Vice President, Senior Investment Strategist
Vice President, Portfolio Manager
Charles V. Johnson
Vice President, Associate Portfolio Manager
- Reports of new coronavirus (COVID-19) infections outside China are forcing markets to revisit prior assumptions around the epidemic’s impact on economic growth and earnings.
- Despite lower mortality rates, investors should monitor COVID-19’s exponential infection rate and the resulting containment measures, because they could have a material impact on global economic activity.
- Portfolios that are overexposed to cyclical global growth could be challenged as the full extent of the economic damage is revealed.
Major global equity indexes and commodities aggregates sold off over -3% on Monday, February 24th and suffered additional losses in following days as coronavirus (COVID-19) infection clusters appeared in South Korea, Iran, Italy, and Switzerland. Figure 1 shows that the sell-off has not only been broad-based but also that it has erased gains from the end of January when many markets sold off in part due to the first wave of news about the virus. In contrast, safe-haven assets, such as U.S. 10-year Treasury bonds and the U.S. dollar, have held up relatively well over this period.
Figure 1: Returns of major asset classes
Returns in USD. For the U.S. dollar, a cap weighted aggregate of major DM currencies is used. For illustrative purposes only. It is not possible to invest in any index. Every investment program has the opportunity for losses as well as profits. Past performance is no guarantee of future results. Sources: Acadian calculations based on Bloomberg, (fixed income), MSCI (equity indexes). Index Source: MSCI Copyright MSCI 2020. All Rights Reserved. Unpublished. PROPRIETARY TO MSCI.
Global equities and commodities had rallied during the first three weeks of February. This reaction may have been founded on optimistic assumptions around the effectiveness of containment measures in China. The consensus expectation then was that global growth would rebound strongly after a weak Q1. This was consistent with ongoing PBoC guidance for a V-shaped recovery1 and expectations of a supportive stance from global central banks.2 We also suspect that investors were anchoring their expectations for coronavirus around SARS’ muted impact on the global economy roughly 17 years ago.3
However, this episode underscores the risks of overgeneralizing from one particular past event in setting expectations regarding a circumstance like the present one.4 Relative to SARS, we have murkier understanding of coronavirus’s trajectory owing to in part a lack of clarity around even rudimentary terms such as case identification, which has led to repeated revisions of case counts. In addition, coronavirus’s particular epidemiological characteristics, including its contagiousness without symptoms and uncertain and possibly extended incubation period, are also likely contributing to unreliable case identification.5 Moreover, while coronavirus’s mortality rate has been lower than for SARS, the infection rate has been substantially higher (Figure 2), prompting extreme quarantine measures and adding to fears of reacceleration of infection if governments were to prematurely relax restrictions. How individuals and governments react to the epidemic’s progression will have a material impact on global economic activity particularly with respect to services, consumer discretionary, travel and transportation. From a macro perspective, China now has a more pivotal role in the global economy than when SARS struck. (Figure 3) Consequently, we would anticipate more material and protracted global impacts from disruptions in Chinese supply chains.
We would strongly encourage investors to avoid overreacting to emotionally evocative headlines in the face of the heightened uncertainty. Putting recent moves into context, although a single-day drop of more than 3% is uncommon for major equity indexes, such events do happen on average about 1-2 times a year.6 Over the short term, information out of China and other regions could continue to add to uncertainty and, hence, contribute to further volatility, as we’ve seen as the week has evolved. In addition, we may get conflicting/new evidence about the virus’s characteristics from regions outside China as the infection spreads.
Figure 2: Cumulative Reported Cases (left) and Mortality Rates (right): Coronavirus versus SARS
Cumulative Reported Cases (left) and Mortality Rates (right) as of 02/26/2020. Sources: Acadian calculations based on World Health Organization (SARS), Bloomberg (COVID-19). For illustrative purposes only.
Figure 3: China’s share of global GDP
China’s share of world GDP based on PPP. Sources: Acadian calculations based on IMF data. For illustrative purposes only.
Looking forward, earnings preannouncements point to a global slowdown.7 China PMI reports on February 28th and March 1st may offer further insight into the impact of coronavirus containment measures. Another near-term milestone event for investors to monitor is the WHO declaration of pandemic status for COVID-19, which could further dampen economic activity if it spawns additional containment measures although it would also unlock much needed aid to accelerate recovery efforts.
With respect to Acadian’s investing activities, we are monitoring the situation and portfolio exposures closely. We have not intervened in our systematic process at this time, consistent with its underlying premise that discretionary management is prone to judgmental error. But we will review this stance as the particular circumstances warrant.
The dominant themes driving markets at the beginning of the year were reflation and global growth. Markets had bid up equities with strong earnings prospects resulting in more optimistic earnings expectations as observed in multiple expansion across global regions.8 As markets now price in greater likelihood of a protracted earnings slowdown, they have quickly reversed part of this multiple expansion. Unbalanced portfolios that are overexposed to cyclical global growth could continue to be challenged as the full extent of the economic damage is revealed. While it is too early to predict if, when, and how markets will recover, we would encourage investors to do their best to remain dispassionate in their investing activities and focus on distinguishing signal from the considerable noise related to this rapidly evolving story.
2 "Minutes of the Federal Open Market Committee January 28-29, 2020"
3 "Globalization and Disease: The Case of SARS" - Brookings Institute
4 Please see our prior research on how markets react to geopolitical shocks, including epidemics, “-“Geopolitical Shocks: What to Expect from the
Unexpected,” July 2017, which makes use of broad dataset.
5 "Healthcare Professionals: Frequently Asked Questions and Answers" cdc.gov
6 Using MSCI ACWI daily returns Jan 1,1988-Feb 20, 2020 and S&P500 daily returns Jan 1, 1951-Feb 20, 2020
7 “Company Profit Warnings Signal Virus already a Global crisis” – Bloomberg 02/25
8 For a brief discussion on earnings expectations as of end of year 2019, please see our earlier work “A Multiple Expansion-Driven Rally”
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