As Coronavirus continues to dominate headlines and market movements, we have looked at the initial impact on markets. While the outbreak has been known about since January, the market remains very much in a discovery state, reacting aggressively to the latest news.
To better understand the financial market’s journey since the start of the outbreak, we have taken a step back from the volatility of the last week and broken down the period into three parts. 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 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 coronavirus and there was no person to person transmission outside of China was an additional comfort.
Currently, investors are attempting to price in a potential pandemic, as pockets of infection are springing up globally (including South Korea, Italy, Japan and Iran). 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 last month has therefore 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 have naturally underperformed, 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 coronavirus 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. However, market movements are now being driven by the fear of the potential worst-case scenario.
While portfolios have clearly been impacted and a potential global pandemic is outside of the usual risks that concern investors, a market fall of 10-20% typically occurs every 12-18 months. Portfolios remain diversified with exposure to fixed income and alternatives, which have given a degree of protection. Equities will always remain a core component of portfolios as they are the primary driver of long-term growth, however, investors need to hold their nerve during a time of market panic. History would suggest that this pays off over time.
It is impossible to predict the shorter-term movements over the next few weeks, however, it is reasonable to expect further volatility. Portfolios are constructed to cope with such periods, being diversified across geographies and asset classes, and regular quarterly rebalancing will take advantage of extreme movements, adding to areas that have fallen and reducing those that have held up well. To put emotion to one side when investing is often the most challenging factor, however, such violent market movements will inevitably throw up opportunities moving forwards.