Things will get worse before they get better......but they will get better
The novel coronavirus (COVID-19) first identified in Wuhan, China in January has spread to more than 25 countries according to the Centers for Disease Control and Prevention (CDC).
The World Health Organization (WHO) distributes daily Situation Reports which identify daily and cumulative confirmed and suspected cases of COVID-19 and related deaths in China (by province) and worldwide. Based on the WHO Situation Report #36 dated 2/25/2020 there are over 80,000 confirmed cases – approximately 77,800 of which are in China – and 2,700 deaths worldwide, all but 34 of which are localized to mainland China. However, data integrity out of China must be called into question, as they have incentive to underreport as well as a history of doing so in previous outbreaks, and they have limited diagnostic capabilities across the nation. Many experts believe the number of infected could be 3-4x as large in China, which means the official fatality rates may be artificially high – given those with mild symptoms are less likely to be officially diagnosed and registered – and should be closer to or even below 1% as opposed to 3%+.
Leadership within the WHO have not yet dubbed COVID-19 a pandemic, but with new reports surging in Europe and the Middle East, we may well be heading that way. Experts believe we are likely 2-4 weeks away from seeing a more widespread outbreak around the world.
Leadership within the WHO have not yet dubbed COVID-19 a pandemic – effectively an epidemic that spreads to a certain number of countries across multiple continents – but with new reports surging in Europe and the Middle East, we may well be heading that way. According to reports, it took 7-10 weeks for the coronavirus to reach epidemic levels in China. As such, we are likely 2-4 weeks out from seeing a more widespread outbreak in the US and other countries around the world.
After reports of the outbreak first emerged in the central China city of Wuhan, authorities around the globe have taken steps to mitigate the contagion. Various travel restrictions have been imposed worldwide, quarantines established where confirmed cases have been reported, and public events have been cancelled. In China specifically, the government has placed a dozen cities under quarantine, shut down factories, businesses and schools, and restricted travel in the affected regions. While these actions by the Chinese should help to minimize a more significant viral outbreak from the source, they may also further inhibit data integrity as these isolated rural areas typically have even less access to medical facilities.
The coronavirus has negatively impacted the global economy in 3 primary ways:
Supply chain disruption as many factories and business centers have been shut down
Reduced sales of consumer goods into China, particularly luxury goods and energy supplies like oil and gas that are in less demand with quarantines and factory/business shut downs
Decreased travel and tourism – Chinese tourism has grown in recent years to account for nearly 20% of global travel (which has now virtually come to a halt), and fear of coronavirus has kept international travelers away from Asian ports
The coronavirus represents yet another shock to both supply and demand from China, coming on the heels of the recent trade war which demonstrated the Chinese bottleneck to US and global manufacturing and production. To some extent the trade war created the need to migrate supply chains away from China and towards other countries like Vietnam, Thailand, and Mexico. As such, many multinational companies have already taken steps to diversify their manufacturing supply, and we believe this disruption will motivate others to do the same. The current shutdown will likely help us to identify further bottlenecks out of China, as one never knows who is supplying our new suppliers.
This supply chain disruption will most likely stunt economic growth and consumer spending across the globe to some degree, but China itself and neighboring, dependent countries (like Thailand and Hong Kong) will feel it the most. At this point, a staggered reopening of factories was planned. However, reports show a large number of factories remain closed and those that are open are not functioning at full capacity.
Factory reopenings in China are behind schedule. If production delays continue, expect global growth to shrink further. But even so, people are still going to buy cars and iPhones.
If production returns, business and consumer activity will likely rebound quickly in the second quarter and then return to more normal levels to finish the second half of the year. Full-year 2020 global growth may still lag around the world, and will likely be negative in China. In the US, we expect growth to remain positive for the year.
However, if production comes back online more slowly than expected, obviously global growth will shrink further and we may not reach a full recovery by the end of the year. Even so, people around the world are still going to buy cars and iPhones, so we believe there is a natural stopgap to diminishing growth.
