The coronavirus outbreak has wreaked havoc on global equity markets, creating rare opportunities for a disciplined investment approach. We share our assessment of COVID-19’s impact on economies and markets and an update on portfolio positioning for Causeway equity strategies.
Economic Impact
• We expect the outbreak of the coronavirus to weigh on global gross domestic product (“GDP”) growth, with the greatest drag on China and South Korea, as well as on already weak economies in Europe and Japan. The length and severity of the demand shock from the virus scare remain unclear. A China recession—even if not recognized in the official data—has negative ramifications for most major economies and markets.
• Sovereign bond yields have fallen dramatically amid uncertainty over the virus’ economic impact. Virus-related fear has pushed an already compressed term premium (the additional compensation investors require for lending for longer periods) to a near-record low of -116 basis points. The “fear factor” element implicit in the negative term premium will likely remain in place until further clarity emerges regarding the economic impact of the virus.
• Many multinational companies, as well as those operating entirely in their domestic markets, will likely continue to suffer supply chain delays and rising costs, largely from work disruption in China, Japan, South Korea, and parts of Europe. However, we believe the earnings and cash flow setbacks will ultimately be temporary, and normalcy should return to supply chains and logistics as virus fears recede over time.
Government Response
• Monetary policymakers already have begun implementing supportive measures to ease the financial pain of a prolonged slowdown, such as the People’s Bank of China’s 10 basis point cut to the loan prime rate. The US Federal Reserve (“Fed”) made an emergency 50 basis point cut to interest rates in early March, attempting to combat the impact of widening credit spreads on financial conditions. Australia and Canada lowered policy rates in March as well. The interest rate cuts will likely not have a significant effect on consumer behavior in the short-term, but we believe they should allow for better flow of capital through credit markets and provide ample liquidity in an activity lull.
• A more direct response to counter the effects of the demand slowdown from coronavirus is fiscal stimulus. The Chinese government has pledged to be more proactive in its fiscal policy. Forms of stimulus may include more traditional infrastructure investment, such as rail and power, as well as new economy infrastructure, including 5G and health care. We believe the virus outbreak may act as a catalyst for European economies, in particular, to enact fiscal stimulus.
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