In a meeting with an emerging market equity manager a few weeks ago, the manager took some time to carefully explain all the shares he had not been buying since news of the spreading coronavirus had begun to unfold in the media. The manager was eyeing some consumer discretionary names, but had not seen valuations reach a point that reflected the impact that coronavirus would have on businesses. After the last ten days, we suspect that he will be taking another look at some of the names on his wish list.
The impact Covid-19 will have on economic growth in 2020 is now being recognised by central banks with both the Fed and the Bank of England acknowledging that growth will be slower this year due to the effects of the virus. Oxford Economics estimates growth could be 1.3% slower, equivalent to over $1bn in lost output.
Markets did not seem to recognise the threat posed by Covid-19 at all, until very abruptly, they did. 2020 was off to a strong start and following stellar returns in 2019, investors were considering whether equity markets could continue their run of form. The conditions had been good: central banks were accommodating, the initial trade agreement between the US and China has been welcomed, and (closer to home) the UK election delivered a result with greater political clarity. All of which sat in contrast to equity market conditions at the start of 2019. Turn the clock back a year and equities had experienced a difficult and volatile end to 2018. If they weren't quite battered, then they were definitely bruised. At that point the economic outlook was weakening, but 2019 went on to deliver equity market returns of over 20%. If there was too much pessimism last year, was there too much optimism this year?
With economic data improving at the start of 2020, equity markets still appeared to be riding last year’s wave of central bank support. Global equities rose around 5% in between January and mid February. In an environment where markets were torn between strong US economic data and coronavirus fears, the strong US data clearly won out. That, however, changed on 21st February when fears over a reacceleration in the number of new Covid-19 cases meant markets could no longer ignore the significant impact the virus will have on earnings. Since then we have seen global equities fall around 10% (at the time of writing). Some of the casualties are the more cyclical companies and easy to spot: Chinese car sales were down 92% for the first two weeks of February; but others will take time to emerge for example, developed market businesses hampered by a shortage of components from China and Japan.
When framing their analysis of the likely impact, investment managers have tended to refer to the SARS epidemic, when there was a short but sharp hit, with a brisk recovery for businesses and economies as the disease faded. The hope is that if Covid-19 can be prevented from becoming a longer term issue, economies might recover in a similar fashion. The caveat is that China is much bigger part of the global economy today (17%) than it was during the SARS epidemic (6%) and the impact is likely to be global in nature. Nevertheless, we hope that the volatility we have seen in markets will give active managers an opportunity to adjust their portfolios to take advantage of some opportunities to gain exposure to quality businesses that will be winners in the long term, at more attractive valuations.
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