Multinational companies that rely on sales in China will certainly feel the effects of the coronavirus outbreak. With the shutdown of factories and businesses, demand for energy-based commodities like oil and gas have waned. The Consumer Price Index came in below expectations in January over the prior month mostly due to lower gas prices from increased supply.
Companies that rely on sales in China will certainly be hit, but consumer activity should snap back when the outbreak is under control.
With quarantines established around the country, many Chinese nationals are “on lockdown”. US-based companies like Starbucks and Apple have closed many of their retail stores on mainland China in response to the outbreak. Brands like Nike and Tesla with large revenues generated from sales in China will likely miss earnings expectations for the quarter. Airline and other transportation companies are cancelling trips to and from China.
All that said, we believe these effects to be short-term in nature – when the outbreak is under control, consumer activity will snap back and then return to normal levels.
Many Asian economies have come to rely on revenue generated from tourism, particularly from mainland China given Chinese tourism has grown in recent years to account for nearly 20% of global travel. With the imposed travel restrictions, Chinese nationals are kept at home. Additionally, widespread fears about the coronavirus have kept other international tourists away from Asian ports. While these economies may not recover the lost revenue, travel will certainly start up again once the outbreak has been contained for a period of time.
China’s President Xi Jinping and economic policymakers have been proactive in responding to the coronavirus outbreak. The People’s Bank of China (PBOC) has injected additional liquidity into the system and introduced special lending at sub-market rates for businesses involved with food and healthcare. Additionally, the PBOC is exercising leniency with borrowers – particularly those in the more effected provinces – and seems to be lifting, for now at least, the crackdown on the use of non-government secured financing. What’s more, local governments are offering subsidies to companies struggling to cover the costs of basic essentials including electricity, gas and water.
Chinese policymakers have been proactive in responding to the outbreak, but their actions may exacerbate a fiscal deficit and worsen the condition of the Chinese economy.
All these actions have been taken to alleviate the burden to small and medium-sized businesses that have been battered first by the trade war, then by the crackdown on non-government loans, and now by the coronavirus – without such measures, widespread bankruptcies of these businesses would be likely. However, such federal monetary intervention may exacerbate a fiscal deficit and worsen the condition of the Chinese economy.
The economic impact to the US as a result of the coronavirus had been mostly indirect before this week. We are certainly affected in the same manner as the rest of the world, as discussed above, but not to a significant degree.
US stocks were effectively flat since the coronavirus announcement through last week despite contracting about 2% in the second half of January amid concerns the coronavirus outbreak could have a spillover effect here, particularly with American companies that do business in China. After the significant market pullback this week along with surges in confirmed cases of COVID-19 in Europe and other Emerging Market economies, we would expect these numbers to look much worse through the end of February.
Recent volatility reflects a surge in confirmed cases worldwide, and will likely continue as news breaks. This may present an opportunity to begin negotiations for the next phase of the trade deal between the US and China, assuming the Chinese economy is further weakened by the outbreak.
A big question mark in all this turmoil is what will happen with Phase One of the trade deal between the US and China? Certainly the technical implementation of Phase One has been hindered, with non-essential US personnel being evacuated and business operations across the nation slowed precipitously. That said, as the Chinese economy weakened in the last year, China was more willing to negotiate and agree to make a deal. With economic activity stalled on the mainland, China may be more willing than ever to negotiate Phase Two.
The near 2000-point plunge in the Dow this week came after a surge of new cases were reported over the weekend around the world, namely in Iran, Italy and South Korea. While no one likes to see such a dip, the truth is we believe the markets were finally catching up to the reality of the coronavirus outbreak.
Market assumptions greatly underappreciated the scope of the coronavirus. First, it assumed this was a “China issue” and at worst an “Asia issue”. Now however, confirmed cases are being reported in several countries around the world, with a surge in Europe and the Middle East. Second, the market assumed this outbreak would be resolved quickly, and only impact first quarter consumer and production activity. As the outbreak has spread, it remains unclear how long we will feel the effects of this virus. Both of these assumptions were proven wrong over the weekend proceeding the recent declines, causing the markets to abruptly realign with the current reality of the coronavirus.
