These are costly times, in human terms first and foremost, but also in economic terms. As the new coronavirus continued to spread last week, eleven towns in northern Italy were placed in quarantine, ten of them in Lombardy, a region that accounts for 22% of Italian GDP. Meanwhile, France banned public gatherings (see also The Last Word, below), and the UK prime minister called a meeting of Cobra (due today) to discuss prevention and containment meaures.
Some major global gatherings have already been cancelled, like the World Athletics Indoor Championships, or suffered from downscaling, such as Milan Fashion Week. Others remain very much up in the air, among them the UEFA European Championships this summer (with the final due at Wembley on 12 July), and the Olympics in Tokyo. The number of confirmed cases – which has reached around 90,000 – may only represent 0.001% of the global population, but the globalisation of COVID-19 has already hit both economic forecasts and equity markets.
“There is an economic impact [in China] but I think more concerning is the global impact,” said Alistair Thompson of FSSA, manager of the St. James’s Place Asia Pacific fund. “A lot of people are comparing the virus to SARS but, as the numbers have shown, the coronavirus is much more serious than SARS. In 2003, when SARS broke out, China was a quarter of the size in terms of impact on [global] GDP – it now accounts for 16% of GDP.”
Last week was particularly brutal. The world’s leading index, the S&P 500, fell by more than 11%, as did the FTSE 100. Continental European stocks, oil and even Asian stocks – which had already taken a major hit due to the virus – all suffered a tough few days. It was the worst run on financial markets since the global financial crisis; and calls into question how long the current bull run, which has lasted now more than a decade, can endure – for the moment, however, it just about trundles on. Already, global markets are in correction territory, defined as a dip of 10% or more from their last peak; but some analysts fear they may yet fall into a bear market, defined as 20% below their last peak.
Given the relatively long incubation period of the virus, which makes early detection dificult even as carriers are contagious, it would be unwise to entirely discount such forecasts, but the reality is that the likely trajectory, at this point, remains shrouded. Yet that may change in the next few days. Silvio Brusaferro, president of Italy’s National Institute of Health, said on Sunday that the coming week will determine whether measures introduced by the government in Italy, the worst-affected country in Europe, are proving successful in containing the virus’s spread. Whatever the outcome, though, it is clear an economic hit is inevitable.
“Until we see a peak in the coronavirus infection rates, efforts to contain the virus will significantly dampen economic activity,” said Johanna Kyrklund, Group Chief Investment Officer and Global Head of Multi-Asset Investments at Schroders. “Markets also have to digest the likely impact of supply chain disruption on corporate earnings. Investors can expect a rocky ride in coming weeks, but markets are underpinned by the fact there is plenty of money swashing around on the sidelines that could be invested. And of course bond yields remain very low, making equity yields more attractive. One area to watch is emerging markets, where value is starting to emerge in some of the equities and currencies.”
It takes a cool head, to quote the UK’s most popular poem, to “keep your head when all about you / Are losing theirs”. One outcome that is surely certain amid all the volatility on markets is that plenty of investors will make hasty decisions, selling when the market falls and so crystallising losses. In the short term, of course, the combination of immediate news and human emotion can cause mayhem on markets. Yet it is at moments such as these, that long-term fund managers look for opportunities.
“At this point, we do not think anyone can accurately predict the development path of COVID 19 in China and elsewhere,” said Ken Broekaert of Burgundy, co-manager of the St. James’s Place Greater European fund. “Without knowing this, it is also extremely difficult to accurately predict the direct effects on companies, and especially the secondary effects. We have limited exposure to the direct impacts of COVID-19 and to China. We are monitoring the valuations of all portfolio holdings and will buy [through this period of falling markets] if we see attractive opportunities.”
Global supply chains are particularly vulnerable to tighter borders, quarantine controls and protectionism, meaning they are at risk from containment and mitigation actions taken by governments around the world.
“Companies will be asking themselves whether they have made their supply chains too efficient,” said Hamish Douglass of Magellan, manager of the St. James’s Place International Equity and Global Growth funds. “Many people have moved a lot of their supply chains to China and have very minimal inventory and slack in the system. When part of the system goes down for any period of time you’ve got no latency there. People are going to have to think about how supply chains operate in this world if these outbreaks become more prevalent.”
As it happens, there is a great deal else going on in politics just now, not least in the UK, where negotiations begin today on the UK’s new trade arrangements with the EU and a new trade deal with the US; but also in the US, where Joe Biden has made an unexpected surge in the Democrat primaries. For the moment, however, there looks to be only one story moving markets in a major way.
It’s often said that good and bad things come in threes. The same, it seems, goes for the Budget, which will become a “trilogy” of financial statements over the course of the year, Treasury officials announced this week.
Chancellor Rishi Sunak is expected to delay some of the government’s biggest decisions on tax, spending and borrowing until the autumn, as the government tries to juggle its political pledges. While a freeze in Corporation Tax is expected to go ahead, a “mansion” tax and higher fuel duties may be delayed for several months. It also seems likely that any review of pension tax breaks will be pushed back until later this year.
While the Conservatives’ election manifesto pledged to spend more on the NHS, social care and schools, they also committed to reducing the deficit and curtailing borrowing by 2022.
If the government is to honour its spending pledges without incurring more debt, it must raise taxes, the Institute for Fiscal Studies warned this week. But without doing a U-turn on its pledge to not raise Income Tax, National Insurance or VAT, the government has limited wriggle room.
“We need a resolute focus on long-term outcomes and delivery, not short-term headlines,” reaffirmed former chancellor Sajid Javid during his resignation speech in parliament on Wednesday. “The fiscal rules that we are elected on are critical … to keep spending under control, to keep taxes low… and to pass that litmus test that was rightly set in stone in our manifesto – of debt being lower at the end of the parliament.”
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In The Picture
It has been a tough month on markets, as movements have been driven by fears over growth and, increasingly, COVID-19, rather than by company specifics.
The Last Word
We are facing a crisis, an epidemic that is coming. We know that we’re only at the beginning…
Emmanuel Macron, the French president, last week
Burgundy, FSSA, Magellan and Schroders are fund managers for St. James’s Place.
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