The coronavirus (aka “nCoV” or the “Wuhan virus”) appears to have originated in the final few days of 2019 and spread rapidly within the city of Wuhan in central China. It then quickly spread beyond Hubei Province into other parts of the country and has since spread worldwide in a limited capacity as infected people travelled before showing obvious signs of the virus’s symptoms.
Observers were quick to point to the similarities with SARS which hit Asia in 2003 with evidence so far pointing to the coronavirus being more contagious. At its peak, SARS added 100+ patients per day compared to the coronavirus, which is currently averaging 790 new patients per day. However, the coronavirus also has a lower fatality rate so far of 2-3% versus 6.6% for SARS.
The rapid acceleration of the outbreak has led to a slowdown in economic activity in China. Public transport in the epicentre, Wuhan, was suspended, inter-city travel severely curtailed and international travel has slowed sharply. The lunar new year holidays have also been extended by three days and some manufacturing hubs have announced additional week-long production suspensions. This will inevitably place short-term pressure on China economic growth at a time that it was just beginning to recover from the 2019 slowdown caused in the main by the trade dispute with the United States.
The Equity Income team does not make top-down calls on China macro and invest from the bottom up, however we feel it is inevitable that Chinese GDP growth for the first quarter at least will be negatively impacted by the industrial and transport shutdown, especially given the outbreak’s width and depth. Consensus views on Q1 currently point to a 6% year-on-year growth for the Chinese economy, and that may now be under threat but only to a limited extent – Hubei accounts for just 4.5% of China’s GDP. Further, past incidents of events, including the SARS outbreak, tells us that the trajectory of growth resumes once the crisis has past; in other words, recovery will continue but it may be delayed.
Potential short- and long-term disruption outcomes
In the case of a short-term disruption, recovery will likely be dominated by inventory restocking which tends to cause a counter-cyclical surge in demand. That will be good for industrial sectors. In the case of a longer-term outbreak, although the negative impact on the economy will be deeper, Beijing will likely step in with stronger policy support, giving infrastructure-based investment a boost, as well as potentially a financial stimulus in the form of easier lending.
The sectors most likely to be negatively impacted by the virus outbreak are mainly in the Consumer Discretionary Sector. Retail (RMB 1 trillion or USD 144bn of retail sales were recorded during last year’s lunar holiday), Entertainment (lunar new year week accounts for 9% of annual cinema excursions but cinemas are now shut), and Travel (8% of annual domestic tourism took place in the same week last year) will all be hurt.
The factory shutdown will impact some Industrial sectors but at this point, it is hard to identify which factories or subsectors will be most affected. On the potential positive side, Personal and Household Care producers including mask and rubber glove companies could potentially benefit from a short-term demand boost. We also notice with interest that Tencent opened higher on Wednesday as traders see more people staying home…and playing computer games.
The same pattern will likely emerge globally: short-term disruption would likely fade quickly helped by government support for parts of its economy that were affected - we see, for example, that Singapore’s government has already said it would support tourism-related industries that were similarly affected during SARS. If the outbreak is prolonged, and the rest of the world is impacted heavily by such an outbreak, central banks will likely keep to their current accommodative pattern for longer. The danger is that should the outbreak continue in the same pattern as SARS did in 2003, the impact on the global economy could be greater – then, China accounted for just 4% of global GDP; now, it is closer to 16%.
Potential market impact
Shanghai’s A Share market is not scheduled to open until Monday 3 February, but Hong Kong’s market fell 2.5% on Wednesday to add to a 2.5% loss at the end of last week and this is in line with falls in China-based ETFs traded in London and New York. Other markets in Asia have also felt the effects. Thailand’s market is down 7% already in January, and is easily the worst performing market in Asia, just as the authorities there say they expect tourists from China to fall by 2 million this year, depriving the tourism industry there of around USD1.5 bn.
Unless there is a quick deceleration in the spread of the virus in the next few days, this Shanghai’s market may open lower on Monday. Encouragingly, however, the US and Europe markets rallied on Wednesday, suggesting some composure is returning to the equity market. In the bond markets, the US Treasury yield, which briefly inverted during Tuesday trade, also resumed its previous trajectory, suggesting this market too feels the worst is not far away.
Other asset classes have also been affected. Safe-haven assets such as gold and the yen (and the Swiss franc) have all rallied; oil fell sharply on worries over global growth and copper prices fell to four-month lows with many other metal prices also falling. Government bond yields in many countries also fell abruptly with the much-watched US Treasury.
Eastspring’s Asian Equity Income team takes a long-term view on our stock positions and view the current disruption in the stock market as short-term in nature. We continue to believe that the businesses we own are durable and will outperform over the cycle. We purchase each stock with a margin of safety and are careful not to overpay. We use any short-term price dislocations as a buying opportunity and are mindful that good companies could sell off as a result of what should be a one-off event and not a structural change in the market. We have been cautious towards the Consumer sectors in China on the back of what we view as expensive valuations prior to the outbreak, so we are watching valuations closely.
We understand the contagion and fatality ratios as mentioned above are not as bad so far as those of SARS days. On top of this, there is the positive reaction of the Chinese authorities in quickly isolating the city of Wuhan, then several other Hubei cities, to stop the spread of the disease. Halting transport was also a proactive and positive move that will likely slowdown the spread of the virus, and with this in mind, we note the greater transparency of the China government in communicating information. In turn, this leads to a more knowledgeable populace who have self-reported symptoms and taken steps to improve personal hygiene.
That said, this is a serious outbreak of a serious virus, and we are thus watching the situation very carefully.