Market comment - Q&A: market turmoil regarding coronavirus

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Since the end of last week, financial markets are in a risk-off mode. This is caused by the coronavirus, which has made many victims in several countries by now. In this Q&A, ABN AMRO shares its view on the behaviour of the coronavirus and how it is impacting the financial markets.

Financial markets are worried. What is happening?

Financial markets are falling since the end of last week, due to the coronavirus. The world index (MSCI All Countries) lost almost 7% in euros, while also interest rates dropped. Safe havens such as gold jumped higher.

Especially the spreading of the virus outside China to countries such as South-Korea, Japan, Singapore, Italy and Iran, is cause for concern. Financial markets are fearing the virus will become a global outbreak. This will hurt businesses and the world economy. Companies such as Apple, Philips, Diageo and Lufthansa have already issued a profit/revenue warning because of the standstill of the Chinese economy.

How serious is the coronavirus outbreak?

It is difficult to answer this question. We are no medics and sometimes the data is difficult to analyse. Especially data from China is not always transparent nor reliable. In general, however, we can say the virus is highly contagious. An infected person can pass the virus on to 2 to 2.5 people. This number is high, but not extremely high (3 or higher). The virus is, however, already contagious during the incubation period. The incubation period varies from a couple of days to two weeks or even more. This makes the virus difficult to contain.

The mortality rate for the coronavirus in countries with a good health care system seems to be closer to 1% than to 2%. This makes the coronavirus different from SARS (with a 10% mortality rate), but the rate is higher than for a normal flu outbreak (with a mortality of 0.1%)1. Elderly people and people with lung diseases are more vulnerable to the virus. Young and healthy people are less vulnerable: they sometimes do not even notice they have and/or carry the virus.

Financial markets are concerned about infected areas going in a complete lockdown, resulting in an economic standstill. This has the biggest negative economic impact, as both the demand and supply side of the economy are hit hard.

1 Source: Bloomberg

What is the impact on the economy according to ABN AMRO?

Due to the coronavirus, we have lowered our economic forecasts for 2020. We believe the Chinese economy will come to a standstill in the first quarter, on a quarterly basis. We do expect that operations in China will resume during the coming month. For the year 2020 at large, we have lowered our expectations for the Chinese growth from 5.8% to 5.5%2.

Overall, we believe the first half of the year economic growth will be weaker, while the recovery in the second half will be stronger than earlier expected. We still do not expect a recession. Nevertheless, with spreading to South-Korea, Japan, Singapore and Italy, a larger part of the world economy is at risk. China’s share of the world economy is almost 19%, while the other four make up around 8% of global GDP. Of those four countries, Italy’s share is just under 2% and around 15% of eurozone GDP3.

Sectors worldwide that are hit hard due to the outbreak, are transportation (for example airlines), the tourism & leisure industry, and other parts of the consumer discretionary sector, such as retail, luxury goods and cars. In addition, the real estate market (financials sector) in China saw a huge drop. In general, cyclical parts of the market are under pressure owing to growth fears and dropping commodity prices. In that respect, especially the energy sector (oil related) and materials (bulk chemicals) are being hurt.

Sectors that behaved defensively have online offerings such as gaming, media & entertainment and food delivery. From a safe-haven perspective, consumer staples and utilities have acted defensively. Health care is somewhat special. The pharma segment is acting defensive, while the health care insurance segment was hit hard, as a result of the caucuses outcome for Democratic candidate Bernie Sanders in the run up to the US elections.

2 Source: ABN AMRO Group Economics
3 Source: ABN AMRO Group Economics

ABN AMRO recently added risk to the portfolio. What is ABN AMRO currently advising investors to do?

Half February, we have made adjustments to the portfolio. We have added risk to the portfolio, resulting in a slight overweight in equities. The decision to add more risk was taken when markets had briefly corrected on the news of the coronavirus in China. Spreading of the virus to other countries was limited. Also, macro-economic data were improving, the earnings season was good and low interest rates made equity relatively attractive.

Before making any adjustments, we are monitoring the financial markets and the outbreak closely: if and how the virus is spreading further. In the course of an epidemic, economic activity typically drops when an outbreak is taking place, but when the worst is over, a strong recovery will follow. Especially, if additional support is provided by central banks and governments in the form of additional stimulus. We do not think this is the right moment to make changes in the portfolio, as markets are very volatile and because there is much unknown about how the virus will develop over the coming weeks. As such, we remain slightly overweight equities and underweight bonds.

We expect market sentiment to turn positive again with the first signs that the worst of the virus outbreak is behind us, or under control. Also, news from firms and factories reopening their doors is positive. Announcements from central banks with more monetary stimulus will be helpful, as well as government announcements of fiscal stimulus to help the economy.

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