The Covid-19 outbreak has been a textbook example of a “black swan” event. It robbed global financial markets of their chance to bask fully in the afterglow of the US-China trade deal and cast a shadow on what was otherwise a relatively optimistic outlook for 2020. The spread of the virus is beginning to show signs of slowing, but the longer-term impact of the outbreak will continue to reverberate in various ways across geographical regions and asset classes.
In order to gain a range of perspectives on the outbreak and its potential economic and market impact, Nikko Asset Management has gathered the views of the following investment teams and experts, representing many of our major asset classes and geographical regions.
- John Vail, chief global strategist
- Eric Khaw, portfolio manager (Asian equities)
- Truman Du, senior portfolio manager (China equities)
- Yeu Huan Lai, senior portfolio manager (Singapore equities)
- Shigeru Aoyagi, chief portfolio manager and Shinya Takada, senior portfolio manager (Japan equities)
- Brad Potter, head of Australian equities (Australian equities)
- Multi-Asset team (multi-asset)
- Koh Liang Choon, head of fixed income, Asia (Asian fixed income)
- Global Fixed Income team (global fixed income)
We hope that this range of views will provide a useful reference to readers as they navigate the global financial markets.
John Vail, Chief Global Strategist
Firstly, heartfelt sympathies to the victims and deep respect and thanks should go out to the medical and other support staff in China and other affected countries. No country could have been fully ready for such a disaster and Herculean efforts, by both the government and civilians, have been made to treat its victims and contain its spread.
Clearly, China will now make a strong push to increase medical health care. Although much has been accomplished since the Severe Acute Respiratory Syndrome (SARS) crisis in 2003, even more government assets and efforts should be spent on improving the lives of its citizens in general, especially on pollution and heath care. In pollution control, there have been gaps in implementation due to the desire to boost the economy, but now China will likely concentrate less on GDP targets. Clearly, the world can help China in this effort to improve its standard of living.
Indeed, Japan has long been able to help on the pollution front, while its medical technology has also been rapidly accepted in China. The US also has sold medical goods and services, and may sell the most advanced ones if relations improve. China’s success in these efforts will be important in being a key neighbour for Asia and there is little doubt that it will succeed in improving the lives of its people.
In sum, given historical patterns in recent decades and the newly improving virus-containment data in China, the global economy should recover well from this crisis. As for the Tokyo Olympics, there likely is only a minor chance that they will be disrupted and hopefully this crisis will be a distant memory by then.
Eric Khaw, portfolio manager: Covid-19 is not a structural problem for Asian economies
The situation regarding the novel coronavirus is still evolving and fluid. There will be a short-term hit on the GDP growth of Asian countries because the outbreak caused huge disruptions to regional businesses and the travel plans of workers. This was especially true in China, where many production facilities were shut down.
However, our base case is that any economic slowdown caused by the coronavirus will be fleeting. In short, the outbreak isn’t a structural problem for regional economies. The modest cyclical recovery in Asia that we are expecting in 1H 2020 will be delayed due to the outbreak, but we expect it to still occur in Asian economies in 2H 2020.
Policymakers and central banks are all acutely aware of and concerned about the impact of the virus and we expect more policy actions to offset any short-term impact. All in all, we see any market pullback as a good time to buy quality companies with good long-term structural prospects at reasonable prices. But having said that, the recent market pullback due to the concerns over the Covid-19 has still been very mild and brief.
The coronavirus situation is probably going to accelerate the shift towards cloud computing and software as a service. Companies are realising the importance of remote access, with more employees now having to work from home. That is going to move more enterprises towards cloud services.
