Exposure rates of the Dorval Asset Management Range – 31st January 2020

As the United Kingdom and the European Union parted ways after a rocky 47-year partnership, investor anxiety homed in on the coronavirus.

China accounts for 17% of world GDP as compared with 4% during the SARS outbreak in 2003, so the epidemic will have a hefty short-term impact for the world economy. However, judging by past experience, this type of economic shock can be largely and quickly reversed after two to four months of disruption.

 

155 million Chinese tourists in 2018 vs. 15 million in 2003
Chinese residents’ departures from China (excluding diplomatic and military staff, etc.)

Millions of people

 

The coronavirus epidemic has a very low fatality rate at this stage, but it is spreading swiftly, and is also affecting the economy via lockdown measures i.e. quarantine for entire towns, flight restrictions into and out of China, store and factory closures, etc. This severely hampers spending by the 155 million Chinese tourists (cf. chart 1), which is currently worth between 20% and 30% of tourist spending worldwide, and the effects are particularly visible during the Chinese New Year period, which is usually buoyant for the sector. China is the world’s factory, and is obviously highly integrated into the manufacturing chain for several industries, so a great deal of disruption can be expected. Lastly, China is the leading consumer of commodities, so industries in this sector could be particularly hard hit. Commodities prices have already slid around 10% since the epidemic broke out (cf. chart 2).

 

Commodities prices plunge due to coronavirus epidemic

LMEX index (industrial commodities, LHS) / Oil prices (Brent, RHS)

 

However, the drop in commodities prices also drives purchasing power, and lifts industries that rely on these materials. Similarly, the drop in long-term rates that we have seen since the start of the epidemic has a positive effect. Lastly, and most importantly, the short-term dent from this type of event is very easily reversible. Even if a small number of companies collapse over the period, modern epidemics have very few long-lasting macroeconomic effects (somewhat similar to a long-lasting strike). By way of example, Goldman Sachs believes that the coronavirus outbreak could slice 0.4% off US GDP in the first quarter of the year, with the shock almost fully absorbed in the second quarter, leading to a neutral effect over the full year 2020. In the same vein, Bloomberg analysts expect China to suffer a 1.5% slowdown in 1Q, although only 0.2% over the year as a whole, with 5.7% growth in 2020 vs. 5.9% previously expected.

Lastly, the epidemic emerges at a time when indicators confirm that recessionary forces affecting the worldwide manufacturing industry since spring 2018 are easing. Manufacturing PMI for developed countries has been recovering slowly since October, including – and even in particular – in countries most exposed to world trade (cf. chart 3). New car registrations have taken a clear upturn in Europe over the past few months, showing that the previous decline was particularly a result of disruptions in supply due to the energy transition and regulatory changes. Lastly, concern on world trade eased after the US and China signed their agreement. French GDP figures (-0.1%) and Italian stats (-0.3%) for 4Q admittedly disappointed, but the overall situation still points to an underlying economic stabilization after two years of slowdown. The coronavirus epidemic will very probably push some cyclical indicators down again in February/March, but a second phase of gains is very likely once the shock has passed, in our view.

 

Epidemic breaks out at start of world trade recovery
Manufacturing PMI for main exporting countries

Average manufacturing PMI: Germany, Japan, South Korea, Taiwan

 

Some observers think that the drop on the stock-markets since the start of the epidemic (-8% on the MSCI Emerging, and -2% for the MSCI World) is still too small when compared with the risks from the disruption created by the coronavirus…but who knows? However, we do note that volatility has increased a significant five points (cf. chart 4). Additionally, part of the market shock is absorbed by the stabilizing effect of the drop in long-term rates, just like last summer. We have tactically increased the weighting of US bonds in our international portfolios in order to cushion any hypothetical fresh drop in equities over the days ahead. 

 

VIX has gained 5 points
VIX = implied volatility indicator on S&P 500

Volatility spikes due to trade war / Coronavirus effect

 

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