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The outbreak of a new disease in the city of Wuhan was first reported in late December 2019. The virus causing the disease was identified as a new coronavirus that crossed the species barrier into the human population. The virus is currently known as 2019-nCOV, and attention to it increased dramatically over the last week as the number of infected people increased exponentially, as the death toll started to rise, and as word spread the virus belongs to the same typology as the notorious SARS-virus (Severe Acute Respiratory Syndrome). The memory of SARS, which killed 774 people in 34 countries (out of 8,098 infected people, a mortality rate of just under 10%) is still very much alive in the region, contributing to the panic.
But China and the world learned a lot from the SARS outbreak, and authorities have reacted much quicker, more forcefully and more transparently in the current crisis. China took the unprecedented step of effectively putting Wuhan under quarantine, and imposed travel bans in the region affecting 36 million people. Experts however doubt this will stop the virus from spreading quickly. Preliminary evidence suggests the incubation period of the virus seems to be 5-10 days, during which one can infect other people, and there is a high probability thousands of infected people fled Wuhan before the ban was installed. Closing the door when the horse is already out of the barn will not help here. But other measures, such as banning mass gatherings and the sale of wild life, a possible source of infection, might help to diminish the infection spreading.
While it is too early to try to precisely quantify the impact of the coronavirus on the economy as the epidemiological uncertainty of the outbreak is still huge, we can get a rough assessment of the situation out of what we know already. The severity of the impact of the coronavirus will depend on the “attack rate” (the proportion of the people that fall ill) and the “case fatality rate” (the proportion of deaths among infected people). A first rough estimate is that every infected person spreads the virus to 1.5 -2.5 other people, meaning the disease will not stop autonomously. But the fatality rate, currently around 4%, seems to be much lower than was the case with SARS, and most of the deaths have been related to elderly people with existing medical problems. For comparison, it is estimated the “normal” yearly flu takes 20,000 to 60,000 lives in the US alone. And as the Corona virus-type is well known and Chinese authorities already published the genetical code of this new variant, experts think a vaccine could be available within a year. So while we face a severe health crisis here.
Which does not of course mean there will be no economic or market impact of this crisis. There is evidently a direct impact on the affected region, as Wuhan is a major transportation hub in the region and an important production center for the already battered automobile industry. It is also very clear travel, tourism and leisure industries worldwide could take a severe direct hit. The psychological impact on consumer confidence could further undermine the already weakening overall consumption in China, as witnessed during the SARS-outbreak: Chinese retail sales growth slowed from 9.2% year on year in December 2002 to 4.3% in May 2003*, knocking an estimated 1.5% of Chinese growth. Knock -on effects of the crisis on other sectors are already visible. For example, the sharp drop in the oil price is a direct consequence of the expected onslaught on air travel. It remains to be seen whether a prolonged slump in consumption will affect investment plans, but firms are unlikely to cancel investments quickly unless the virus is confirmed to be substantially more potent than recent rather short-lived virus outbreaks suggest. And higher government spending on healthcare could moderately offset the hit to consumption. Increasing risk aversion in financial markets could compound the effects on demand, as they could raise the cost of capital for firms. On the other hand, compensating effects might soften the impact of the crisis. Lower oil prices should soften the impact on Western consumers, and safe-haven flows are already pushing rates lower again, partially shielding debtors from the impact of higher spreads. A 2004 analysis estimated that the SARS-crisis resulted in an output loss of about US$ 40 billion for the world economy. Some (contested) studies put it at a much higher level, but more importantly, there is general agreement that much of that loss was recuperated fairly quickly as the crisis abated. Of course, China has grown since 2003, and its impact on the world economy is much larger now.
But as long as the epidemiological uncertainty compounds the economic uncertainty, trying to gauge the potential impact of 2019-nCOV on China and the world economy more precisely is an impossible task. So while markets logically discounted the increased risk premium into the most directly exposed travel and leisure sectors, they also concluded pharma and health care stocks should profit from the crisis. And safe-haven assets as German government bonds, Treasuries, gold, Swiss Franc and Japanese Yen also profited. Investors holding on to a well-managed diversified portfolio have thus largely been shielded from the crisis. Moreover, many see the Corona-story as just the spark capital markets needed for a healthy and arguably overdue adjustment in risk premia after the very strong performance over the last few months. A correction could open up new and more interesting investment possibilities. In the meantime, we maintain our current allocation views, recommending diversified portfolios where our favoured safe-haven assets remain gold, US treasuries as well as the Japanese Yen. Investors should remember not to panic and hold on to their defensive positions as part of a diversified strategy, and closely monitor the situation for signs the outbreak gets under control.
*Source: National Bureau of Statistics of China
Brown Shipley Investment Office
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