Truman Du, senior portfolio manager: China A-share market will recover later this year
For the immediate future, we have taken a relatively cautious view on the stock market as the novel coronavirus could still last for a while. But we strongly believe the China A-share market will recover to a new high later this year once the virus is under control. Then again, we think the impact on the Chinese economy due to the coronavirus could be bigger than that of the SARS epidemic in 2003. Due to the high transmissibility of the coronavirus, travel plans of many mainland Chinese were disrupted during Lunar New Year holidays, negatively impacting consumption and spending. We remain confident, however, that the Chinese economy will recover once the outbreak is fully contained, hopefully by mid-year. We believe the Chinese government will implement appropriate measures to counter the economic downside pressure. Any economic slowdown in China due to the outbreak will therefore be temporary and China's GDP should recover to a 5.5–6% growth rate in 2021.
In the near term, however, A-shares could come under pressure, reflecting rising concerns over the possible economic slowdown and likely impact on 1Q 2020 earnings of listed companies in China. But over the long run, the novel coronavirus will not change the long-term upward trend of the A-share market, which will be driven by earnings growth and re-ratings.
As earnings results will be announced in two months' time, we will keep an eye on sectors and companies with strong earnings growth momentum. On the whole, we still like technology stocks and high-quality consumer stocks.
Yeu Huan Lai, senior portfolio manager: Less optimistic toward air travel and hospitality sectors
The outbreak of the coronavirus in China, with cases also in Singapore, has made it necessary for us to re-examine our scenario of a modest acceleration for economic growth in 2020. While there are differences, our experience during the SARS epidemic in 2003 is the most sensible reference. In 2003, almost all key indicators fell sharply over a period of one-two quarters and recovered to normal levels one-two quarters following the peak of the epidemic. Economic growth was impacted only for a single quarter. We are hopeful that the same pattern will prevail for the current outbreak but remain watchful given differences between the two diseases, as well as the relatively greater level of connectivity with China and importance of the Chinese economy in 2020 versus 2003. In particular, the far more aggressive countermeasures taken in 2020 imply a sharper short-term downturn, but bode well for more effective containment.
The 1.5% forecast for Singapore GDP growth, which we had pencilled in for 2020, will now certainly have to be downgraded, with growth likely to slow more significantly in 1Q and 2Q of 2020. However, in the early stages of the epidemic, pinpointing a new forecast is still difficult. During the SARS outbreak, Singapore GDP growth fell 4.5 percentage points in 2Q 2003 before rebounding by 5.6 percentage points in 3Q 2003. Supportive measures will soften the blow somewhat, including targeted fiscal measures, which the Singapore government has already flagged, and possibly another round of monetary easing by the Monetary Authority of Singapore in April. In terms of valuations, we find some assurance in currently attractive levels, with the price-to-book ratio of the Singapore market close to the lows seen during the SARS outbreak in 2003.
Amidst the developing epidemic, we have become less optimistic towards the air travel and hospitality sectors, which will be impacted to a larger extent. In contrast, we continue to be more favourable towards "New Singapore" stocks, which represent the future economy of Singapore. These tend to be in sectors like technology, data centres, healthcare, logistics, tourism and consumer services. We also continue to like corporate restructuring candidates, which are companies looking to reorganise or reinvent their business models in order to be more relevant in the future economy. We remain positive on selected property developers due to corporate restructuring and significant asset redevelopment opportunities.
We continue to take a positive stance towards investing in dividend stocks, especially where dividends are supported by healthy and structural earnings growth. Forward dividend yields remain among the most attractive in the Asian region, highlighting the importance of dividends as part of the total return equation for investing in Singapore stocks. However, valuations have become fuller in the S-REIT space, and unless long bond yield expectations become more supportive due to the coronavirus epidemic, we will maintain a relatively more neutral stance in the sub-sector.
Shigeru Aoyagi, chief portfolio manager and Shinya Takada, senior portfolio manager: Assessing the virus as a risk factor that impacts consumption behaviour
As with the 2003 SARS epidemic that lasted from the winter 2002 to summer 2003, the current coronavirus outbreak does not pose an extreme danger and the situation is likely to be brought under control with the passage of time. That said, immediate containment measures were not undertaken soon after the virus was identified and a number of tourists were allowed to travel from mainland China to the surrounding countries. We therefore believe that the outbreak could require about six months to be brought under control, as with the 2003 SARS epidemic.
