We should look behind the virus frenzy

Markets are exquisitely unpredictable, and each year, events – financial, economic, geopolitical, or otherwise – occur which few see coming, but cause powerful ripples across financial markets.
By Richard Brown,
Published 3rd Mar 2020, 06:00 BST
Richard Brown, Director, Kleinwort Hambros, Head of Yorkshire OfficeRichard Brown, Director, Kleinwort Hambros, Head of Yorkshire Office
Richard Brown, Director, Kleinwort Hambros, Head of Yorkshire Office

The first month of 2020 has been full of tail risks materialising. First, markets were consumed by the spike in geopolitical tensions between Iran and the US; quite contrary to the initial knee-jerk “risk-off” reaction, the market reaction to this dissipated rather quickly.

However, since the tail-end of January, the fear of the Coronavirus has gripped markets. Given the epicentre of the outbreak is in China – a critical pillar of the global economy – theory suggests the virus can slow China’s growth, and therefore have second-order effects on markets.

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Similar viral outbreaks (i.e. SARS in 2003; Swine Flu in 2009; Avian Flu in 2013; Ebola in 2014) followed quite a standard market pattern. Global equities, measured from the first registered case abroad, sold off between 5 per cent and 8 per cent over the next 10 to 25 trading days. Conversely, US Treasuries – the ultimate safe-haven asset – rallied.

However, in each case, equities recovered fully no later than 35 trading days following the first registered case abroad, and much earlier in some instances. Bond prices also reversed partially or fully over this 35-day period.

Historical precedent is rather clear, these incidences tend to be storms-in-teacups, and best “looked through” for those investors with time horizons beyond a few months.

Can this time be different? Of course, it can. China is the World’s second largest global economy based on market prices, and the biggest in purchasing power parity terms. Anecdotally, we know this outbreak has caused 70,000 cinemas across the country to be shut; the international coffee chain Starbucks has closed 2,000 of its Chinese branches; Toyota has temporarily halted car production.

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There is no denying there will be a negative economic impact. Although the virus seems to have passed its peak in China, it is spreading rapidly elsewhere with more than 30 other

countries reporting infections.

However, when analysing “new information” such as geopolitical tensions or viral outbreaks, a sober reflection of the historical data is often a better indicator of what comes next as opposed to initial, frenzied theorising. History would suggest the Chinese economy will suffer a slowdown, but markets will likely rebound in short order should this virus follow the path of similar previous outbreaks.

The Chinese economy has been decelerating for over a decade. While this year might be worse than originally expected, it does not signal a dramatic new paradigm. This may also be offset by slightly better than forecasted growth in the developed world in 2020 as the stagnation in manufacturing appears to have stabilised, and crucially, has not been contagious to the wider services sector.

Our view remains that we are in a slowdown, but with a recession not imminent. It is prudent to remember that slowdowns can last for years, and the premium from risk assets is positive during this phase of the cycle.

In aggregate, we have changed neither our underlying global macro views nor our headline asset allocations.

Related topics:ChinaStarbucksIranCoronavirus