Coronavirus - A Considered Approach

This article was written on the 10th March 2020 and some information may be out of date however, many of the concepts are still valid.

When we look at these areas of possible concern, we gather information from as wide a net as commercially possible; our independent research houses, Chief Investment Officers and Portfolio Managers both from investments inside our portfolios as well as external funds, a number of global economists that we have access to, financial commentators, University professors, market analysts, and particularly in this situation scientific and medical experts writing in medical professional journals and relevant data and alerts  from the World Health Organisation.

We hope this will allow you, like it does us, to take a considered approach free of any media hype or sensationalised views. As always, your adviser is available if you wish to discuss this article or any aspect in more detail.

Despite prior predictions by experts to the contrary, 2019 was an uncommonly strong year for equity market returns, well above long-run averages. While this run continued in early 2020, we considered if a market pullback was likely and if so what would be the catalyst as geopolitical tensions between the US and China had eased, Trump’s impeachment was acquitted, Brexit was being worked through slowly, the outlook for global growth had been improving and generally most developed countries economic data, interest rates and fiscal policies were reasonably conservative. 

Markets initially were relatively immune to the ongoing novel Coronavirus outbreak in China, however the rapid spread of cases outside of China has led to a re-evaluation of the risks. Fears around the Coronavirus, also called COVID-19, have gripped markets over the past few weeks causing the biggest one-week drop on Wall Street since the financial crisis.

Yes, the Coronavirus in the short term is shaping up to be a major market event, but do we believe this will lead to a global recession? The unpredictable nature of the COVID‑19 outbreak coupled with media hype makes it difficult to forecast short‑term market moves, however in this environment, we believe it is important to keep a longer‑term perspective on markets and a number of aspects need to be borne in mind:

The boring bit: China, US and Global Economic Consideration

  • We expect global central banks to continue to take a wait‑and‑see approach. China’s initial policy response focused on crisis management. So far, aside from the Chinese government’s containment and medical assistance provided,  the People’s Bank of China (PBoC) response has been relatively restrained, with $US174bn of liquidity provided to banks and $US4.4bn of special loans provided to affected firms.

  • We continue to expect the PBoC to manage the renminbi within a tight range despite the potential for moderate depreciation against the U.S. dollar. In other words, our view is they’ll responsibly still aim for their growth targets and likely release further economic stimulus in stages as needed.

  • The Chinese Politburo endorsed more forceful monetary and fiscal stimulus policies to meet this goal and roll out more detailed medium‑term stimulus measures over the coming months.

  • COVID‑19 has already reached a point where it will significantly impact the first‑quarter economy due to the rapid rate of infection has forced the shutdown of factories and other places of work, disrupted supply chains and led to extensive bans on global travel. The recent signs that the spread of the Coronavirus in China has peaked could point to a potential recovery in the second or more likely third quarter.

  • The political leadership is shifting from all‑out containment to a more balanced approach between containment in areas where the virus is still severe and promoting a return to work in areas where the virus appears to be easing. Outside Hubel province, the centre of the outbreak, economic activity In China has returned to around 50 per cent of normal activity and Is likely rise to 70 per cent in the next few weeks.

  • Despite markets being affected in the short term and some residual effects in the medium term due to trade and tourism numbers, the spread of COVID‑19 globally has not reached a level that we believe will severely weaken the long‑term growth outlook in the U.S. and other developed economies.

  • Unlike natural disasters such as floods and earthquakes, capacity should bounce back once things return to normal; factories and offices remain untouched and most people who fall sick will recover and return to work.

  • Though US markets have recently reacted severely, the US economy appears better placed to withstand disruption, meaning a mild slowdown is more probable than a recession if the virus is contained.

  • The RBA cut rates by 0.25% already and has indicated a willingness to cut further. The US Fed recently did an emergency 50bps cut, though is probably reluctant to cut interest rates further at the moment unless extremely necessary as the economy is on a strong footing and the Presidential election is less than nine months away.

  • The Australian Government has announced stimulus measures worth around $18billion with funding for extra health clinics, and boosts to the economy with direct payments both to individuals and businesses with turnover of up to $50million and tax incentives for those with turnover up to $500million.

  • Market expectations for further world-wide central bank and government intervention remain high, even where monetary stimulus has limited impact and fiscal stimulus, which can be much more effective, will take time to materialise. However economic and market impacts are rarely synchronised- so as evidence of stabilisation of the virus spread comes through, markets are likely to rebound (even if the economic effects have yet to play out).

The interestingly gory bit: SARS, MERS, Swine Flu, and Empirical Evidence

 
 
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Do you remember when the Swine Flu, SARS, or MERS were about to decimate the world? There is great debate currently whether the Coronavirus can be compared to SARS or any other prior outbreak; our view is that it is irresponsible not to consider historical occurrences. (“History doesn't repeat itself but it often rhymes,” as Mark Twain is attributed to saying).