The immediate impact of the coronavirus outbreak on Japan is the decline in the number of tourists visiting the country. Furthermore, domestic tourism has also fallen, with Japanese themselves avoiding popular and crowded travel destinations such as Kyoto. Japanese high-tech and automotive firms do not have a strong presence in the regions of China heavily affected by the virus, and so far the outbreak has not had a strong impact on manufacturing activity. At the same time, the reduction in the number of flights shows that the movement of both people and goods is starting to drop off slightly. Production output and private consumption will decrease as a result and negatively impact corporate earnings in the January-March quarter, although we expect any impact from such factors to eventually fade.
We also note that if the epidemic shows signs of being successfully brought under control in China, the country’s production activity could recover sharply, aided by economy-boosting measures. Japanese manufacturers, notably those in the automotive and electronic component sectors, are likely to benefit strongly in that case.
It is difficult to gauge the potential scale of the epidemic and its full impact at this juncture, but what can be said with certainty is that restrictions in the movement of people is hurting consumption. Weaker private consumption will eventually begin affecting upstream production activity. It will therefore be important to watch for this development and react accordingly. It is also difficult to gauge how the virus outbreak could impact the Olympics in Tokyo this summer, but if the epidemic lingers, it could have an effect on private consumption. We have therefore become cautious on sectors that are likely to be impacted if consumption by individuals cools down.
Brad Potter, head of Australian equities
The best case scenario as it stands now, assuming the virus is kept well in hand, is that China’s GDP will be impacted only during the first quarter of 2020. Some estimates suggest that it will decline by some 200 basis points in that period, but the virus has been unusually both a demand and supply shock, so it could be much deeper.
The global impact should be somewhat less, but countries that are large trading partners with China will be more affected. Australia is one of those large trading partners and thus may feel more of a material effect, although only a limited amount of impact is currently evident within the country’s commodity sector. We are, however, seeing tourism being hurt badly now that all inbound flights from China have stopped, and education will be affected as many international students have not been able to enter Australia. Discretionary spending is also feeling the effects with many companies calling out this development during the current reporting season.
The likelihood that China initiates stimulus once they bring the virus under control is high and such steps will help the economy for the rest of the year. Previous examples of these type of shocks have illustrated how underlying demand never disappears, but is delayed; therefore, a catch up in demand becomes a feature.
Multi-Asset team: Overview
The newly-identified coronavirus has certainly grabbed headlines over the last month. In the first weeks, each passing day seemed to escalate concerns with upside surprises to the number of new cases, the death toll and the spread to different countries. While the evolving statistics are clearly a concern, the disease is more than likely to be contained, allowing risk assets to regain their footing—similar to SARS back in 2003. However, given that the number of new cases is still on the rise combined with an elevated risk of profit-taking, it is sensible to hedge risk.
Economic and market impact
The economic impact is likely to remain focused on China, hurting mainly consumption, but also having knock-on effects including disrupted supply chains. Clearly, travel will be hit and tourism will decline throughout Asia. While there may be some derivative impact outside of Asia, such impact is likely to be limited provided the shock to supply chains is not protracted.
Importantly, while the escalation of new cases will impact economies to varying extents across different regions, as was the case with SARS, such impeded growth will most likely be regained in the quarters that follow. In 2003, MSCI China equities sold off 14% over 15 months, but was followed by a 55% rally–partly driven by new China stimulus. Since China is handling this crisis much more aggressively than in 2003, the period of the downturn is likely to be shorter.
