Pandemic: there are risks, but don’t overreact
The spread of the virus pandemic has pushed local and global equity investors to the edge
THE COVID-19 virus, initially known as the coronavirus, has pushed local and global equity investors to the edge. Using Barry Ritholz’s scale of investor emotions, we find ourselves at the anxiety level and the up-trend of developed market equities since the end of the 2008/09 global financial crisis is severely threatened.
A break in the up-trend is likely to lead to fear and panic as a major selloff and a bear market could be in the offing. But will it?
The effective lockdown of factories in China saw exports shrink in January and February by more than 17 percent in US dollar terms, while imports declined by four percent.
In addition, HIS Markit reported that supply chain issues saw the global economy in February slump at its steepest rate since 2009, with both the global purchasing managers’ indexes (PMI) of services and manufacturing sectors falling below 50 points, indicating contraction in the global economy.
Inventory holdings and stocks of finished goods plummeted and even our own retailers warned of empty shelves of goods imported from China in coming months.
The contraction in China is such that the manufacturing PMI of China Federation of Logistics and Purchasing (CFLP) in February fell to 35.7 points, which is worse than the 38.8 points at the lowest point during the 2008/09 global financial crisis.
But what lies ahead? The Covid-19 cases in Mainland China up to now month by month cumulatively trump the worldwide Sars cases by a factor of around 38. Therefore, 38 cases of Covid-19 are reported for each Sars case reported.
If the same trend or trajectory of the cumulative cases of Sars reported worldwide will play out during the current Covid-19 crisis, the cumulative cases in Mainland China can be expected to peak at nearly 300 000 in May this year from around 80 000 currently.
The epicentre of the outbreak of Covid-19 in Europe is Italy, and massive drastic measures have been implemented to contain the spread of the virus.
The only guidance of how things will play out on the global economic front and financial markets is to look at how they reacted during the ensuing months after the outbreak of the Sars virus in November 2002.
I used the ISM manufacturing PMI for the US as an indicator for global economic activity. The US manufacturing PMI fell below 50 points in the fourth month after the first cases were reported and the contraction deepened as the number of reported cases increased exponentially.
The US economy stabilised after a vaccine was discovered, but continued to contract and only returned to expansion after no more new cases of Sars were reported. It is, therefore, possible that global economic activity may continue to be subdued over the next two to three months, but will bounce back strongly afterwards.
Yes, I know that the doomsayers are calling for a crisis similar to the 2008/09 global financial crisis. The main difference between the current Covid-19 crisis and the 2008/09 crisis is that we are currently sitting with a supply shock of goods due to the shutdown of factories in Mainland China and, to a lesser extent, Italy, while in 2008/09 the supply shock was the dearth of liquidity.
Currently the Baltic Dry Index’s drop by more than 70 percent indicates that international trade has dropped significantly due to lack of supply from China. In comparison, the Baltic Dry Index dropped by more than 90 percent in 2008 due to an effective halt in international trade.
In the first four months after the outbreak of Sars in November 2002, emerging markets as measured by the MSCI Emerging Market index in terms of US dollars fell by 7 percent.
Despite the further exponential increase in the cumulative number of reported Sars cases over the ensuing two months, emerging market equities made a strong comeback and recorded a 7 percent increase on the levels before the Sars outbreak. Yes, the development of a vaccine was the turning point.
Currently the US stock market is approaching the cheapest levels since 2016 and my market valuations point to consumer confidence that has been shattered in the US. Confidence could come in at up to 8 percent lower than the previous reading.
Current indications are that the number of new Covid-19 cases in China has stabilised and is dropping somewhat. The Chinese authorities have also urged factories to resume operations and workers to return to work. If they don’t, you can expect massive stimulatory measures and significant pressure from the Peoples Bank of China and the authorities to force them to do so.
Although it is early days, it seems that the main threat to the global economy is slowly but surely subsiding and that disruptions in economic activity will eventually end.
It is evident from the global PMI numbers that massive pent-up demand has built up in the global economy.
Incidentally, the normalisation of the Chinese economy after the Sars onslaught led to solid economic growth and growth in asset values for many years to come.
The Covid-19 virus is perhaps what the global economy needed to ensure a solid foundation for strong global economic growth next year. In my opinion there is a more than even chance that the current anxiety on equity markets will subside, but risks will remain high for the time being. Keep your emotions in check though!