What We Know
Although data are preliminary, there seem to be over 17,000 cases of the coronavirus reported globally. Reported deaths are just over 360, making the death rate after catching the disease around 2%. This virus seems to be less deadly but more contagious than the 2003 SARS outbreak, which had a mortality rate of 8%. China is acting decisively, more so than they did during SARS, even taking steps to build hospitals in short order to alleviate some of the bed shortages in affected cities. This virus is likely to continue to spread until its projected peak in late February/early March. A quicker resolution is unlikely, as finding and testing an effective vaccine would take months, even in a best case scenario.
So far, it appears that markets have taken the coronavirus as a cue to begin a long-overdue global stock market sell-off. With U.S. equity market sentiment extended and valuations a bit stretched as we entered 2020, a sell-off like this is not surprising. While U.S. equities appear poised for a rebound today following Friday’s sell-off, fear about the virus caused stocks in mainland China to plummet nearly 8% in their first session back since the Lunar New Year holiday. The decline was swift and broad-based, with all but 162 of the almost 4,000 stocks in Shanghai and Shenzhen recording losses.
Global bond markets have reacted as one would expect in a flight-to-safety environment. Bond prices have rallied while yields have fallen, once again showing the fixed income market's ability to move in the opposite direction during equity market pullbacks.
Global GDP growth estimates have been reduced as economists attempt to calculate the impact this virus will have on global trade and consumption. The early impact has been most concentrated (but not limited to) transportation, luxury goods, tourism and consumer discretionary in general. We believe the markets most affected will be those closest to the areas of infection: China, Hong Kong, South Korea, the ASEAN group of countries, and Japan.
So far, the major economic impacts have been on the supply side, with reduced working hours and logistical disruptions for transportation and delivery. Lower demand may also be a consequence of fear of infection and quarantine. We expect lower consumer spending in both manufactured goods and services. We believe that this virus will take 0.5% to 1.0% off of global GDP in the short run, with U.S. GDP reduced by 0.1% to 0.2%. These estimates may prove to be a bit too conservative, however, as the aggressive steps China has taken to combat the spread of the virus may put even more downward pressure on growth. To help offset this drag on economic activity, the Peoples Bank of China lowered its seven-day reverse repo rate and injected a total of 1.2 trillion yuan into money markets.
We attempt to look ahead 12 to 18 months in our work and believe that while this virus may have a short-term impact on global GDP, history says that once the virus has run its course, GDP will likely snap back and make up for the losses it experienced during the decline. In essence, we believe that total GDP growth for the next 12 to 18 months will be the same in the aggregate, but the virus will make this path of GDP growth more back-end loaded.
We maintain a neutral allocation to equities and a small underweight to fixed income in the “lower-for-longer” rate environment. We also have a small overweight to diversifiers to provide some downward protection and buffer the volatility associated with this late stage of the market cycle.
What We're Watching
The number of new cases reported on a daily basis. History shows that once this number starts to fall, markets tend to calm down with the knowledge that the worst may be behind us.
South Korean exports into China. This will be a good indicator of Chinese aggregate demand and should shed some light on the overall strength of the Chinese economy.
The length of time the coronavirus remains a headline issue. The longer this situation stays in the headlines, the deeper impact it will have on global confidence and global spending.
There remains great uncertainty around this virus, its spread and the ability to contain it. We will continue to monitor this situation daily, making adjustments to our recommendations if the facts warrant a different tactical outlook. For now, we believe the best course of action is to be neutrally postured in a well-diversified, global investment portfolio.