OCBC OneWealth App– Hope in the time of Covid-19

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Covid-19 outbreak

Hope in the time of Covid-19

25 February 2020

Markets tumble as pandemic fears escalate

The economic impact of the Covid-19 outbreak had mostly existed in the realm of theoretical speculation until it became all too real.

Cautious profit guidance from companies like P&G and Apple over the past week on account of supply chain disruptions and reduced consumer demand drew the market’s attention to the negative ramifications of the coronavirus outbreak on earnings. Since then, markets have been on edge. Add to it the spike in new confirmed Covid-19 cases outside of China (Chart 1), and the result is shaken investor confidence and a mad rush for the exit.

There’s no denying that there was some degree of complacency in the pricing of risks of the outbreak in markets outside of Asia in the lead up to the recent risk-off move.

For a third consecutive session, investors fled risk assets (Chart 2) for the reassuring arms of safe havens, pushing down US Treasury bond yields to record lows and bidding up the price of gold. Given the sharp moves in continental markets, it’s clear that the Covid-19 outbreak is not just a problem for Asia.

The trigger

Indeed, fears of a global pandemic surfaced after countries like Italy, South Korea and Iran – countries in three different continents – reported a spike in the number of fresh cases.

To date, Italy has reported 229 confirmed cases, a sharp surge from just three cases last Friday. The country has reported seven deaths.
South Korea reported 231 new cases on Monday, bringing its total to 833 with seven fatalities.
Iran reported 61 confirmed cases and 12 fatalities, a sharp rise from eight deaths and 43 infections reported just a day earlier.
Meanwhile, Afghanistan, Bahrain and Kuwait joined an ever-expanding list of countries reporting new cases of infections.

While the increase in the number of cases in Italy, Iran and South Korea has been described as "deeply concerning," the World Health Organisation’s (WHO) director general said the outbreak is not yet a pandemic and urged countries to take the appropriate steps to contain the virus quickly before the situation escalates.

Authorities in affected countries have undertaken severe measures to minimise human movement in a bid to contain the virus. Italy issued a ban on public events over the weekend and imposed a virtual lock down in at least 10 towns. Other measures also include the closure of public buildings, limiting transport, and monitoring and quarantining individuals who may have been exposed to the virus.

Meanwhile, South Korea raised its infectious disease alert to its highest level, enabling the government to ban public activities and temporarily close schools to contain the spread of Covid-19 infections. Countries like Turkey and Iraq, which share a border with Iran, have imposed stringent restrictions on border crossing.

The escalation in the spread of Covid-19 globally has heightened concerns about the potential scale of the economic fall-out. With governments increasingly resorting to severe measures to curtail human movement within countries and across borders, economic activity will inevitably face disruption. It is yet uncertain how long these measures would have to be put in place to stabilise the situation. It is also unlikely that we’ve seen the peak of confirmed cases in these affected territories.

Economic damage might well be deeper and longer lasting than some of the optimistic scenarios that were prevalent when the S&P 500 index hit its most recent high on 19 February. An acknowledgement of this prospect has led to a repricing of risk.

Meanwhile, in a region already struggling with slow growth, economic disruption in Italy – the Eurozone’s third largest economy – poses a recession threat to the currency union.

Furthermore, the decision by European countries not to suspend the Schengen free travel zone within the European Union could increase the risk of cross-border contagion if virus screening and contact retracement processes are not sufficiently robust enough.

Learning from experience

The good news is that these measures should be effective if China were any indication. The number of new cases coming out of China has steadily declined (Chart 1), which attest to the efficacy of locking down affected cities and restricting movement as much as possible. This offers a tested blueprint for countries looking to clamp down the spread of the virus quickly.

Learning from one country’s experience should allow others to adapt and respond effectively. After all, for Asia, this is not their first rodeo. The lessons from SARS still ring loud and clear.

With governments reacting swiftly, decisively and extensively to contain the virus, the hope is that some short-term economic pain will be a small price to pay for longer-term stability.

Policymakers to the rescue

On the macro-economic front, policymakers will likely step in with supportive expansionary fiscal plans and dovish monetary policies to cushion against growth pressures. Asian economies have taken the lead in this regard.

For instance, the Singapore government has introduced the most expansionary budget in decades while Indonesia’s central bank had cut interest rates recently to mitigate the potential impact of the coronavirus outbreak on its economy.

In the US, Federal Reserve Chairman Jerome Powell has stated that the central bank is monitoring the developments of the coronavirus outbreak very closely and stands prepared to respond with the appropriate monetary policy stance should the economy require a boost.

As it stands, the unexpected decline of the Markit US services Purchasing Managers’ Index (PMI) into contractionary territory in February might just keep the Federal Reserve on the dovish side of the policy spectrum (Chart 3), not that they were moving anywhere close to being hawkish.

Similarly, Bank of Japan (BOJ) Governor Haruhiko Kuroda has stated publicly that the BOJ is “fully prepared” to ease monetary policy further to mitigate the impact of the virus outbreak on Japan’s economy. Yet, with monetary policy settings as loose as they are, one could question if there is credible scope for further loosening, and if so, will such easing even be effective.

European Central Bank (ECB) policy makers have acknowledged these limitations to policy, suggesting that the scope for further monetary easing is unfortunately limited and has called for concerted fiscal effort from Eurozone members to reboot growth should the coronavirus outbreak leave a deeper imprint on economic activity.

Whether effective or not, the prospect of further monetary easing and fiscal expansion should keep markets supported over the medium term, as it rides out the period of uncertainty ahead. Markets are likely to remain volatile, with stock movements being subject to developments in the coronavirus story.

Stick to defensives; Pick up quality stocks

For now, defensive sectors are poised to stay relatively resilient amid the risk-off mood. REITs, utilities and consumer staples should remain steady on a relative basis, while stocks in growth sectors including consumer discretionary, energy and technology could face bouts of selling pressure and stay volatile ahead (Chart 4).

Investor sentiment for these growth sectors might remain challenged and fragile amid the prospect of weaker global demand -- particularly in China -- in view of the virus outbreak.

As it stands, weak growth prospects have exerted strong downward pressure on oil prices. Oil and gas companies could face further pressure ahead as the price of their product fluctuates.

Gold and investment grade bonds are other key beneficiaries of increased safe haven flows.

For those with a longer investment horizon, a volatile market presents attractive opportunities to accumulate quality stocks on the cheap, especially since longer-term fundamentals remain sound.

Gold and investment grade bonds are other key beneficiaries of increased safe haven flows.

For those with a longer investment horizon, a volatile market presents attractive opportunities to accumulate quality stocks on the cheap, especially since longer-term fundamentals remain sound.

Volatility brings opportunity

Ultimately, we believe that this too shall pass and that longer-term market fundamentals remain intact, buttressed by receding US-China trade tensions and loose monetary policy. Chances are the current outbreak will only create a short-term blip to growth as opposed to presenting a persistent risk.

Furthermore, central banks are likely to err on the dovish side of the policy spectrum in view of the uncertain economic environment. Meanwhile, governments appear to stand ready to juice up their respective economies with fiscal stimulus should the need arise.

In line with this longer-term view, ensuing volatility and market corrections may present attractive opportunities to accumulate quality stocks. Market turbulence also underscore the need to stay diversified in terms of regional exposure in order to weather an uncertain period ahead.

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