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How Coronavirus Affects Wealth Managers' Investment Thinking

Tom Burroughes

3 February 2020

As authorities in China continue to wrestle with the coronavirus outbreak, prompting travel and other disruptions and closures, we continue to track how wealth managers view the situation. To take one example of business disruption, The
Without any relevant history, investors will map the spread and consequences against the SARS outbreak in 2003. This may be a poor template as both China and the rest of the global economy look very different 17 years later. One week in, the economic damage from the outbreak is already beginning to accrue: cancelled flights, quarantined cities, factories closed, and events postponed. For now, the economic loss has largely been contained to China, but it is likely that it will ripple out in the coming weeks.

Most of the economic damage from outbreaks comes from deferred consumption. Most, but not all, of the activity will catch up. How much of the loss is temporary versus permanent will depend on how long the crisis lasts.

The outbreak is hitting China at an inopportune time. Growth in China is naturally slowing, but at a very natural and managed rate. With China only growing by 6 per cent, an outbreak that shaves 1 per cent -2 per cent off GDP (annualised) represents a serious headwind. Again, how much of that economic loss will be recovered depends on how long and how severe the outbreak is. If policymakers and health officials can’t slow the spread, -2 per cent could prove optimistic. (Again, at an annualised rate).

If economic growth slows significantly, the big policy tools are ill-fitted for the job. Monetary policy acts with a significant lag and longer fiscal spending is not well suited to addressing a slowdown that might only last a few months. While healthcare workers scramble and work overtime, policymakers can do little except provide liquidity and watch.

We expect the recently inked Phase 1 Trade deal to have little meaningful impact on China, so the headwinds from the outbreak won’t offset the gains. We’re sceptical that there will be gains to offset. The outbreak looks like a net loss.  

We expect the economic damage to centre on China and radiate out from there. The market seems to agree as the Hang Seng index is down by over 6 per cent since the outbreak while the S&P 500 and Eurostoxx 50 are down by less than 2 per cent. Markets in the US and Europe are on alert, but they are not yet panicked. Fed Chairman Powell referenced the outbreak, but US markets seem unfazed. The Fed has plenty of ammo in the near term if the outbreak becomes a greater headwind to US growth. We’ll find out tomorrow if Mr Carney at the BoE
While it is still too early to ascertain the economic impact of the virus on China, given the speed at which the infection has spread, the impact is likely to be felt most in the first quarter. Consumption, especially retail sales, is likely to be affected as people across the nation limit their activities outside their homes. To a lesser extent, production will also likely be affected temporarily by the extension of the holidays, as well as by possible subsequent precautionary workplace measures to contain the virus. 

The spread of the coronavirus has prompted companies to limit their travel to China, which will affect hotels, restaurants and transportation. Hong Kong and other regional hubs for tourism (e.g., Thailand, Macau) are likely to see an even larger impact.

China’s increasing share of the global economy coupled with its growing integration in global supply chains means a slowdown in China stemming from the virus could have a larger spill-over than in the past. Back in 2003, when SARS hit the Chinese economy, the global fallout was limited. The country’s weight in global growth at that time was a modest 4 per cent, compared with the 17 per cent share of global GDP today. Fears surrounding the outbreak may cause a behavioural shift and impact travel and tourism globally. Chinese tourists have driven sustained growth in travel across Asia, having increased from 2 per cent of the total number of tourists in 2002 to 9 per cent in 2017. Global central bankers have also voiced their concern: the Federal Reserve in its January meeting stated that the coronavirus outbreak posed a risk to its economic outlook for the US in the short-term, via a China slowdown that could spill over to its trading partners.

In addition to measures to contain the virus, monetary and fiscal policy measures are likely to be used as necessary to provide liquidity and credit support to mitigate any lasting impact on growth. Earlier this week, the People’s Bank of China (PBoC) announced that in anticipation of an incoming liquidity shortage, it would provide sufficient liquidity support to support banks and businesses which were negatively affected. On the fiscal front, authorities could announce a bigger 2020 budget deficit in March, if the cost of fighting the epidemic is substantial. Even with strict containment measures and scope for monetary and fiscal response in China, DBRS Morningstar expects a negative pressure on growth in the current quarter.

If there is an effective policy response, the economic effects are likely to be contained to 1-2 quarters. However, it is too early to tell how quickly and how long the virus will continue to spread. DBRS Morningstar continues to monitor the Coronavirus situation for potential impact on its global sovereign ratings.