During SARS, the US composite PMI continued to rise and the US equity market followed, helped by a cautious Federal Reserve (Fed), which erred on the side of caution and kept policy easy. Notably, while the heart of the SARS epidemic lasted three months from mid-March to late June, 2003, US 10-year Treasury yield declined roughly by 100 basis points, partly as a reflection of fear and also the easy Fed, so US Treasuries were still a reasonable hedge. The conditions are very similar to today, though China is far more important to the functioning of the global supply chain than it was back in 2003.
Hedging makes sense given the level of uncertainty concerning the virus itself and the extent of the economic impact. Risk assets are currently pricing for a V-shaped recovery as was the case following the SARS outbreak in 2003, but the disruptions to the global supply chain are extensive and could drag on, in which case the “V” could turn into a “U” and a more prolonged earnings slowdown. Risk assets have performed exceptionally well since the fourth quarter of last year and equity positioning is heavy, meaning that risk of profit-taking is elevated should there be any earnings surprise to the downside.
Hedging equity risk is sensible, mainly in Asia, but also in derivatively-impacted markets like Europe, for its connection to the China supply chain, and like Latin America, which deeply depends on Asian demand for its natural resources. The US may be the least directly exposed, but valuations are particularly rich and the all-important technology sector is exposed to breaks in the supply chain.
Hedging Asian and broader emerging markets currency risk is also sensible as risk-off events tend to support the dollar. While our base case is that bond yields will rise as growth returns, holding duration during this period of risk-off is also supported. For US equities, volatility is still cheap; therefore, an option-based hedging strategy makes sense in light of Fed easing that could carry markets higher notwithstanding high valuations and elevated risks.
Asian fixed income and credit
Koh Liang Choon, head of fixed income, Asia: Asian central banks expected to reduce growth forecast; Asian bonds seen doing well
While the coronavirus mortality rate is low compared to that of SARS, which gripped the world in 2003, the rate of infection is higher. Hence, we will continue to monitor the situation closely. In the short-term, the main impact on Asia would be a slowdown in consumption growth, as the majority of the population would likely reduce shopping and travelling. However, most Asian countries are now better prepared and well equipped to handle the crisis, and the situation is expected to improve over time. Meanwhile, Asian central banks are expected to slightly reduce their growth forecasts and employ mostly accommodative monetary policies. Against this backdrop, Asian bonds are expected to continue performing well, possibly outperforming equities in the near-term. Within the Asian bond market, we shifted to "neutral" from "negative" on low-yielding countries as growth is expected to slow in the near-term. We continue to favour bonds from mid- to high-yielding countries such as Indonesia and Malaysia.
Underweight Singapore dollar (SGD) and Thai baht (THB) vs Philippine peso (PHP)
On currencies, we are underweight on the SGD and THB vs PHP, due to Singapore's open economy and Thailand's high reliance on tourism, with a particular dependence on tourists from China. Moreover, Singapore and Thailand have some of the highest numbers of cases of coronavirus infection outside of China. We favour the PHP as it is a defensive currency. The country's lower reliance on tourism and healthy remittance flow should keep the PHP elevated.
Credit spreads to remain under pressure near-term, but sharp recovery possible once virus-related concerns subside
The coronavirus outbreak upended the constructive backdrop for credit spread performance at the year’s start. Based on current information, we still expect the impact on Chinese—and Asian credits more broadly—to be relatively contained and in range of the SARS experience, with some near-term widening followed by a possible swift recovery. But much will depend on the eventual severity and duration of the situation, and the flow-on impact on business and consumer confidence. Compared to the time of the SARS epidemic, the Chinese government is more proactive and has swiftly implemented strong measures to control the epidemic. While the situation remains fluid, hopes are that the government can bring the situation under control within a relatively short period of time and thus lessen the negative economic impact and credit fundamentals. The early sharing of information with the international community has also hopefully reduced the potential spread of the virus across Asia and rest of the world.
