Darius Svidleras
Investment Portfolio Manager

Last month we questioned, if coronavirus in China can be considered as “Black Swan” for the global economy and financial markets. The key message was that unless virus spreads to other countries and turns to global pandemic, situation is likely not to cause major panic in the markets. Until the last decade of February this was indeed the case, as global equities continued rising higher and updating new all-time highs. Situation in China also started to stabilize since 12th of February with growth of new cases and deaths slowing down, and the country gradually returning to normal life. 

However, circumstances started to change radically since around 20th of February, as one after another South Korea, Italy and Iran registered rapid increase in cases, indicating that the spread of the disease is following similar scenario in these countries as it was in China, just with one month lag. In addition, cases in other countries though not at epidemic levels  still continued to grow, and thus by early March new daily cases of coronavirus outside China jumped to about 2000 cases per day from less than 100 cases per day only two weeks ago. In total, 68 countries registered patients infected with coronavirus, and though World Health
Organization did not announce global pandemic yet, in essence, one might say that it has already started. One of the key characteristics of coronavirus is long incubation period, and it is highly feared that even in countries with low number of cases after some time full scale epidemic may commence.

New cases of coronavirus outside China per day​

Source: WHO

Performance of selected assets in February

Source: Bloomberg

Taking into account such risks, global equity markets experienced one of the most rapid declines in history, in one week dropping by more than 10%. In fact, S&P-500 experienced fastest decline of 10% from market top ever. At the moment, equity investors fear that coronavirus might lead to paralysis of various parts of the global economy, which in its turn would cause global recession and significant bear market in stocks. China has already printed record low number for economic activity as measured by PMI in February, when travel inside country was widely restricted, and large part of enterprises temporarily shut, in order to contain the spread of the virus. And if other countries, especially most developed ones, such as USA, Japan or Germany would experience similar economic consequences in case of the coronavirus spread, it would lead to drastic negative revisions in corporate earnings and potentially much lower prices for majority of global equities.

China manufacturing PMI

Source: Bloomberg

Already now some companies, like Apple for example, are warning that their revenue and profits will be negatively affected by the coronavirus. Although the exact impact is hard to evaluate, we are seeing analysts reducing their earnings growth estimates for this year. Corporate earnings in US are now expected to grow 7.4% compared to 9.2% just two months ago. And in Europe, analysts are basically expecting no earnings growth in the next 2 quarters. Such reduction in earnings make stocks more expensive, as equities valuation is measured as price paid per unit of earnings.

In addition to equity selling, heightened risks forced investors to pile into global government bonds, which experienced one of the strongest rallies recently, with US 10-year treasuries reaching record low yield of around 1%.
Such change indicates that bond investors expect strong actions to be taken by global central banks in March, and in case of FED potentially even cutting interest rate not by usual 0.25%, but at least by 0.5%. While such drastic cuts usually happen at the start of recessions, this time, if global coronavirus spread would simultaneously start to slow down, easing may actually improve economic outlook and stabilize equity markets.

US government bond 10-year yield


Source: Bloomberg

This is actually what happened in China. After the first initial shock in late January to stock prices (just as it happened around the globe one month later), local equity market has bottomed on 3rd of February with People’s bank of China injecting record high amount of liquidity into its financial system. One week later coronavirus cases in country also started to decline, and Shanghai Composite strongly rebounded. Therefore, similar scenario indeed cannot be excluded to repeat on a global scale as well. 

Liquidity injections in China and performance of Shanghai Composite


Source: Bloomberg

Moreover, in addition to monetary stimulus, it is likely that affected countries would pursue expansionary fiscal measures, in order to compensate for damages brought by coronavirus disruptions. Italy and Germany already indicated that they are ready to increase spending, if situation would require doing that. And again, if coronavirus global threat would turn out just a temporary phenomenon, such fiscal measures might be also enough to stimulate solid economic recovery after few months of negative growth. 

So overall, different scenarios are possible, but extra caution is definitely warranted at the moment, as uncertainty is high. A lot depends on the magnitude of the epidemic outside of China, which is currently a big unknown. Moreover, it will take time to assess to what extent was the damage to the global economy permanent and how much it would affect corporate earnings. In such volatile markets it is extremely important for investors not to fall into panic but look at the big picture and remain long term oriented. In fact, for the long investment horizon the current set back may even provide good points of entry into the market.

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