The rapid spread of a new coronavirus out of China was the clear cause of the volatility that struck markets last week. The scale and breadth of the volatility—seen across equity, credit, currency, energy, metals and safe-haven markets—was a reaction to the level of uncertainty at this early stage of the outbreak.
That distracted investors from Brexit finally becoming a reality, the latest Fed decisions, China’s Purchasing Managers’ Index print and fourth-quarter GDP data from the U.S. and the euro zone. All of that hit the wires last week, a very mixed bag of news to support the slow-but-steady growth and rates environment described in our recent Asset Allocation Committee Outlook.
We think the prevailing economic conditions were indeed an important aspect of the market response to this public health event, however. Ongoing concerns about how much longer the current cycle has left to run, and extended valuations in many markets, had already made investors sensitive to risk. Respect for those underlying conditions is important for investors, regardless of the nature of the catalysts that might trigger a flight from risk in the markets.
First and foremost, 2019-nCoV is a human challenge. Early estimates are that tens of thousands of people could become infected. Our immediate thoughts are with our colleagues and clients in China and around the world who are affected. We wish everyone good health and hope for rapid containment of the outbreak.
The virus is also an economic challenge, however. Factories are not reopening after the Lunar New Year holiday, supply chains are under threat, flights are being suspended, stores are closing.
One relevant comparison is with an earlier coronavirus outbreak: that of Severe Acute Respiratory Syndrome (SARS-CoV) in 2002 – 03. That is estimated to have knocked around three percentage points off of China’s annualized GDP growth rate, and 0.1% off of global GDP. Chinese equities dropped by some 10% over the first four months of 2003. Those losses were all recovered by the third quarter, however, once it was clear that the virus had been contained.
Should we anticipate a similar, V-shaped impact this time around?
The new virus is different from SARS. Fortunately, its fatality rate appears to be lower, at 2 – 3% rather than 8 – 10%. But that, together with its longer incubation period, may allow it to spread faster and further and for a longer period. There have already been more recorded cases of 2019-nCoV than of SARS.
China’s economy is also different today from in 2003: It is eight times bigger, more integrated into the global economy and more reliant on services and consumption, which are especially vulnerable to disease-containment policies, particularly around the busy Lunar New Year period. Those factors could all add up to a bigger economic impact than that of SARS, both in China and worldwide.
China was criticized for moving slowly against SARS. Partly as a result of that criticism, its response to 2019-nCoV has been very aggressive. The authorities have locked down Wuhan, a city in Hubei province that is 40% larger than New York or London.
That may help containment, as might the global coordination facilitated by the World Health Organization’s decision to declare a Public Health Emergency of International Concern, but it could worsen the short-term economic fallout. China has become used to deploying substantial tools to address slowing growth, however: Its major commercial banks have already cut interest rates for businesses in Hubei.
At the time of writing on Friday, a reasonable assessment is that the economic and market impact of 2019-nCoV could be similar in scale to that of SARS: a loss of 0.1% of global GDP with an eventual full recovery, but longer in duration.
We are encouraged at suggestions that the outbreak may peak soon and that a vaccine could be available in as little as three months’ time. Nonetheless, the virus’s long incubation period means it could be mid-February or later before we can be sure the outbreak has been contained.
We believe we need that certainty to make considered investment decisions. At the moment, markets are wrestling with how to discount this event. They cheered an impressive earnings report from Apple, which makes iPhones in Greater China and generates 17% of its revenue there, too. A day later, despite similarly impressive earnings, they sold down Starbucks stock on news that it was closing half of its stores in China.
Therefore, while our current expectation is for a SARS-like, V-shaped impact that we do not believe would warrant new portfolio hedges, we do not yet favor using current volatility to add risk aggressively. For now, we continue to monitor the situation carefully, not only via public information sources, but also via our own global research platform in the affected sectors, from airlines and retail to health care and pharmaceuticals.