Unless the situation worsens considerably, we do not expect the major central banks to implement any immediate rate cuts or additional quantitative easing-related measures. However, they are likely to highlight the downside risks in their upcoming policy meetings and reiterate their accommodative stance. Chinese authorities are already implementing a targeted monetary and fiscal easing strategy. We expect this to continue with perhaps a bit more intensity, together with additional measures to stabilise the financial markets in the near term. These measures should help mitigate the widening pressure on credit spreads and support a recovery once the virus spread is contained.
Other views from the Asian fixed income team:
- Chinese government bonds: A temporary slowdown by the Chinese economy in the wake of the virus outbreak is expected to favour the bond market. The 10-year Chinese government bond yield, which has fallen below 3%, could target a near-term low of 2.8%.
- On the Chinese yuan (CNY): USD/CNY is likely to range between 6.95 to 7.05, potentially breaking out either way depending on whether the coronavirus cases peak (and therefore limit its economic impact to Q1 2020) or continue to increase (e.g. the virus mutates).
- Economic impact is likely to be concentrated in service sectors with consumer confidence cratering as people avoid gathering in crowds. This would mainly affect traditional retail goods and services. A rewind to 2003 shows modelled impact of between 2.5% and 0.5% of GDP loss for heavily affected countries.
- Healthcare as a whole may not see an uptick in the medium-term since this is being treated as a public health issue. The main immediate beneficiaries would be specific manufacturers of used/stockpiled PPE and drugs, such as Roche’s off-patent Tamiflu in the first instance though efficacy has not been tested against 2019n-CoV and Gilead’s Remdesivir is also being trialled having been used for MERS treatment. Developments highly dynamic in real time.
- While e-commerce could benefit from the quarantine with bricks-and-mortar retail being restricted, but the effects would be patchy at best.
Global fixed income
Global fixed income team: Virus outbreak tempers growing chorus for rising global yields
Just as there were initial signs that the global growth outlook was finally turning positive, after a prolonged period of trade-related uncertainty, the dominant story for markets in the first weeks of the new decade has been the sudden arrival of coronavirus. The growing chorus at the start of the year for global rising yields was shot down rather quickly by the outbreak of the virus. As the news of the virus has become more widespread, it has compounded fears of a further global growth slowdown and a return to risk-off sentiment within financial markets.
From a market standpoint alone, which is not to overlook the significant and tragic human impact of the viral outbreak, China has taken drastic measures to contain the local epidemic: restricting travel and enforcing quarantines on several cities. As a result, we have already observed a rather dramatic decline in commodity demand from China, with Brent crude prices down nearly 15% YTD as a result of the expected slowdown. With growing uncertainty surrounding the duration of the outbreak, China’s aggressive action to combat the spread and the resulting impact to domestic demand certainly raises our concerns that this black-swan event will, at the very least, weigh on global growth in the first quarter. Moreover, we expect that the outbreak will likely also remain a drag on global growth beyond the first quarter.
Beyond the direct observation in the fall in commodity prices, we also note anecdotally that Alibaba Group’s recent warnings that the Covid-19 outbreak is exerting a fundamental impact on the country’s consumers and merchants, and will, therefore, hurt its revenue growth. A fall in commodity prices and declining global growth are expected to have a deflationary impact, and as such we do not see any catalyst for central banks to hit their inflation targets in the face of such strong headwinds any time soon. Additionally, outside of Asia, we predict that the virus will have ramifications in Europe, in particular Germany, whose economy could find itself in an even more precarious position given the country’s already weak export growth and industrial production output. While we initially thought that getting past the drama of US President Donald Trump’s impeachment could be a catalyst for higher bond yields, the headwinds have merely shifted to a new source of global uncertainty.
For the rest of the quarter, we predict that speculation surrounding the spread of the virus is likely to continue dominating financial market returns and investor sentiment. We are gradually learning more about the virus and its impact: how fast it spreads, its mortality rate and the potential damage it could cause to the global economy, so the current uncertainty related to the outbreak will over time diminish.
Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s portfolio, nor constitute a recommendation to buy or sell.