Coronavirus outbreak in China

February 2020

What happened?

• Since late December 2019 a new coronavirus strain, the 2019-nCov virus, began to emerge from Wuhan China.
• The outbreak has been predominantly focused in China, however is spreading to other countries.
• The outbreak has prompted border closures from several neighbouring countries including travel bans on Chinese citizens with Australia one of the more recent cases.
• This led to renewed concerns over global economic growth but weakness in China and Asia more generally.
• Australia has not been immune from this trend. Despite Australian equities performing well in January, China-exposed sectors such as resources and tourism have been notable underperformers.

• Why did the outbreak affect markets? Investors fear that the outbreak will further weaken a slowing Chinese economy and the consequences of this for countries dependent on Chinese growth (such as Australia). There are fears that this will continue to weaken global trade, investment and ultimately, company profits.
• Implications for your portfolio
• Growth concerns and fears over China weakness have benefitted bonds and assets unhedged to the Australian dollar.
• Until now, markets have generally shrugged of the risks posed by the Corona virus. In January and most of February weakness in international share markets was largely restricted to emerging markets with US shares for instance flat during January (and Chinese shares down 6.7%).
• On Monday 24^th February stockmarkets around the world fell sharply as cases outside china increased. This volatility is expected to continue over the coming days and months.
• Historically, shocks to the market caused by similar events (eg SARS in 2003) are short lived however can increase short term volatility.
• Over the past 18 months we have been increasing the defensive allocation in our model portfolios and feel they are well placed to ride out the expected market volatility caused by the corona virus.
• We will advise if we feel that continued fluctuations in share market prices warrants changes to portfolio allocations to increase defensiveness and lower risk.

Ongoing Monitoring and action

Our base case at present is for the outbreak to be gradually contained in the near term with its impact on the economy limited to weakness in the March quarter and potentially the June quarter of this year.

We expect periodic updates on the virus to contribute to market volatility at times. The scale of the economic shutdown is also likely to see poor economic data released in upcoming months (reflecting the weakness in trade and production as activity has softened).

Authorities also stand ready to commit to further stimulus with the People’s Bank of China committing to injecting further liquidity over the weekend. Locally the RBA can cut interest rates further if it anticipates weaker labour markets with the Federal Government also engaging in disaster recovery spending to offset the impact of the bushfires.

We will provide further updates if this view changes. For any further questions please contact your adviser.

What is the coronavirus and where did it begin?

The coronavirus is a new viral outbreak that emerged in the city of Wuhan in central China. It is believed to have originated in a live animal market in December 2019 and has seen 427 deaths reported globally out of 20,624 confirmed cases of infection to date.

A coronavirus is part of a broad group of viruses that target our respiratory system and are mostly found in animals. One more recent case was the SARS epidemic in the early 2000s. This outbreak is of the 2019-nCov strain with the belief that it was initially carried by animals and transferred at a live animal market in Wuhan late last year.

The symptoms are akin to that of the flu. A fever, cough or shortness of breath are among the initial symptoms. These can then lead to the more serious and potentially fatal pneumonia-like complications for infected individuals. The incubation period is between one to two weeks before people can show symptoms posing an additional challenge for authorities.

Timeline

• December 31, 2019: Symptoms are reported in Wuhan and later tied to the Huanan Seafood

Market.

• January 7, 2020: Cause identified as 2019-nCoV virus by Chinese health authorities
• January 9, 2020: First death tied to 2019-nCov is reported in Wuhan.
• January 13-15, 2020: International cases are reported outside China by Japan and Thailand
• January 23, 2020: China suspends travel in and out of Wuhan as well as several other cities within the province affecting approximately 50m people.
• January 24, 2020: Chinese authorities begin emergency construction of two new hospital facilities to be ready by February to house patients.
• January 30, 2020: The World Health Organisation declared the virus a global health emergency.
• January 31 to February 3, 2020: More cases outside of China in addition to work halts within China. Neighbours close borders to China as a defensive measure
• February 2, 2020: Australian government announces barring of entry for mainland Chinese visitors who are not citizens or permanent residents.
• February 3, 2020: The Australian government evacuates 243 citizens and permanent residents from Wuhan to be quarantined on Christmas Island for two weeks

Sources: Time Magazine, BBC

Human impact

The John Hopkins CSSE using a mix of Chinese, WHO and other data sources has reported 20,624

cases with a total of 427 deaths and 667 recovered at the time of writing (4 February 2020). Within this total there have been 190 cases confirmed outside of China and 2 deaths both of people either from Wuhan or who have recently visited there.

Sources: John Hopkins CSSE data visualisation, WHO, CDC, ECDC, NHC and DXY Confirmed cases Mortality rate (RHS)

This mortality rate is not tracking at an extreme relative to previous outbreaks (for context SARS had a fatality rate of approximately 10%) and according to this chart from The New York Times the range of estimates is mostly below 3%. In addition, the current 2.1% mortality rate may be potentially overstated given the potential for unreported, nonfatal cases where people have been infected and have since recovered or are recovering. We do note however that even with relatively low mortality rates, depending on how contagious it is, many people can suffer and even die as a result.

