Markets fell again sharply today (Wednesday 26th February) following similar falls on Monday, amidst heightened press reporting on the spread of Coronavirus.
This strain of flu, given its long non symptomatic contagion period will spread faster across the world than previous similar outbreaks such as Sars, Swineflu, Ebola etc., particularly also given the greater international trade and travel since previous outbreaks. The death rate at 3% is not out of line with other illness that relies upon the body to fight a disease without medical assistance. It is likely that a large proportion of the 3% will be the elderly or already ill, such that the death rate amongst the healthy working age population is likely to be very low. Preventative vaccines and post contagion treatments are being developed – albeit at early stages of testing with no guarantees, and accordingly, in the meantime the accepted practice of dealing with the outbreak is to limit human interaction.
The economic impact will be global and thus companies quoted on stock markets of countries with no recorded virus cases will also be impacted. Already we have seen the closing of 2000 Chinese outlets of Starbucks, which impacts this US stock, and the closure of Toyota factories in China, which impacts this Japan quoted stock.
The impact on corporate profitability will stem from government enforced quarantine (such as in Wuhan and Northern Italy), corporate imposed containment (worker lay-offs / suspensions) or self-imposed reduction in human interaction. This leads to reduced domestic consumption (e.g. travel, hotels, restaurants, shopping) and reduced productivity (e.g. factory closures, supply disruptions). Indeed recent data shows that whilst world trade volumes were steady by the end of 2019 (neither contracting or growing), there are now signs that the measures taken to contain coronavirus have hit trade flows, particularly in Asia (e.g. Chinese and South Korean imports / exports and Japan tourism)
Looking ahead, the reduction in economic activity will make it more likely central banks will reduce rates and engage in further quantitative easing to reduce corporate strain through the cost of debt. Within the bond markets it is telling that US rates (where there is room to cut) have moved much more than their European counterparts.
However, the supply side shock in basic goods / non-discretionary consumption industries where demand changes little, means inflation could pick up too, not usually an environment in which central banks would be reducing rates, but some have already discussed changing their inflation objectives to one of long term averaging, thus indicating a preparedness to allow inflation to rise above 2% for a sustained period before raising rates again.
In respect of trade in more discretionary goods, ordinarily a pent up demand is created which releases into enhanced activity once the crisis subsides, and restrictions are relaxed, such that firms should ‘catch up’ later.
The long multi-year upward march of markets until now has caused a lot of commentators and investors’ concerns regarding the timing of the next market dip. The virus is perhaps the excuse needed such for a price correction, such as we are seeing now, and one must expect it to deepen further temporarily before recovering when much more will be understood in how to deal with / contain the virus’s impact and continue life as near normal. We are not able to predict that timing. Neither are we day traders or reactive traders – but long term investors. Similar outbreaks in the past have been short lived and so we are maintaining our long term positioning on the basis it will self-right later this year.