Author: Alastair George
It is too early to be certain on the relative infectiousness or mortality rate of the new coronavirus first observed in China in early December. Nevertheless, there have been close to 3,000 confirmed cases and 40m people in China currently facing travel restrictions as authorities attempt to control the spread of the virus. At the present time, in our view the key for investors is to focus on the economic costs of controlling the outbreak, rather than fearing mass panic. A downgrade to Chinese GDP for Q120 appears likely. Until cases have peaked, we believe travel and entertainment sectors are at risk of underperformance.
It was a surprise to us just how resilient markets had been in the face of adverse coronavirus headlines, given the precedent of SARS and its impact on markets in 2003. At this early stage, while basic parameters such as the R0 value (the number of new infections per infected human) and mortality rate are subject to a high degree of uncertainty, it is a fact that in China 40m people already face significant travel restrictions.
Indications are that the outbreak is at the relatively early stages in China and it will take some time to bring it under control there. Nevertheless, while there have been some cases outside China there does not appear at this stage to be an epidemic of viral pneumonia in other nations – where public trust in data collection and case reporting is relatively higher.
The number of reported cases is likely to escalate sharply as the awareness of the disease grows but estimates of the mortality rate also decline as testing becomes more widespread for milder cases. In particular, China’s current reported case mortality rate of 2.9% may significantly overstate the actual danger from infection if there is a much larger number of undiagnosed and minor cases.
On the critical assumption that the mortality rate is no worse than other viral respiratory diseases such as influenza, scenarios of mass panic are less likely to develop. Work to find a vaccine, building on the research for a SARS vaccine may bear fruit within a 2-year period. In such a scenario, economies will be impacted by the measures taken to reduce transmission but provided these are not as draconian as those currently imposed in China the economic impact would be relatively modest.
|MERS-CoV (as of September 2019)
Source: World Health Organisation, CDC, Wuhan Municipal Health Commission
We believed a cautious portfolio positioning was appropriate prior to the news on coronavirus. This view was largely premised on the fact that forward multiples of US and continental European stocks were close to the top of their ranges for this cycle, suggesting an economic upturn was fully discounted and there was little margin of safety for unanticipated events.
Today’s (27 January) market declines therefore represent something of a correction towards our position by the market. There is insufficient data on this viral outbreak to suggest a radically bearish change to our cautious view at this time. However, investors should now apply a discount to sectors where the economic impact of attempts to control the coronavirus outbreak are likely to hit hardest.
In this regard, consensus GDP forecasts for China’s growth during 2020 are likely to come under pressure with spill-over effects across the region. Travel, discretionary and entertainment-related sectors are also likely to underperform until a peak is seen in the rate of infections and restrictions on travel and social contact lifted. We note it may also take some months, rather than days or weeks, for the evidence for any reduction in the rate of infection to be visible in the data.
The risks to a nuanced portfolio response to this viral outbreak is a much greater rate of infection outside China, which would suggest rapid human-to-human transmission despite public awareness measures. In this respect the coming weeks will be critical; should cases outside China remain low and there is no need for precautionary curtailment of normal civilian activities, the effect on the world economy and markets is likely to be modest. If the data show however a sharp rise in infections or a surge in hospitalisations outside China, this would be much more serious for markets.
At present, there is sufficient uncertainty that this more bearish scenario cannot be wholly excluded, although it looks less likely given the 10-14 day incubation period and that the virus was effectively in unimpeded worldwide circulation between early December and mid-January.