The Novel Coronavirus is the epidemic no one saw coming – one that has made investment markets volatile in recent weeks. Hear from Colonial First State’s George Lin, as he explores the potential impacts of the epidemic on economies and investment markets.
Snapshot: what happened?
- China locked down the city of Wuhan (a population 11.1 million) and much of the province of Hubei (a population of 58.5 million) on 25 January due to the spread of the 2019 Novel Coronavirus (or 2019-nCov).
- At the time of writing, the number of confirmed cases has risen to more than 14,500# and there have also been some deaths. The vast majority of cases are inside China alone, but others have been confirmed abroad.
- The Chinese government has imposed a number of additional measures to control the spread of coronavirus – including the extension of the Chinese New Year holiday.
How might this affect the economy?
The nature of the coronavirus makes precise market forecasting difficult. However, we believe the level of uncertainty could result in a higher level of volatility in financial markets – especially for shares. We explore below:
- The Coronavirus has already impacted the level of economic activity in China, and we think other economies may also be impacted – with the East Asian economies such as Hong Kong and Taiwan being most at risk due to their close proximity to China and the number of Chinese visitors they have.
- Overall, we think the impact on financial markets will likely concentrate on certain regions or industry sectors. For example, Chinese and Asian shares will be most affected, while some technology stocks will also be negatively impacted due to China and East Asia’s central role in the global technology supply chain.
- In Australia, the first negative impact will likely be the flow-on effects of fewer Chinese tourists. However, the demand for Australia’s commodity exports to China should remain relatively intact over the medium term, assuming that the coronavirus stabilises as expected – potentially around May or June this year.
Market reactions so far
- Share markets have been volatile. The S&P 500 Index fell 1.7% on 27 January and then rose by 0.6% a day later. The Nikkei Index fell by 0.6% and the ASX 300 Index fell by 1.5% on 28 January. And the Hang Seng Index fell by around 2.4% in its first trading day since the Chinese New Year holiday.
- In comparison, safe-haven assets have rallied, driving yields lower as investors moved money into the more conservative fixed interest market. For example, the US 10-year bond yield was at 1.66% at the end of trading on 28 January – the lowest level since early October. Australia’s 10-year bond yield closed at 0.99% the same day.
- At the time of writing (3 February), the Australian Dollar (AUD) was trading at around 0.66 US Dollars (USD), down from 0.70 USD at the beginning of 2020.
Market deep dive
The outbreak of the coronavirus is the first unexpected hurdle of 2020. This is an epidemic that is difficult to quantify due to the nature of the virus as well as the relative lack of transparency in China. However, we offer some insight below:
- So far, events somewhat resemble the SARS outbreak of 2002-03 – initial reports of mysterious cases of respiratory illness linked to exotic eating habits, official claims that everything was under control, more cases and then deaths reported, and confirmation that the virus can be transmitted from human to human, which resulted in drastic measures imposed by the central government in Beijing.
- If we look back to SARS as an example, the first case was traced to a Chinese farmer in November 2002, but local authorities did not officially notify the World Health Organisation until February 2003. The number of cumulative cases in China did not peak until mid-May that year. History therefore suggests that the health situation in China will deteriorate further before stabilising sometime in May or June.
- The positives, however, include the quicker response from the Chinese government this time and the scientific progress made in epidemic science since 2003. Within a week of reporting the outbreak in Wuhan, Chinese scientists were able to identify and isolate this new type of coronavirus. By 12 January, they also shared the genetic sequencing, where they found the 2019-nCov to have at least 70% similarity to the genetic sequence of SARS and 40% similarity to the Middle East Respiratory Syndrome. And by mid-January, the first diagnostic test for the virus was developed. Despite positives, there are still some levels of uncertainty as to how the virus will develop and the scale of infection, meaning the economic implications cannot be certain.
- We expect the Chinese economy to be the most impacted given that the reported cases are concentrated in that region. While the SARS outbreak provides some high level comparisons, we believe the economic impact of the Novel Coronavirus on China will likely be more severe than SARS, where Chinese economic growth only slowed marginally, for a number of reasons:
– Firstly, the Chinese economy started 2020 in a weaker position having just recorded the lowest annual economic growth in 20 years and limping out of a damaging trade war with the US.
– Secondly, much of the province of Hubei, including the city of Wuhan, is locked down indefinitely. While one can argue that Hubei accounts only for 4.3% of Chinese GDP, the supply side disruption is more significant due to Wuhan’s status as an important national transport hub. Wuhan is also an important logistics hub, accounting for 1.2% of national freight traffic by weight in 2018.
– Thirdly, while the extraordinary measures introduced by the Chinese government are necessary to control the spread of the virus, they are likely to lead to a shock to supply and demand as well as significant risk-avoidance behaviour by Chinese consumers. This could curtail economic activity, which anecdotal evidence suggests is already happening. For example, the aggregate box office for the top ten Chinese movies on 25 January was $1.12 million. The following Sunday, the trickle of business halved again to a total of just $510,000.
- The negative economic impact of the coronavirus means that equities will be affected the most. During the SARS epidemic, for example, MSCI Asia ex-Japan lost 7.7% (versus the 5.5% gain for MSCI World) from when deaths were first reported until the number of new reports stabilised. The extent of underperformance will be industry and country-driven – China and Hong Kong will likely fare the worst, while stocks across airlines, high-end retailers, casino operators and hotels (particularly in Asia) will be the worst affected.
- Timing the equity market is always a challenge. Using the Hang Seng Index during SARS as a rough guide (as Hong Kong was the most affected city), the index bottomed out at about the same time as the number of new reported cases stabilised. We doubt that anyone can forecast the peak of new cases but the consensus seems to be around four months away.
While the highs and lows of investment markets may cause some concern, it is important to remember that superannuation is for the long term. In our view, the negative economic impact of the coronavirus is likely to be short term in nature. And once investment markets are convinced that the epidemic is under control and various restrictions have been lifted, we think economic activities could gradually return to their normal levels.
# Source: New York Times as at the morning of 2 February 2020, Sydney time.