Episode description
Over the last several weeks, many clients and alliances have been asking for our opinion on the corona virus outbreak and its effects on the economy. In reality, what everyone really wants to know is “how is this corona virus going to affect my investments?” Since the outbreak, we have experienced a classic risk-off response, albeit relatively modest to this point. No one has a crystal ball when comes to pandemics or epidemics. What we do have is a world filled with emotion, and emotion is driving market conditions – basically some selling of stocks and buying of bonds.
What we know so far, emerging market equities, airlines and oil prices have cooled since Jan. 20, the day Chinese officials confirmed the virus can spread from person to person. Perceived safe-haven assets such as U.S. Treasuries, as well as their inflation-protected peers, have gained in value and yields have continued to fall. Our assessment is further confirmed by the Volatility Index (VIX) which is widely used as a gauge of U.S. stock market volatility. It reached its highest level since October 2019. In spite of these signals, risk-off sentiment has been relatively limited, with modest pullbacks in high yield credit and U.S. stocks. That is most likely due to mostly positive results in the current quarterly earnings season - so far results are in line with expectations for global growth to edge higher throughout 2020.
Anyone who works with our firm knows that research is a key element in everything we do. Naturally, the corona outbreak led us to glean from other global disease epidemics. What we found is encouraging - economic growth and markets have historically responded with a V-shaped pattern. Initial reactions tend to include a slowing of consumer spending while assessments are completed. It doesn’t take long for a temporary economic decline to be felt across the globe.Now, the rebound in a v-shape pattern tends to happen rapidly much like the downturn. Pent-up demand eventually helps fuel the rebound. History tells us that recoveries are typically led by retail and manufacturing sectors since many service sectors simply cannot replace lost revenues. We are talking about things like tourism.
As with any outbreak, gauging the impact can’t happen overnight due to so many unidentified factors related to the corona virus. Think about it for a moment, we hardly know the duration of this virus or the severity of the outbreak in China – and whether it remains largely contained geographically. What we can say with confidence is reduced flow of people and goods due to travel restrictions and quarantine measures are likely to effect demand in the short term. Similar to the 2002/2003 SARS epidemic, the fear of slower global growth is plausible. We are still waiting on Chinese authorities to provide more evidence of a slowdown in the growth of this virus. When that response comes, one of the key factors will be how much stimulus China will apply to this crisis. In our opinion, this is a very important part of the solution. This situation is different from others in that China plays a huge role in the global economy: in fact, China makes up 15% of global GDP today in purchasing parity terms. Incidentally, that is three times its size in 2003, when the world was hit by the SARS virus. Similar to the SARS epidemic, investors fear that the current outbreak could hurt economic activity and ultimately slow global growth.
Putting this into perspective, China is a key component of global supply and failure to control the outbreak could disrupt the supply chains of certain industries, with potential for bottlenecks. Ordinarily, and this is not intended to diminish the severity of corona virus, we would classify this as an isolated event.However, we must keep in mind that potential shifts in economic regimes may happen this year, which could further exacerbate a situation like corona virus – in other words, growth slows and conditions worsen if inflation begins to move higher. Add to this puzzle a flattening yield curve in recent weeks, markets could be signaling that our Fed will be inclined to cut rates more than one time this year.
Bottom line: We still see global growth edging higher this year, given easier financial conditions, a break in global trade tensions, and generally positive economic data. 2020 kicked off with an encouraging start due to the latest quarterly earnings season. Of course, we admit our viewpoint could be overly optimistic but the data supports further growth. The corona virus outbreak, though transitory, creates downside risks to our optimistic outlook for continued growth. For the near term, we believe U.S. Treasuries may provide a source of portfolio balance against any growth scares and market declines could provide opportunities for investors seeking riskier assets. Until our next podcast, remember to stay calm and avoid impetuous decisions based on the medias passion for selling fear.