The global economy entered 2020 on a slightly improving note, with forward-looking data pointing to a potential uptick in activity. However, this was quickly derailed by the assassination of Iranian military leader Qasem Soleimani by the US and more significantly by the increasing severity of the coronavirus outbreak originating from Wuhan, China. This outbreak has made it difficult to read too much into the near-term economic data as it is unlikely to have captured much of the true impact. Furthermore, it may be many months before the full effect on company revenues and profits is known, further clouding the outlook. Nevertheless, it is now a certainty that there will be a significant negative impact in the short term to both the global economy, trade and company prospects.
After being arguably overly complacent about the outbreak when it was contained to China, the market went through a dramatic selloff, beginning on 17th February, as investors attempted to price in the spread of the virus worldwide, with new outbreaks in Italy, Iran and South Korea. Furthermore, the oil market added fuel to the fire when Saudi Arabia reacted to a lack of a deal with OPEC (and Russia) to cut production, vowing to increase output dramatically and discounting sales. A 30% fall in Brent crude prices on 9th March led to a 5-8% falls in equity markets, making it the worst single-day fall since the financial crisis, although quickly superseded with successive daily falls during the following weeks.
As a result of the market moving aggressively to a “risk off” stance, there has been a significant divergence in asset class performance over the quarter. This follows a year of very similar returns from all assets. Government bonds have performed well in this environment as a result of rapidly falling interest rate expectations, at the expense of equities.
In response to the developing risks, there have been increasing levels of stimulus from both Central Banks and governments through interest rate cuts and fiscal packages. The Fed has intervened repeatedly into the markets to ensure liquidity is present.
We are increasingly of the view that the market reaction is overdone and the economic impact, whist sharp, will ultimately be short-lived.
While the coronavirus outbreak has been known about since January, the market took time to react.
Firstly, the initial selloff was initiated by the announcement by Chinese authorities that the city of Wuhan would be locked down. To investors this signified both the potential severity of the outbreak but also a realisation of the economic impact. With limited (and untrusted) data coming out of China, the market extrapolated a rapidly spreading infection and sold equities, buying safe-haven assets such as gold and US treasuries.
The next phase was a period of cautious optimism, where it appeared that the rate of spread of the virus was slowing. Bullish equity investors were keen to take this as a sign that they could look through the event, as it may only impact one quarter’s earnings and there could even be a bounce in demand once everything returned to normal. Furthermore, a belief that other countries were able to successfully identify carriers of the virus and there was no person to person transmission outside of China was an additional comfort.
Investors then attempted to price in a potential pandemic, as pockets of infection sprung up globally (including South Korea, Italy, Japan and Iran). The more widespread disruption means that there is an increasing likelihood of a global recession and one that may persist for longer than initially feared.
The path of markets through the quarter has been volatile. Global equities peaked on 20th January and fell close to 5% into the end of the month. However, as investors became more relaxed that the virus would be contained, they rallied, erasing the fall. Asian markets naturally underperformed during this period, however, over the same period a fall of 1.6% was not significant.
The crunch point came on 24th February, when it was confirmed that over the weekend a significant outbreak was occurring in Italy. The realisation that the virus was embedding in Europe (and elsewhere), came as another shock to markets that had begun to relax with it being brought under control in China.
Market participants appear to be laser-focused on the data points and were keen to see the level of recovery being higher than new cases, suggesting that the infection is receding. The contagion has gone through three distinct phases, the initial spread of infection in China, the subsequent containment (and reduction in daily cases) and the spread worldwide. The gyrations of markets have followed these phases, reacting negatively to the initial outbreak, consolidating on the prospect of containment and then a more extreme negative reaction to rising rates of infection outside of China.
The pockets of infection appear to follow a similar progress, discovery of an outbreak, a rapid increase in the number of cases for ~2 weeks and then slowdown as societies and governments react. Given the suspected 14-day incubation period, this appears logical.
Relative to population size most outbreaks have been negligible (based on official statistics). However, most scientists agree that the real number is likely to be much higher as many individuals, particularly the young, may only have mild symptoms. As with previous outbreaks, the true rate of infection may only be known many months/ years following the pandemic.
More positively, there is evidence that outbreaks at a country level can be relatively short-lived. See our full analysis of coronavirus in countries here. Positively, from this analysis, it appears that from the period of rapid growth, countries taking appropriate action are able to control the spread. Indeed, China has almost wiped out the virus in a little over two months.
While there are only a few examples of this trend, there does appear to be consistency. The difficulty is determining what the links are between this trend and the government action, individuals’ behaviour change, reporting and the virus itself. It is clearly too early to place much weight behind this; however, it is useful to keep in mind that this is a transitory issue which ultimately will dissipate. Nevertheless, with many parts of Europe and North America yet to experience a full outbreak, the market sentiment may get worse before it gets better.