  • The SARS outbreak caused 8,098 cases and 774 deaths in 17 countries. Although the first cases appeared as early as November 2002, China initially denied and had no containment measures in place and it was not until April 2003 that the World Health Organisation issued a global health alert and the first quarantine measures were introduced. With Coronavirus, China alerted and acted quickly to contain it, while already the World Health Organisation has declared the outbreak a Public Health Emergency of International Concern, (only the 6th time this measure has been invoked). However, the WHO recently commented that the incoming data does not yet fit the definition of 'pandemic'.

  • With a death rate among those infected currently around 3 - 6% depending on individual country figures, the coronavirus is somewhere between the 2003 SARS outbreak and 2009 swine flu outbreaks in terms of lethality, which had death rates of 10% and 0.03% respectively. While the more lethal SARS outbreak ended up infecting a relatively tiny 8,000 people worldwide, the swine flu affected around 1 billion, or 15% of the world’s population. SARS was not labelled a “pandemic” by the World Health Organisation, whereas swine flu was. The table below shows infection and death rates for major disease episodes of the last 100 years.

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  • The above table has not been updated to include Italy, which has boosted this figure of late, both in the number affected and death rate as their antiquated hospital system currently is not coping. Figures as at 12 March are approximately 118,000 cases in 114 countries with mortality of 4,291 people.

  • For context, the common annual flu affects around 400 million (5%) of the global population each year, with a death rate of around 0.1% (500,000 people) each year. The below chart illustrates this:

  • Another perspective to consider is the World Health Organisation (WHO) currently attributes between 300,000 and 650,000 deaths per annum from the normal annual influenza virus (with 3 to 5 million cases of severe illness) and the current mortality rate of COVID-19 appears to be no more significant from a humanitarian standpoint.

  • Mortality rates are drifting higher over the last month but are heavily skewed towards the older population and those with pre-existing conditions. Iran and Italy being major areas of concern, however neither of these countries represent as significant a proportion of world GDP as do other countries such as China, USA, Japan, Germany and other nations where stronger health controls are in place.

  • According to WHO, the current fatality rate however is well below that of SARS (which was around 10%) and Camel Flu/MERS (around 34%) of the early-to-mid 2000’s and 2010’s though the rate of contagion and spread of this coronavirus is significantly higher.

  • World governments have significantly increased their awareness in an effort to address the spread of the virus. Dr Mike Ryan, WHO’s Emergencies Chief, said on the 12 March ‘We have observation that tells us that there is a strong element of controllability in this disease’.

  • A number of medical commentaries suggests that, as per the normal cycle of influenza, as the Northern Hemisphere warms through spring through to summer, the new number of patients may peak in March and fade away gradually. The total number of cumulative patients will then plateau and decline with the onset of warmer weather.

The important bit: Your Money

  • While SARS dented global markets in early 2003, investor sentiment recovered upon control of the outbreak. To put things into perspective, the MSCI China and Hang Seng Index rose 93% and nearly 50% respectively from the lows in April 2003 after tumbling around 15% from the start of 2003

  • This recovery wasn’t limited to Chinese markets. International and the Australian market place also recovered quickly:

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  • The world has seen many epidemics in the past and they tend to be short-lived, particularly those seen during this millennium (SARS, Swine Flu, MERS and Ebola) due to advances in treatment and vaccine development.

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  • Equity markets have already priced in a significant adjustment down in growth and profit expectations as well as fear, yet historically health related events such as these have seen markets experience a recovery over the next 6 – 9 months.

  • While confidence is a vital component of economic behaviour that underpins financial markets and investor returns, history has shown time and again that changing a long-term investment strategy during times of short-term volatility may not be a smart move. Staying the course means investors are more able to avoid crystallising losses during a falling market and can capitalise on gains once the market rallies again.

Our belief is that the combination of stabilising and slowing new case count and supportive fiscal and monetary policy announcements from numerous world governments, the IMF and World Bank will help to ease and reverse the effects on markets, while interest rates are likely to remain very low for a number of years yet.

Warren Buffet, the billionaire chairman of Berkshire Hathaway, called the coronavirus outbreak "scary stuff" but said stocks remain a good long-term investment and that he won't sell stocks despite the threat of a pandemic. Buffett said investors cannot predict the market's long-term performance by looking at the daily headlines. "There's always trouble coming," he said. "The real question is where are those businesses going to be in five or 10 years."

While only time will tell, it is our belief companies with strong fundamentals will rebound once the global outbreak is under control, then markets as a whole will follow suit.

At Evolution Financial, we care about your money, your peace of mind and your health. If you or someone close may be at risk of contracting the virus via travel or other means, we urge you to seek medical attention for testing immediately. If you are concerned and wish further information, we highly recommend reading the following links:

Brad Stewart