Market assumptions greatly underappreciated the scope of the coronavirus. When these assumptions were proven wrong, the markets abruptly realigned with the current reality of the outbreak, causing the declines experienced this week.
With uncertainty on the rise, there has been a global flight to the safety of gold as well as US Treasuries, pushing long-term interest rates down and inverting the yield curve once again. However, we believe US economic fundamentals remain sound. Should this outbreak continue, it’s certainly possible the Fed could move to address downside risks, much as it did three times in 2019.
In the coming weeks it seems likely confirmed cases of coronavirus will continue to multiply around the world and in the US. A travel restriction from China remains, and a 14-day quarantine for travelers returning stateside who have been exposed. The US government is enacting various measures to attempt to detect and track the potential spread of the virus, putting its pandemic plan into effect as a precaution. Should this outbreak become more widespread in the coming weeks, we will likely see federal monetary intervention to provide diagnostic supplies and equipment to state and local hospitals and labs in addition to requests being put to Congress to allocate additional emergency funds to bolster the coronavirus response.
It is likely confirmed cases of the coronavirus will continue to multiply in the US in the coming weeks. Should a notable outbreak occur, know that we are not unprepared – the US is the global leader in infections disease detection and response.
The US is the global leader in infections disease detection and response. We are more prepared than any other country to respond to an outbreak. Not only do we maintain the Strategic National Stockpile with ready-to-distribute supplies – such as masks, respirators, gloves, antibiotics, mobile hospital units, and more – our hospitals train and run drills for such events, and we have an established laboratory network to improve effectiveness and efficiency of diagnostics. While prolonged supply chain disruption may impact our ability to obtain and distribute supplies in the case of an extended outbreak, know that we are the best in the world at responding to such health emergencies.
At the beginning of the year we made changes to client portfolios, as we felt a minor rebalance was prudent in order to preserve recent gains and prepare for possible heightened volatility in the year ahead. Within Fixed Income, we exchanged exposure to High Yield for a combination of Long-Term US Treasuries and Gold. Within Equity, we exchanged the vehicle used to gain exposure to the mid cap space to reduce our concentration of growth-focused companies.
Your portfolio was built, and is continually monitored and updated to address and adapt to periods of volatility.
So here’s the good news…your portfolio was built, and is continually monitored and updated to address and adapt to periods of volatility! If you cannot accept this as true, and you continue to lose sleep in your anxious state, then we should discuss what actions you can take to assuage your fears and help prevent you from making a costly, emotionally-charged mistake.
For a more in-depth review of this conversation, read our recent article “Recession…Are YOU Ready?”
With the developments in the last few days, it is clear we have not yet turned a corner in containing this outbreak. Confirmed cases of COVID-19 coronavirus are multiplying, with over 5 different countries reporting a new outbreak in the last few days alone. We must all face the facts…coronavirus will not be confined to Asia and it will not burn out quickly. This outbreak will very likely get worse before it gets better. With such uncertainty, we fully expect a rollercoaster of market volatility in the coming weeks and months as new information (good or bad) is released on the subject.
It is clear we have not yet turned a corner in containing the coronavirus. The outbreak will very likely get worse. Expect a rollercoaster of volatility as news breaks, but understand investors tend to overreact to negative events which can often be more damaging than the event itself.
That said, don’t underestimate the power of negative thoughts and expectations. History has proved that investors have a tendency to overreact to distressing news, which can oftentimes be more damaging to markets and economies than the event itself. Have the courage to “Fight the Narrative” and understand that while the situation will intensify as the outbreak spreads, we are not about to star in the real-life edition of “World War Z”. Eventually, we will get this outbreak under control and everything will normalize.
If you can tune out the commotion for the next 2-3 years, then just sit back and enjoy the ride. However, if this volatility keeps you awake at night, then we should discuss what actions you can take to address your concerns and help prevent you from making a costly, emotionally-charged mistake.