Markets must wake up to the risks of the coronavirus
It is still too early to be certain on the relative infectiousness or mortality rate of the new coronavirus. Nevertheless, there have been close to 10,000 confirmed cases, and 40m people in China are currently facing travel restrictions.
The virus has now spread to 23 territories, including the UK, where two cases were confirmed last week. Given this, what impact will the coronavirus have on the global economy?
At the time of writing, it is our view that investors should focus on the economic costs of controlling the outbreak, rather than fearing a mass panic. In fact, it was a surprise to us just how resilient stock markets have been in the face of adverse coronavirus headlines, given the precedent of SARS and its impact on markets in 2003.
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Indications are that this current outbreak is at the relatively early stages in China, and it will take some time to bring it under control there. Nevertheless, while there have been some cases outside China, there does not appear at this stage to be an epidemic of viral pneumonia in other nations.
The number of reported cases is likely to escalate sharply as awareness of the disease grows, but estimates of the mortality rate will also decline as testing becomes more widespread for milder cases.
National economies will be hit by the measures taken to reduce transmission, but provided that these are not as draconian as those currently imposed in China, the economic impact should be relatively modest.
What can we learn from previous pandemics? Given the changes in the global economy since SARS or the Spanish Flu events of 1918, a direct read-across to the coronavirus may be misleading. Also, at the early stages of an outbreak such as this, it is uncertainty which has the largest impact on markets. Investors should be careful not to implicitly exclude the impact of uncertainty in their analysis.
For example, we do not know with any certainty whether the coronavirus outbreak can be contained at this point, nor what public health measures will have to be employed. Furthermore, the number of confirmed coronavirus cases has grown rather more sharply than during the early stages of the SARS outbreak.
There have been a number of studies which attempt to model the impact of an influenza outbreak on the world economy. These indicate that a decline of between one per cent and five per cent of global GDP relative to baseline should be expected in the event of a pandemic — depending on the severity.
A decline of five per cent of GDP would represent a serious shock to both the economy and the outlook for corporate profits. In these circumstances, a sharp move lower in equities would be expected, in addition to a switch to safe-haven assets.
However, even a moderate outbreak would be likely to have consequences for markets over the coming quarters, as investors have priced in a global recovery. Investors should now apply a discount to sectors where the economic impact of attempts to control the coronavirus will hit hardest.
Right now, the biggest risk to a nuanced portfolio is if reports surface of a much greater rate of infection outside China, which would suggest rapid human-to-human transmission despite public awareness measures. If the figures do show a sharp rise in infections or a surge in hospitalisations outside China, this would be taken negatively by markets.
As such, we remain cautious on equities and would screen portfolios for holdings where public health measures may adversely impact profits.
Given all these uncertainties, the coronavirus has the potential to have either a limited or serious negative impact on the world economy. Unlike a trade war, a pandemic cannot simply be called off by politicians.
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