After initially reacting with relative caution to the onset of Coronavirus, the outbreak in Italy over the weekend caused global equity markets to drop sharply. The reason for the fall was concern that attempts to contain the virus within previously infected areas had failed and the chance of this becoming a pandemic has risen.
The key reasons for the market reaction are;
- Supply chain disruption – This is the restriction there has been on the production and transportation of the raw materials required for industry. China produces a large percentage of these (for example they account for around 50% of global steel production) and many of these industries have suffered shutdown. Even in cases where production is relatively unaffected, the freight and shipping industries are working on severely reduced capacity which affects distribution. Obviously, as the virus spreads to other regions this stifling of supply will be relevant there too.
- Lower profits – The disruption to the supply chain will affect a company’s ability to produce goods in the near term, causing a drop in future profits. As equity markets are forward looking this is reflected by falling share prices.
- Slower economic growth – Global economic growth has been a concern for several years as people question how long the current expansion can last. The beginning of 2020 saw increased optimism that growth would be reasonable this year, helped by a thawing of US/China trade relations. However, Coronavirus has meant a revision down of the first quarters growth to zero and with the full extent of the impact yet to be seen, this would appear likely to drop further in the coming months.
The selloff has affected most shares negatively, the FTSE is down 6.8 % on the week with the European markets down around 8% with the Dow Jones and S+P 500 showing a similar fall (as of Thursday). The travel and airline industries seem to have been hit the hardest so far. EasyJet lost over 16% of its value on Monday and has continued to fall and at time of writing the stock was down 29%. It has also been a difficult week for online hotel/flight booking companies and the large hotel groups. Indeed, any firm that depends on people moving freely around the world has suffered the most so far. It would be expected that as supply chain slows and any stock piling unwinds, many other areas would be affected, but again it is extremely hard to forecast as it depends on the success or otherwise of efforts of containment.
When considering the figures above it is important to consider a couple of other factors that make this situation different to earlier outbreaks of new strains of illness such as SARS in 2002/2003. Firstly, since SARS China has opened its economy and become a major driver of the economic growth we have seen in the last decade. Its weighting to global markets is now 3 times what it was in 2003. The second point that when SARS first appeared, global markets were relatively low with the recovery from the dot com crash in quite early stages. Conversely, Coronavirus has come at a time when many markets are at all-time highs following the long period of expansion which would suggest that the potential for volatility is greater.
As is usually the case in times of stress, there have been some areas that have benefitted (although in this instance very few). The price of Government Bonds has risen, alongside Gold, as investors look for the tradition safe-haven asset classes. The inverse relationship between the price of a bond and the yield it pays is important to consider here. As yields have been driven lower and fears of an economic slowdown have increased, there is a growing feeling that the US Federal Reserve may act by cutting interest rates more aggressively this year than had previously been anticipated. Lower rates would be generally good news for equity markets and the more optimistic view would be to accept that there is going to be high volatility in the near term but the this does very much depend on how disruptive Coronavirus becomes to the global economy.