Authored by Archie Hart, Emerging Markets Equity
12 March 2020
The views expressed in this communication are those of the contributors at the time of publication and do not necessarily reflect those of Ninety One as a whole.
The events of Monday 9 March were the biggest ‘risk event’ in global markets since the Global Financial Crisis (GFC). There were two key contributors to the turmoil:
Firstly, the quarantining of 25% of Italy’s people (and 40% of its economy) crystallized fears around the spread of the coronavirus. Then, Italy placed the whole country under lockdown. Fears are directly over the life-threatening effects of the virus globally, and indirectly over the economy-threatening effects of the controls imposed to impede or stop the spread of the virus. Secondly, the fall out between Saudi Arabia and Russia has resulted in the collapse of the oil price as “OPEC+” effectively fell apart with Saudi Arabia vowing to regain lost market share in the oil market by discounting aggressively. As a result, equities across the energy sector experienced a widespread sell-off.
Contagion has spread to credit markets with spreads blowing out (11% of the US high yield market is related to energy) and signs of incipient stress, not least the collapse of US 10-year government yields to historically low yields of c.0.6%. Clearly, either the bond market or the equity market is correct, but not both. If the bond market is correct, then the equity market has significant downside. Or vice-versa.
Today, we are seeing some resilience in equity markets amid hopes for a large, globally co-ordinated, economic and financial stimulus. It is uncertain as to whether this will eventuate and even if does, whether it will be effective. There are two possible extremes to the outlook going forward. A ‘goldilocks’ scenario, where coronavirus comes under control without significant longer-term economic effects and economic growth resumes after a one or two-quarter. Or, a ‘multiple bear’ scenario, where an uncontrolled virus outbreak destroys social and economic confidence and leads to a major global recession. A third scenario is perhaps something in between.
It is very early to make a call on the outlook as the situation is developing rapidly on a daily basis. One complicating factor here is the role of psychology. A major difference between the SARS outbreak in 2003 and the coronavirus pandemic of 2020 is the ubiquity of social media (Facebook, WeChat, Twitter etc). This could magnify social concerns to such an extent that they wreak a significant economic impact as concern over the virus goes viral.
The second-order effects of the coronavirus and oil price decline are also likely to be significant. If this nationwide quarantine brings the Italian economy to its knees, could this trigger another crisis in the Eurozone, similar to 2011? Could US growth slow, making November’s presidential election too close to call? Could depressed oil prices trigger renewed (or in some respects, a continuation of) turbulence in the Middle East? There is much to ponder.
Amid this chaos, the only bright spot is China, whose people are quietly beginning to go back to work. Yesterday’s visit of President Xi Jinping to Wuhan is a strong indication that the Chinese government believes that it has brought the virus under control in a city which was the epicentre for the outbreak. Almost all of the new confirmed cases are currently being reported outside of China. Indications of the beginnings of recovery in China are many and varied. For example, at the height of the virus, 80% of Starbucks shops in China were closed, a figure that now stands at 10%. Congestion in Chinese cities is 85% of year-ago levels, however subway traffic is just 35% of year-ago levels, so many are clearly still concerned around the spread of the virus in public places.
First-quarter GDP growth for China will clearly be significantly impacted. The second quarter should see some continuing recovery – energy usage continues to rise as factories re-open – however it would appear that we will have to wait until the second half for China’s economy to be substantially normalised. Risks around this are whether there are renewed coronavirus outbreaks in China, whether Chinese consumer/investor behaviour has been significantly impacted and whether China sees significant contagion from its trade partners due to coronavirus impacting their economies. Notwithstanding the evident risks here, the nascent recovery of China will be an important underpinning to emerging markets equities as it represents more than 30% of the asset class
We continue to remain constructive on China, whilst being cognisant of these elevated short-term risks. We remain confident in the long-term prospects of the businesses we are invested in: importantly, we are yet to see significant stress in any of these companies. With regards to the outlook, we believe our style-agnostic process has – and will continue to – deliver attractive performance in the long-run, whatever the future trajectory of economies and markets. Dislocation in the markets is also likely to present us with compelling opportunities to identify stocks with the attributes we are so strongly focused on. We continue to focus on our process and our risk disciplines.
To close I feel it would be remiss not to mention that we also have business continuity plans in place such that we can continue to manage your portfolios under any eventuality.