{"id":89783,"date":"2020-03-03T23:11:47","date_gmt":"2020-03-03T22:11:47","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/weighing-up-potential-market-impacts-from-the-coronavirus\/"},"modified":"2020-03-08T21:36:42","modified_gmt":"2020-03-08T20:36:42","slug":"weighing-up-potential-market-impacts-from-the-coronavirus","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/weighing-up-potential-market-impacts-from-the-coronavirus\/","title":{"rendered":"Weighing up potential market impacts from the coronavirus"},"content":{"rendered":"

The coronavirus is a clear shock to the world economy. In its nature the disease is very
\ndifferent from the likes of SARS and swine flu in that the transmission rate is far higher and
\nmercifully the death rate is much lower. The other clear difference is that the infection has now
\nclearly left Asia. Up until the weekend Europeans and people in the US could be comfortable
\nthat this was a China issue with selective outbreaks in the rest of Asia. Now, with the
\ndevelopments in Korea and most critically in Italy over the weekend, this comfortable view of
\nmarkets has been shattered with the S&P close to 7% off its highs of only five sessions ago[[Bloomberg, 27 February 2020]].<\/p>\n

Where do we think the coronavirus will develop? Being a non-medical and non-public health
\nperson it is very difficult to forecast. I find it hard to believe we will not have a more significant
\nnumber of cases. The fact there have been school holidays throughout Europe, with many
\nfamilies vacationing across the continent, just exacerbates this. So, the question is how
\nsuccessful the authorities will be at containing any outbreak.<\/p>\n

I am encouraged at the success of Singapore in limiting cases and experiencing no deaths. Of
\ncourse, as we look ahead, we think the coronavirus outbreak will die away \u2013 the heat of
\nsummer should bring a relief in transmission rates, but even before then successful
\ncontainment should see the disease incidence taper. Looking at Chinese statistics (assuming
\ntheir accuracy) we can already see the aggressive containment strategy producing results.
\nThere will be a time when this crisis is over, and it should be in the coming months.<\/p>\n

So, what will the economic impact be? So far we see two clear impacts: lost consumption and
\nlost supply. Looking at the evidence from China, as the disease becomes the dominant factor
\nin people\u2019s thinking consumption falls. An Adidas market update last week stated that its
\nChinese business had fallen by 85%[[Adidas says business activity in China has tanked roughly 85% due to coronavirus, CNBC, 19 February 2020]] \u2013 at that level there is little mileage in analysts trying to
\nsecond guess the numbers. It is a clear disaster, but it is temporary. In a few months, and
\ncertainly before the end of this year, we will likely be back on trend. However, I suspect that a
\nsignificant portion of the drop in consumption will be lost forever. While we might still ultimately
\nreplace a smartphone, we are unlikely to buy that new spring season outfit.<\/p>\n

The second element is supply disruption, where we are seeing clear evidence of critical
\ncomponent shortages leading to underproduction. Apple already confessed to this last week[[Apple warns of coronavirus causing iPhone shortages, The Guardian, 17 February 2020]],
\nand we will hear much more. Again, if inventory is unavailable it will miss consumer demand
\nand a portion will ultimately be lost. In some industries where inventory cycles are the norm,
\nwe will enter a period of inventory adjustment. The depth of the down cycle and how global this
\nevent becomes will determine the required period of adjustment. It looks likely that we could
\nhave another \u201cindustrial recession\u201d driven by the coronavirus, similar to the 2012 euro crisis,
\nthe 2014-15 oil price collapse, and the 2018-19 trade dispute-driven slowdown. None of these
\nevents triggered an overall recession and given the temporary nature of the coronavirus event
\nwe would not anticipate one this time \u2013 though in the case of Japan and perhaps Germany we
\nmight see one, albeit mild.<\/p>\n

Companies will experience a period of negative earnings revisions which will continue to
\nnegatively impact the market even if its capacity to shock becomes limited. While we have not
\nmade a formal estimate, it is possible we will see earnings downgrades of double figures. This
\nwas the impact of the aforementioned viral slowdowns and would be enough to remove the
\nearnings growth that was forecast this year.<\/p>\n

Another way of thinking about this is that the slow growth environment the world economy has
\nexperienced since the global financial crisis (GFC) will continue. During that period the
\naverage company has struggled to grow earnings. Figure 1, for example, shows the
\ndevelopment of global earnings relative to the tech sector over that period.<\/p>\n

Figure 1: Companies last 12 months earning (1988-2019)<\/strong>
\n\"-695.jpg\"<\/a><\/p>\n

Coronavirus as an event means this trend will continue in 2020. Of course, it is not just
\ntechnology businesses that fit this category, but also medical tech and quality growth
\nbusinesses that can deliver in all economic environments. Earlier this week Mastercard issued a profit warning[[Mastercard cuts revenue outlook on coronavirus impact, FT.com, 25 February 2020]], reducing its revenue growth forecast by two to three percentage points.
\nChecking the company\u2019s performance during the GFC, even with the headwind of a strong
\ndollar it sustained revenue growth of 3%[[Visa, MasterCard cut costs as revenue growth slows, Budapest Business Journal, 16 February 2009]]. Good businesses outperform and consolidate their
\ncompetitive position during tougher times. <\/p>\n

In the medium term one of the clear implications that coronavirus brings is further pressure to
\ndiversify or even shorten supply chains. For the past 30 years the successful model for a
\nwestern business has been to lengthen supply chains to access cheaper inputs in low wage
\neconomies, of which China has been the poster child. President Trump has provided political
\nresistance to this; coronavirus adds a focus on security of supply.<\/p>\n

Over the next decade as the use of artificial intelligence increases, the frequency with which
\ncompanies make, for example, demand forecasts will rise, and the way businesses will take
\nadvantage of these insights is with a shorter, more agile supply chain with automation helping
\nto offset the resultant cost pressures.<\/p>\n

Finally, while the above discussion provides a framework for thinking about the impact of
\ncoronavirus, it is a fast-changing situation. I hope you all stay safe.