The coronavirus – things may get worse before they get better
After an extended Lunar New Year holiday period – due to the coronavirus outbreak – Chinese financial markets plunged when they opened on February 3 for the first time since January 23. Many local equities reached their daily limit of a 10% downturn. Chinese authorities are taking various steps to limit the economic repercussions of the epidemic, such as cutting the reverse repo rate and airing the idea of invoking a "flexibility clause" in the new Phase 1 trade agreement with the United States, since China may have difficulty living up to its trade-related commitments in the short term.
Other Asian stock exchanges showed mixed performance, and global stock markets have reacted more cautiously. Measured by the MSCI All Country World Index in USD, global equities have gained about 0.2% in the past week and have climbed by 0.6% so far this year, while a broad Chinese index such as the CSI300 is down 7% this year.
The coronavirus continues to spread rapidly. No one knows how severe the epidemic will be, but assuming a manageable outcome, the impact of the coronavirus on China's economic growth may be an annual deceleration in the range of 1 percentage point. That would mean around 0.1 point lower global growth. But this impact would be offset in a scenario where there is a recovery after market worries have faded and postponed consumption and capital spending materialise. If the virus should nevertheless continue to spread at a rapid and accelerating pace over a long period, it would probably have a more lasting impact on the economy. In that case we are also likely to see more actions by the authorities to ease this impact.
Naturally it cannot be ruled out that the situation may become more serious. But based on earlier experience, the findings of epidemiologists and the steps already taken, there are still many indications that the spread of the virus can be limited, so that its long-term effects will be manageable.
New Investment Outlook: If growth holds, stock markets will hold
On February 4, we published our latest quarterly market view report, Investment Outlook. It presents our take on both global and Nordic equities, fixed income investments and the general financial market situation. Last year's stock market performance was among the best in a long time. Although we expect another positive stock market year in 2020, due to the recent market rally, upside potential is limited and risks of setbacks have increased.
Of the three theme articles in this issue of Investment Outlook, two deal with areas where we expect growth regardless of which way the economy moves. The first focuses on part of global sustainability efforts − access to an increasingly scarce resource: clean water. We also explore two aspects of the continuing digitisation megatrend: the potential of robotisation and the role of cybersecurity. Our third theme article concerns one of the most important political processes in modern Europe: Brexit.
Read the full report or a two-page summary at seb.se/investmentoutlookreport
Conditions in global manufacturing are improving
The numerous sentiment indicators for the manufacturing sector that were published on February 3 generally pointed to an economic recovery. The revised figure for the euro area strengthened last week's upturn, while other European Union member countries showed higher purchasing managers' indices (PMIs) than expected. In the US, the Institute for Supply Management (ISM) manufacturing PMI rose to 50.0, beating the expected level of 48.5 (50 or above denotes expectations of economic expansion). This was up from 47.8 in December, and the ISM index has thus regained almost its entire decline since July 2019. Globally, PMIs are now comparable to the levels of last spring.
As expected, the Federal Reserve left its key interest rate unchanged
At last week's policy meeting, the US central bank signalled that its key rate will remain unchanged for some time while it evaluates the impact of earlier easing. Fed Chairman Jerome Powell's responses to questions about inflation and the ongoing review of the US monetary policy framework were interpreted as meaning that the Fed will continue to provide a market-supporting monetary policy and wants to nudge inflation upward to 2%.
Our market view in summary
The ongoing coronavirus epidemic is generating uncertainty. So far, market price movements have been fairly limited; most investors seem to expect the impact on growth and earnings to be manageable and relatively transitory. Yet there is no doubt that its effects will be noticeable in both global growth and in the earnings of listed companies during the first quarter of 2020, since large portions of China's production system have been shut down. If the spread of the virus is not slowed during the coming weeks and months, there is an obvious risk that the impact will be larger, especially on share prices. At present, however, we expect that we can eventually shift our main focus of attention towards more traditional economic and market drivers.
In recent days, we have seen surprisingly strong purchasing managers' index (PMI) figures, especially for US manufacturers. This reinforces our scenario of stabilising growth that can eventually regain new momentum, although these PMI measurements mainly pre-date the coronavirus outbreak. Meanwhile low interest rates and bond yields will persist for a long time to come. A combination of relatively healthy economic growth and ultra-low rates/yields should provide the basis for a favourable stock market climate.
The problem is that after last year's sharp upturns, stock markets have already priced in a lot of this optimistic scenario. Equity valuations are at or near historical peaks, exceeded only by the stock market bubble period around the turn of the millennium. Low bond yields and interest rates justify higher valuations than historically; if our scenario of decent growth and low yields/rates persists, investors can probably accept even higher valuations. Share prices may thus climb a bit further in this scenario. But given stretched valuations, upside potential is still limited, as is the market's resilience to negative news.
Judging from the ongoing corporate report season, fourth quarter 2019 earnings look set to end up a bit above the prevailing low expectations. If this trend holds, this will also provide support to share prices, but as long as uncertainty about the coronavirus persists, we will maintain our cautious attitude towards near-term stock market performance. There is a major risk that things will get worse before they get better. If the impact on growth is not too big, any stock market downturns may create buying opportunities.
Please contact your private banker if you have any questions or concerns.