Economic impact

At a China level we expect the shutdown of transit between cities and programs designed to halt work temporarily to have several flow-on consequences. These include weaker economic growth from weaker consumer and business spending with these activities suppressed by restrictions on movement. The closure of borders by trading partners (and the dependence of said partners on Chinese demand) also raises the potential to drag on global growth. At present it appears localised to countries centred on the Asia-Pacific although other regions including Europe may experience spill over particularly given the importance of demand to the export industries of Germany for example.

The below exhibit from ANZ Research looks at the importance of Chinese demand for both tourism and goods exports (predominantly primary goods such as iron ore and agriculture). As the snapshot highlights China has become a much bigger target market for Australia over the 16 years since the SARS outbreak. This also excludes the importance of service exports such as education which have also increased over the same period.

This leads us to suggest a drag on economic growth domestically for at a minimum the March quarter and potentially beyond to the extent that infections continue to grow, and economic activity is restricted by travel bans and other controls. Some economist estimates have placed this as a drag of -0.2% on quarterly growth. This coupled with the damage from the bushfires raises the potential for a negative quarter of growth in Australia. It also increases the likelihood of at least one interest rate cut in the near term, consistent with our view that underlying economic weakness would prompt a reaction by the RBA.

Potential scenarios:

• Base case:
  • Virus case growth eventually slows down and becomes under control with restrictions slowly unwound globally.
  • Global growth to materially weaken in March quarter before bouncing back on Chinese government stimulus and central bank rate cuts.
• Extreme case
  • Virus escalation and spread to broader region with tighter border controls constricting global trade and demand
  • Increased chance of global recession offset to the extent the US and Europe can minimise exposure.
  • Material weakness in commodity and export demand sees Australia approach negative GDP growth including potential recession. 

Market impact

The impact on asset markets during January was concentrated on those with direct exposure to China as investors feared the consequences of a weaker Chinese economy. Other proxies for Chinese growth such as the Australian Dollar also fell substantially, reversing its December gains (when markets were excited about a US-China trade deal). These trends have somewhat persisted into February with the Australian Dollar continuing to weaken further.

• Base case
  • Continue to see Chinese equities and related assets e.g. commodities and currencies such as the Australia dollar struggle in near term before gradually recovering.
  • US dollar and other safe havens including gold to be supported by investor “risk off” sentiment with gold benefitting from falling bond yields.
  • Potential for rate cuts domestically as a support for other asset classes.

• Extreme case
  • Weakness in emerging market equities and firms exposed to offshore demand particularly in China e.g. luxury goods and auto manufacturers.
  • Global economic recession based on weakness in China and Asia more broadly.

Sources

Bagshaw, E. (31 January 2020), World Health Organisation declares coronavirus a global health emergency, The Sydney Morning Herald: https://www.smh.com.au/world/asia/world-health organisationdeclares-coronavirus-a-global-health-emergency-20200131-p53we4.html

Barone, E., Tweeten, L. and Wolfson, E. (30 January 2020), A Timeline of How the Wuhan Coronavirus. Has Spread—And How the World Has Reacted, https://time.com/5774366/how-coronavirus-spread-china/ (Date accessed: 3 February 2020)

BBC (1 February 2020), Coronavirus: US and Australia close borders to Chinese arrivals, BBC: https://www.bbc.com/news/world-51338899

BBC (2 February 2020), Coronavirus: China to bump billions into economy amid growth fears: https://www.bbc.com/news/business-51347497 (Date accessed: 3 February 2020)

Doherty, B. and Zhou, N. et al (4 February 2020), Coronavirus: first group of Australian evacuees taken to Christmas Island, The Guardian: https://www.theguardian.com/world/2020/feb/03/coronavirus-qantasevacuation-of-australians-in-wuhan-under-way (Date accessed: 3 February 2020)

Gallagher, J. (31 January 2020) Coronavirus declared global health emergency by WHO, BBC: https://www.bbc.com/news/world-51318246 (Date accessed: 31 January 2020)

Groch, S. (4 February 2020), What is coronavirus and how worried should we be? The Sydney Morning Herald: https://www.smh.com.au/world/asia/what-is-coronavirus-and-how-worried-should-we-be20200121-p53t9d.html

John Hopkins CSSE https://gisanddata.maps.arcgis.com/apps/opsdashboard/index.html#/bda7594740fd40299423467b48e9ecf6 (Date accessed: 4 February 2020)

Sheikh, K., Watkins, D., Wu, J. and Grondahl, M. (1 February 2020), How Bad Will the Coronavirus Outbreak Get? Here Are 6 Key Factors, New York Times: https://www.nytimes.com/interactive/2020/world/asia/china-coronavirus-contain.html (Date accessed: 4 February 2020)

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obtain and consider a copy of the prospectus or other disclosure material relevant to the financial product before making any investment decision to acquire a financial product. It is important to note that the price or value of financial products go up and down and past performance is not an indicator of future performance.