At the time of writing, there have been 4,515 confirmed cases of the coronavirus in 14 countries, with cases predictably growing. Of these, 4,200 are in China, mostly in the city of Wuhan, Hubei Province. All of the 106 deaths thus far (about 3% of those infected), have been in China. While increased fatalities and larger numbers of contracted cases seem nearly certain to be reported, the high degree of regional concentration seems consistent with a moderate degree of contagion; a containable threat.
Impact on China’s economy
The quarantine in Wuhan may have a crushing short-term impact on the Hubei region, but the travel restrictions and intentional changes in consumer behavior in China could have a somewhat larger overall impact in the quarter ahead. This may be particularly acute for China’s services industries such as tourism.
In early 2003 (SARS outbreak), China’s GDP halved in the second quarter and doubled in the subsequent quarter. A similar but less extreme pattern can be expected this year, along with some rather modest impact on China’s trading partners.
Importantly, a setback in China’s economy comes at a time when financial market optimism toward a cyclical recovery has been building. Global equities have risen 11% since the Autumn, largely on the pre-conditions for a rebound in manufacturing activity, with a mild rebound seen in trade and transportation measures from a depressed 2019 thus far. Gains are merely building, but global trade and industrial activity are convincingly poised for such a return to growth. Yet the sharp improvements in cyclical equities have left financial markets in a pause and vulnerable to news like the coronavirus concerns.
More than a virus story
As global markets head into a week of quarterly earnings reports and a decision by the Federal Reserve, Citi analysts see higher volatility in the period ahead compared to the past few months, and favor hedging volatility, with overweight positions in US Treasuries and gold in place for diversified portfolios.
For the full year ahead, Citi’s optimism remains that cyclical industries could confirm the strength seen in equity markets, even if new doubts emerge. The decline in China/Hong Kong markets may present an opportunity, just as was the case following the SARs period.
For those concerned by a likely rise in volatility, Citi’s long-term investment focus is on more than a cyclical snapback or swing in sentiment. Quality income-generating assets, particularly firms able to increase dividends, have outperformed over both the long-term and when markets face short-term challenges.