Diversification—across quality sources of income beyond government bonds, into uncorrelated strategies, into commodity markets that can mitigate the impact of tail risks, into strategies that underwrite through-cycle investment themes—was already a favored approach to the late-cycle environment. It remains so in the current situation. It can help to dampen volatility and maintain the nimbleness to assume risk when the time is right.
In Case You Missed It
- U.S. New Home Sales: -0.4% to SAAR of 694,000 units in December
- U.S. Durable Goods Orders: +2.4% in December (excluding transportation, durable goods orders decreased 0.1%)
- S&P Case-Shiller Home Price: November home prices increased 0.1% month-over-month and increased 2.6% year-over-year (NSA); +0.5% month-over-month (SA)
- U.S. Consumer Confidence: +3.4 to 131.6 in January
- Federal Open Market Committee Decision: The FOMC made no changes to its policy stance
- U.S. 4Q 2019 GDP (First Estimate): +2.1% annualized rate
- China Purchasing Managers’ Index: -0.2 to 50.0 in January
- Euro Zone 4Q 2019 GDP (Preliminary): +1.0% annualized rate
- Euro Zone Consumer Price Index: +1.4% year-over-year in January
- U.S. Personal Income and Outlays: Personal spending increased 0.3%, income increased 0.2%, and the savings rate decreased to 7.6% in December
What to Watch For
- Monday, February 3:
- ISM Manufacturing Index
- Wednesday, February 5:
- ISM Non-Manufacturing Index
- Friday, February 7:
- U.S. Employment Report
Statistics on the Current State of the Market – as of January 31, 2020
|S&P 500 Index||-2.1%||0.0%||0.0%|
|Russell 1000 Index||-2.0%||0.1%||0.1%|
|Russell 1000 Growth Index||-1.8%||2.2%||2.2%|
|Russell 1000 Value Index||-2.3%||-2.2%||-2.2%|
|Russell 2000 Index||-2.9%||-3.2%||-3.2%|
|MSCI World Index||-2.2%||-0.6%||-0.6%|
|MSCI EAFE Index||-2.5%||-2.1%||-2.1%|
|MSCI Emerging Markets Index||-5.1%||-4.7%||-4.7%|
|STOXX Europe 600||-2.5%||-2.4%||-2.4%|
|FTSE 100 Index||-4.0%||-3.4%||-3.4%|
|CSI 300 Index||-||-2.3%||-2.3%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.3%||0.5%||0.5%|
|Citigroup 10-Year Treasury Index||1.5%||3.7%||3.7%|
|Bloomberg Barclays Municipal Bond Index||0.4%||1.8%||1.8%|
|Bloomberg Barclays US Aggregate Bond Index||0.6%||1.9%||1.9%|
|Bloomberg Barclays Global Aggregate Index||0.8%||1.3%||1.3%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-0.3%||0.2%||0.2%|
|ICE BofAML U.S. High Yield Index||-0.3%||0.0%||0.0%|
|ICE BofAML Global High Yield Index||-0.2%||0.1%||0.1%|
|JP Morgan EMBI Global Diversified Index||0.6%||1.5%||1.5%|
|JP Morgan GBI-EM Global Diversified Index||-1.2%||-1.3%||-1.3%|
|U.S. Dollar per British Pounds||0.9%||-0.5%||-0.5%|
|U.S. Dollar per Euro||0.5%||-1.3%||-1.3%|
|U.S. Dollar per Japanese Yen||1.0%||0.3%||0.3%|
|Real & Alternative Assets|
|Alerian MLP Index||-3.6%||-5.6%||-5.6%|
|FTSE EPRA/NAREIT North America Index||-1.6%||1.3%||1.3%|
|FTSE EPRA/NAREIT Global Index||-1.7%||-0.3%||-0.3%|
|Bloomberg Commodity Index||-3.2%||-7.4%||-7.4%|
|Gold (NYM $/ozt) Continuous Future||1.0%||4.3%||4.3%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||-4.9%||-15.6%||-15.6%|
Source: FactSet, Neuberger Berman.