Key points

• While reported new coronavirus cases in China have slowed, the pickup in cases outside China has led to a renewed sharp fall in share markets and bond yields.
• Our base case is that the outbreak will be contained allowing share markets and bond yields to rebound in the June quarter.
• However, the hit to economic activity is deepening & the risks around Covid-19 becoming a pandemic have risen leaving shares vulnerable to more near term falls.
• The key for most investors though is to recognise that periodic share market falls are inevitable & hard to time & so it’s best to take a long-term approach to investing.

 

It has been a turbulent start to the year with Australia beginning the recovery process from the tragic bushfires followed by the threat of a global pandemic with cases of the coronavirus increasing across the globe. Despite these events markets did not flinch in January, with equity markets generating strong returns for the month as liquidity conditions continue to be supportive of markets.

If we look at previous incidents of viral outbreaks, such as SARS in 2003 and H1N1 (swine flu) in 2009, short-term corrections were within the range of 5% to 15%. These corrections were followed by strong rebounds. The consensus view is that global growth will be down in the first quarter of the year as a result of the coronavirus with the key variable being how long the threat of the virus persists.

While history is a useful guide in this case, it must be said that the effect of this epidemic is likely to be greater given China’s dominant presence in the global economy, given the faster spread of the disease and the measures taken to combat it. The extended closure of Chinese industry, restrictions on people movement, disrupted supply chains, declines in key commodity prices, bans on Chinese travel and the flow-on effect to confidence will severely hamper growth in China and the countries and regions most heavily reliant on China.

While at the time of the SARS outbreak China accounted for around 9.0% of global output on a PPP basis, it now accounts for 19%, and this proportion is only likely to increase in coming years, according to the IMF. China accounts for 18% of global tourism spending (up from 4.0% in 2008) while overall tourism (domestic and global) spending accounts for more than 10.0% of Chinese GDP and has been contributing almost 1.5% to annual GDP growth. To place China’s emergence on the global stage into perspective, in 2003 there were 20 million Chinese overseas visits and in 2018, 150 million. The Chinese economy accounted for about 30% of global growth in 2019. So a drop in Chinese GDP growth to 5.0% for the year, assuming the virus is contained within a short period, would detract 0.2–0.3% from global growth.

A big hit to global growth

Whether Covid-19 is soon contained, turns into a re-run of swine-flu or something a lot more deadly remains to be seen. Our base case remains one of containment by the end of March. But the risk of it taking longer is significant and in any case it’s increasingly clear that the economic impact will be quite severe as containment measures spread globally disrupting supply chains and spending.

• Some estimates suggest that as much as 50% of China’s economy has been locked down for the last three weeks which means nearly 12% knocked off Chinese GDP this quarter. While the Chinese Government is refocussing on efforts to restore economic activity outside Hubei and high-risk areas, so far there is only mixed evidence of that. Coal consumption at power stations, migrant flows to cities, property sales and steel demand are up from their lows but remain well below normal levels for this time of year. And there has been no pickup in traffic congestion.

• Numerous companies globally are reporting disruption to supply chains or reduced demand flowing from Covid-19.


• Containment measures including travel restrictions in countries like Japan, Korea and Italy will spread the economic disruption globally.


• Our rough estimate is that March quarter global GDP could now be zero or slightly negative.


• Australian GDP is likely to go backwards this quarter (with our current estimate being -0.1%) thanks to the bushfires and the hit from coronavirus. The vulnerability of the Australian economy to China is apparent from the next chart. Exports to China make up nearly 9% of Australia’s GDP including hard commodities at nearly 5%, tourism at 0.2% and education at 0.6%. For other major countries it’s less than 3%. Chinese tourist arrivals stopped with the travel ban, education is under threat although there is a bit more time and bulk commodity shipments are showing signs of being impacted (although this has been distorted by storms). Clearly the longer it drags on and the more the outbreak and disruption spreads globally the bigger the impact on Australia including the risk of two negative quarters, ie recession. The rising threat to the Australian economy from coronavirus is adding to the likelihood that the RBA will cut rates in March or April and the pressure for more fiscal stimulus in the May budget is increasing.

Concluding comments
The increasing global spread of the coronavirus has increased the risk of greater economic disruption for longer resulting in say a 20% fall in share markets. However, our base case of containment is that Chinese, global and hence Australian growth will rebound in the June quarter (avoiding recession in Australia’s case) although the risk of a delay is significant. Against this background share markets, commodity prices and the $A remain at high risk of more downside in the short-term, but assuming some containment and a growth rebound in the June quarter markets should rebound by then. Easier than otherwise monetary and fiscal policies - with ever more stimulus measures announced in China and more monetary and fiscal easing globally - would add to this. The key things to watch for remain a further downtrend in the daily number of new cases globally and a peak in new cases in developed countries.

In a big picture sense, the fall in share markets should be seen as just another correction after markets ran hard and fast into record highs this year from their last decent correction into August last year.

Finally, for most investors given the obvious difficulty in trying to time any of this – whether it’s a further share market fall of 5% or 20% or no further fall at all and then when to get back in - it makes sense to turn down the noise around the virus and stick to a long-term investment strategy.

If you would like to know more, talk to Michael Sik at FinPeak Advisers on 0404 446 766 or 02 8003 6865.

This article was produced by AMP, (click here to view the full article) and Lonsec (click here to view).

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