The outbreak of Covid-19, otherwise known as the coronavirus, in Italy and elsewhere in Europe has rattled global stock markets in the week beginning 24 February. The global economic impact of this virus was always expected to be significant but three things were previously keeping markets optimistic in the medium term.
- First, stimulus measures, some which we have begun to see enacted, were expected from China and other countries to offset the temporary economic shock.
- Second, the virus was presenting as quite mild. Despite the large numbers contracting it, the mortality rate was relatively low compared with SARS, for example.
- Third, the spread outside China and the wider Asia region seemed to have been contained.
The first two “supports” remain in place but the outbreak of the disease in Europe has taken away the third. Markets have reacted negatively because the wider virus spread implies that the (temporary) economic shock will be larger than previously anticipated, and disruption to global supply chains could be more far reaching than China.
It’s difficult to predict how much the global economy will be disrupted. In manufacturing, supply chains are interdependent, making it hard to estimate a potential decline in output. Equally, it’s difficult to say how much the services sector will be affected, for instance by potential movement restrictions due to quarantine measures. That said, although it’s expected to be significant, the size of the shock may still be moderated by several factors.
- The weather is warming up in the northern hemisphere and that usually slows the spread of viruses.
- In China, the spread of the disease seems to be slowing even as it appears to increase elsewhere, so the news is not all negative.
- Economic policy measures will aim to soften the impact from the production shock with elements of the global supply-chain shut down.
Perhaps the most important point is that, leaving aside the coronavirus, we think the global economy is in fairly good shape. The US economy has been operating near its long-term potential (chart below) and there is some evidence that the rest of the world may return to its long-term trend after a disappointingly weak couple of years. China remains committed to its economic growth targets.
But, it’s not all good news
We can be fairly sure the financial news flow over the next weeks and months will be punctuated with negative stories around both corporate and economic prospects. As we noted, this shouldn’t be surprising because we are already expecting a significant economic impact. But, as individual companies reveal their earnings results and global economic data is published, the headlines will be dominated by negative stories that are telling us something we already know: that coronavirus has had a significant, temporary impact on global economic growth.
We also think it’s highly likely that there will be further Covid-19 cases, diagnosed in further locations, which in turn could lead to further volatility in financial markets in the near term. We expect these to follow a similar pattern to outbreaks in China, where containment measures have been effective at slowing the spread of the disease. In fact, in past outbreaks of disease there is a well-observed pattern of acceleration, which is followed by de-acceleration as containment measures are put in place – meaning there’s reason to believe containment probabilities for outbreaks are higher than it may seem from headlines. We also expect the World Health Organization to label the current outbreak as a pandemic in the coming weeks as more cases reveal themselves across the globe. Again, this is a logical and well signalled next step, but it’s likely to attract headlines nonetheless.
For investors, this can be a testing time. It’s important to remain focused on the medium term economic environment and assess short term news flow for its value in providing new information, rather than what is already known. As an investment team, it’s our responsibility to remain calm and objective on your behalf, assessing the balance of probabilities at any given time when positioning portfolios.
To conclude: a bigger shock demands a response
As we discussed, the economic shock will very likely be larger than earlier anticipated. But that means the global policy response will probably be larger than expected too. This brings us back to the question of how financial markets will balance these two outcomes and the other moderating factors mentioned above.
Here at Nutmeg, we believe a neutral long-term equity exposure remains the right portfolio allocation. Given the increased uncertainty and greater likelihood of easier monetary policy everywhere, we think it also makes sense to have a good exposure to government bonds. Although markets have had a shock this week, we remain optimistic about the global economy for the reasons mentioned above.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.