As new cases of Coronavirus continue to spread across the globe, a key question for investors will be whether it has the potential to trigger a global recession.
According to Anna Stupnytska, global head of macro, Fidelty International, the impact on capacity should be short-lived with factories and offices remaining untouched and most people who fall sick able to recover. However, Stupnytska warned that the downside for investors is that this may prompt governments to adopt a “wait and see” approach before taking action.
She explains: “The Federal reserve in the US has cut rates by 50bps and other central banks such as the Bank of Japan also have hinted at further monetary stimulus, which may help stabilise markets but with policy already loose, have less impact on the real economy.”
Estimates vary as to how the virus will impact global GDP growth. A previous study by the World Bank estimated that a mild flu pandemic would lower global growth by 0.7%, while a more severe case could shave off as much as 4.8%.
The OECD believes that if the spread of the virus continues to escalate, growth for 2020 could be cut from 3% to 1.5%.
Stupnytska said: “While impossible to predict with high conviction, our current base case, at a 60% likelihood, is a 30-50 basis point hit to 3% global growth projection for 2020; our best case, at 20% probability, is 10-20 basis points and our worst case is around 1%.
“Our earnings estimates have also changed since January, although our analysts caution that many company managements themselves still don’t know how bad the impact will be. The ultimate outcome depends on how long the virus persists, the size of the policy response and how far the knock-on effects extend.”
Economic activity in China, the source of the outbreak, has returned to around 50% of normal activity and is set to rise to 70% over the next few weeks, according to Fidelity. Indeed, China’s disciplined handling of the crisis means that, unless it has urged a return to work too soon, it could emerge first, even as the rest of the world gets to grips with containment and mitigating the economic impact. Sectors such as healthcare and online gaming may even be long-term beneficiaries.
However, the picture looks less promising for Europe, which is currently contending with a spate of new confirmed cases. Economies such as Italy are more at risk than China, with growth already sluggish and many countries relying on tourism. Fidelity has cautioned that “signs of green shoots” in Germany in January are expected to vanish, given its reliance on Chinese industrial demand. At the same time, the European Central Bank has less monetary ammunition to respond to the growing crisis, while the European Union’s deficit rules also limit large fiscal spending plans.
Fidelity expects the US to be better placed to cope with the disruption, meaning a mild slowdown is more likely than a full-blown recession. However, expectations that the Federal Reserve will cut rates as early as this month have increased.
Following recent sharp drops across global indices, Stupnytska said it was difficult to tell whether the recent sell-off marked the bottom or whether it would worsen. Markets had been anticipating a poor first quarter, followed by a rebound in the second quarter, however bad news is expected to continue through the second quarter, and potentially the third.
Stupnytska commented: “Market expectations for central bank and government intervention remain high, even where monetary stimulus has limited impact and fiscal stimulus, which can be much more effective, will take time to materialise. However economic and market impacts are rarely synchronised – so as evidence of stabilisation of the virus spread comes through, markets are likely to rebound.
“Beyond economics, the investment implications will differ across regions and sectors. Long-term investors with well-diversified portfolios and flexibility can move tactically to mitigate these risks, and take advantage of pricing dislocations if volatility persists.”
Gold no antidote
Matthew Yeates, senior investment manager, Seven Investment Management, said gold had become a safe haven for investors in recent weeks amid the large swings seen in the equity markets. Yet Yeates warned that holding gold over the long term could be a costly exercise.
He said: “With no yield available, even with rates from traditional government bonds being very low by historical standards, it is still greater than the 0% offered by gold. Even in the rush for safe havens last week gold fell when the threat of a Coronavirus really peaked, falling nearly 5% between the 21st and the 28th. There’s little credible explanation but it is worth remembering gold is not a fail-safe asset when equities fall, as is often believed. From March to November in 2008 the price of gold actually fell by over 30%, despite the same period representing the peak of the financial crisis.
“At present, in our core portfolios there is nothing we have seen to drive enough meaningful conviction to take a position and we retain a zero weight to gold.”
Traditional alternatives have also struggled, Yeates said, with commodities taking a tumble and UK listed infrastructure also enduring a difficult period.
He added: “The alternative basket we hold de-emphasises these holdings for those we think can be cheaper, more liquid and generate returns in up and down markets. Holding a combination of different styles of alternatives focused on long short strategies across asset classes that aim for a low exposure, or beta, to traditional equities offers investors a credible answer to longer term diversification – especially when recent gains on bonds have seen yields fall to historical lows.”
