Assessing the Coronavirus Impact

Last week, we kicked off our first forum of the year in the form of our [i3] Equities & Equity Alternatives Forum in Sydney.

For the very first time, we featured two speakers through a video link and asked them questions in a live session while they appeared on a split screen.

The technology was willing and the session went well, with one of the two speakers even being rated as the top speaker of the forum.

But despite our modest triumph, the underlying reason for using the videoconferencing technology was rather dark: the coronavirus.

With one speaker from Singapore and the other from Hong Kong, neither was in a position to attend the forum in person.

At the time of writing, the virus was spreading rapidly outside of China, with hotspots in Iran, Italy and South Korea.

Watching the spread through the real-time virus tracker provided by John Hopkins University in Baltimore, Maryland, brings a definite apocalyptic feel to the situation.

And we are not even sure we are seeing the full impact of the disease yet as some countries don’t seem to be performing much testing for the virus at all.

For example, the death rate coming out of Iran seems to indicate the number of infections are vastly higher than the official figures indicate.

Markets did not take kindly to the news of the virus spreading rapidly outside of China and sent stocks reeling.

What does all this mean for the global economy?

The ongoing quarantines and travel bans have had a clear impact on sectors such as airlines, tourism, education and consumer good companies that derive a large portion of their revenues from the Chinese market.

But what is equally concerning is how the virus impacts on the technology sector.

It is sometimes easy to forget how much technology has changed our lives. In recent years, we’ve seen technology change the way businesses operate, becoming a large part of how products and services are distributed.

For example, at last week’s equities forum we ran a session on neobanks, a new iteration of banking that relies almost completely upon mobile phones for the distribution of products and services. And many more business models have refocused on the mobile phone as their first point of contact.

You only have to look at the top five largest stocks in the world by market capitalisation to realise how much our economies have become digitalised. All five are technology companies.

With many of the manufacturing facilities for hardware and other technology components located in China, the virus has the ability to cause a significant dent in the global economy.

Markets realised the gravity of this after China’s official measure of manufacturing activity – the Purchasing Managers’ Index (PMI) – dropped to 35.7 from 50 in January. A score of less than 50 indicates a decline in manufacturing and Chinese factories currently seem to be struggling to find workers.

In the private sector in China the picture is not much different. The Caixin/Markit Manufacturing PMI, which includes more small to mid-sized companies than the official PMI Index, dropped to 40.3 for February, its lowest level since the index started in 2004.

If we look at what technology companies have said about the impact of the virus, the picture isn’t any rosier.

Apple, the largest company in the world by market capitalisation, has seen the coronavirus hurt both the supply and demand for its products. In February, the iPhone maker cut its earnings guidance for the March quarter.

Shortly after, both Microsoft and PayPal warned they will miss sales targets due to the outbreak.

Amazon also reported a number of its employees had contracted the virus and said many sellers on the platform had difficulty in maintaining inventories due to closures of factories in China.

Samsung Electronics shut one of its mobile device factories in South Korea after a worker tested positive to the coronavirus. The location of the factory is important as it is part of the Guimi industrial complex, which also houses factories of other companies, including LG Electronics, LG Display and Toray Group.

What to make of all this?

Ray Dalio, the legendary founder of hedge fund Bridgewater Associates, published in January an early analysis of the impact on markets of previous pandemics, including SARS, swine flu and Spanish flu.

Dalio shows in most cases markets reacted initially negatively to the outbreaks, but bounced back relatively quickly when the number of cases peaked and started to fall.

There are signs China is now nearing the peak of new cases and economic activity in parts of the country is starting to pick up again.

Richard Clode, Portfolio Manager with Janus Henderson Investors, wrote in a report earlier this week that after the delayed return to work following the Chinese New Year, most factories, excluding those in Wuhan, have reopened and labour is returning, while raw material and finished-good logistics have restarted.

Apple has reopened 80 per cent of its stores in China and also restarted many of its iPhone factories.

But the spread outside of China is a cause for concern. If the coronavirus develops into a global pandemic on the scale of the 1918 Spanish flu, then the impact on the global economy will likely be much more severe.

Although Dalio warns the Spanish flu coincided with the end of World War I, which not only contributed to the outbreak, but also makes any economic impact from the pandemic hard to disentangle from the war, he also points out this pandemic saw a very sharp slowdown in the United States at the time when mortality rates peaked.

Yet, the Spanish flu affected over 500 million people and had a high death rate at 10 per cent. We are nowhere near this scenario with the coronavirus yet and it is doubtful we will ever get there.

Perhaps the biggest impact of the coronavirus on markets today is the uncertainty it causes for many businesses. Markets hate uncertainty.

Until we get some clarity as to when this outbreak will be contained, markets are likely to remain volatile in the near term.

Wouter

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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.