growth momentum, with PMI's and other indicators pointing to a strengthening of economic growth. This trend will be helped by the recent (minor) trade deal between China and the US, mainly because we managed to avoid a further rise of tariffs. Central banks also continue to provide support to global growth, by expanding their balance sheets and keeping official interest rates near historic low levels. We also expect many Emerging Market central banks to follow, as many of them can afford to cut rates due to the benign inflation environment. We do not think that the Wuhan virus will derail the global economy, but some Asian growth and confidence numbers will be negatively affected in coming months.
Buy the dip?
Since the start of the year, financial markets have already had to digest two significant news events; the first was the killing of the Iranian general Soleimani by the US government, which could result in an escalation in the confrontations between US and Iran, and a mere two weeks later we find ourselves waiting for news updates on Wuhan. After both events, financial markets reacted in a typical knee-jerk reaction with a sell-off in risk assets and buying of safe haven assets. The oil price also moved significantly on both events, with a strong rise immediately after the liquidation of Soleimani and with a strong drop in the last few days on worries about lower oil demand. After the first event this year, the initial market response was quickly reversed, with equities resuming their uptrend and oil prices trending lower. Since the end of last week, we have seen a selloff in equity markets and this morning a drop of about 3% in Chinese equity markets after they had been closed due to the Lunar holiday. Interestingly, US equity markets already started to rebound yesterday, even before knowing the extent of the decline of the Chinese equity markets. The rebound in US equities in our view is testament to the underlying strength of equity market sentiment. As long as central banks remain dovish and supportive for financial markets, it will take quite a sizeable stock to derail the risk asset rally. In our portfolios we will use the dip in Emerging Market equities to add to our overweight in risk assets. We are also becoming more positive on commodities, after the drop of almost 20% in oil prices in the last few weeks. It will take quite some time before the Wuhan virus fades from the news, but financial markets might be inclined to move on soon.