February 20, 2020
HG Research, Singapore
For all the talk about the coronavirus (Covid-19) outbreak, there seems to have been very little in the way of impact on investor risk appetite up to now. Few seem to notice that nearly 50 million Chinese residents have been quarantined (nearly half the country has some form of travel restriction) and that there is a travel and visa ban on more than 70 countries.
It is not at all clear if anybody outside China is aware that Wuhan, the epicenter of the virus, is a major production centre for autos, semiconductors, electronic components and the like. Wuhan is labelled “China’s Optical Valley” and is a key player in the 5G production process. The disruption already caused to other industries around the world is not that well appreciated (not to mention all the cases and deaths). This has a significant impact on the supply chain of mobile-phone chips and modems, circuit boards, optical fibers, and the like.
Moreover, the disease is spreading across Asia. There are new cases daily in Singapore, Hong Kong, Thailand, Malaysia and Vietnam, to name but a few.
Yet, equity investors seem rather unperturbed. From the January 23rd initial high to the January 31st low, the S&P 500 declined a grand total of 3%. That classifies as a hand-wringing correction these days. One would think that a company so reliant on Chinese gambling in Macau, like luxury casino operator Wynn Resort, would be in a huge bear market by now. Far from it. The company’s stock price soared 4.1% last week and outperformed the S&P 500 by 250 basis points (never mind that its Macau operations have been suspended). Or what about Yum China Holdings? Well, it’s stock advanced 5% last week too.
Even the oil price managed to rally 3.4% last week to over $52 per barrel in the face of the EIA report showing U.S. domestic crude stockpiles soaring 7.5 million barrels (in the latest week), or more than double the consensus estimate of a 2.9million barrel build. Not to mention the 30% slice to its 2020 oil-demand growth forecast (380,000 bpd). Copper posted its best week since December as well.
Here are the assumptions behind the stock market’s resilience:
- That the coronavirus will be contained
- That this is only a temporary disruption to GDP
- That this is a marginal event since only 6% of S&P 500 sales are derived from China
- That this will play out like SARS back in 2003 and we will see a vigorous second half global rebound
- That China is on the precipice of a major round of monetary and fiscal stimulus
How realistic are these assumptions?
At this point it is impossible to quantify the full impact of Covid-19 on the Chinese as well as the global economy.
With regard to China, the American Chamber of Commerce in Shanghai reports that nine out of ten companies it surveyed says employees have not returned to work after the Chinese New Year break and are staying at home.
In a survey of 995 small and mid-sized companies conducted by Tsinghua and Beijing universities, 85% stated that they are unable to sustain their operations for more than three months under current conditions, and 30% expected their revenues to plunge by more than half for the entire year due to the virus. Worker quarantines and mobility constraints are making any stabilization in Chinese growth an impossible forecast.
Despite the sentiment and fund flows, this coronavirus outbreak will exert a toll on global economic activity, and the disruptions to supply chains are only now beginning. China’s share of global trade is now more than 11% versus 5% in 2003, and this interconnectedness with the rest of the world has seriously raised supply-chain risks. Not to mention the hit to travel and tourism, like the 3 million Chinese travellers to the United States every year (and spend $250 billion annually now on global travel/tourism). They typically visit for long periods of time and spend a lot of money.
The impact on luxury goods and services globally is huge. Burberry sales are 40% reliant on Chinese consumers. As of now, roughly one-third of all its stores in mainland China has been shuttered. Ralph Lauren makes a quarter of its products in China. According to Jefferies, China actually accounts for 40% global spending on luxury goods ($305 billion) and drove 80% of the growth last year!
The global spillovers are considerable, like in Germany, already hobbled by Brexit and the existing slowdown in China, where 7% of its exports go to China. For the time being, those outbound shipments are at risk.
China has emerged as the world’s largest textile exporter ($280billion or a 40% market share) as well as a huge exporter of furniture (26% of all furniture exports). While we do not see global shortages in these products yet, it is an area to watch if the virus situation is not brought under control in the near future.
Before the outbreak, China’s oil consumption was more than twice what it was when SARS hit and last year, the country accounted for more than three-quarters of the growth in global oil demand, according to the IEA. Its oil consumption is now down sharply as factories stay closed and travel restrictions remain in place even after the extended Lunar New Year holiday comes to an end. Congestion on roads in major cities is far below normal levels.
In that light, OPEC’s forecast that global oil demand will be cut by just 440,000 barrels a day in the first quarter and by 250,000 barrels a day over the year as a whole, looks like wishful thinking on the part of producers. It is doing them no favours, though. A delay in reducing supplies will only make the cuts needed later even deeper.
Despite all the uncertainty as to how the impact of Covid-19 will play out, there is at least a silver lining on the horizon: The increase in the number of daily new Covid-19 cases in China is now starting to slow. Not much at this point, but at least something to pin some hopes on.
Author: Group Investment Office