Global stock markets have been sent sharply lower this week by news that the coronavirus outbreak is continuing to spread outside mainland China, with significant clusters in Italy and Spain in addition to an increase in cases in Iran and South Korea.
Although reports suggest that the number of new cases is stabilising in the Chinese province of Hubei where the virus was first discovered, investors have been unsettled by fears of wider spread economic disruption as companies find it increasingly difficult to maintain normal production levels, travel is restricted and reduced economic activity hits sales and profits.
Initially markets viewed the outbreak as an anomaly largely confined to China where efforts to restrict the spread of the virus such as factory closures and quarantine restrictions would weigh on first quarter economic growth, but would be followed by a rebound later in the year as the outbreak was contained. With the emergence of the virus in Europe and reappraisal of the impact of the disruption in China to supply chains and demand, the market has taken the view that valuations warrant closer scrutiny and the next few weeks will be crucial in determining the direction and magnitude of market movements.
What should investors do?
A period during which global economic data weakens is inevitable and if the situation moves into pandemic territory with multiple outbreaks around the world, then the market will undoubtedly remain nervous and continue to sell off as the economic impact becomes more pronounced.
Attempting to predict the course of the virus is impossible but similar scares such as the SARS outbreak in 2003 have shown that once infection rates slow as they usually do in viral outbreaks, possibly aided by warmer weather, markets rally as the prospect of a longer term impact on economic and business performance recedes.
Countries around the world are taking extraordinary steps to contain the virus and pharmaceutical companies and researchers are working towards a vaccine intensively with reports that human testing could begin in April. On the economic policy front, central banks including the US Federal Reserve and Bank of England stand ready to provide liquidity and interest rate cuts to stimulate recovery. Importantly consumption and demand has been postponed not removed and should the outbreak be contained more rapidly than markets now anticipate the pick-up in activity should provide considerable impetus for recovery.
While conscious of the concerns raised for investors and of the potential for deterioration before matters improve we are not advocating any major restructuring. Balanced portfolios will typically be diversified, including assets such as government bonds and gold which have risen in value due to their safe haven qualities. Exposure to the sectors hardest hit such as airlines, travel companies and natural resources is also limited.
Although safe-haven assets can provide a temporary shelter, values may decline significantly when the situation begins to improve and if interest rates move lower the prospect of higher returns from bonds and cash will become an even more distant prospect, providing continued support for the return potential of equities, including attractive levels of dividend income in many cases. For long term investors, the current bout of weakness may in fact present opportunities as stock market overreaction results in companies being temporarily undervalued. Evidence that the rate of growth of new coronavirus cases outside of China is being contained will be needed though for a rally to begin.