Written by: Michael Geraghty
COVID-19, more commonly known as the coronavirus, emerged in late 2019. It was first identified in Wuhan, the capital of Hubei, China. Infection is primarily through human-to-human transmission via exhalation, such as sneezing or coughing. Symptoms may include flu-like symptoms, such as fever, coughing, breathing difficulties, fatigue, and muscle pain. No vaccine currently exists. Thus far, the fatality rate has been estimated at around 2–3% of cases, with older people particularly vulnerable.
In this note we assess the coronavirus in terms of its impact on humans, economic activity, corporations, and financial markets.
Thus far there have been close to 3,000 deaths caused by the coronavirus — the majority of those in China — in addition to around 80,000 officially recorded cases globally. Worryingly, pockets of the virus have popped up in a range of geographically dispersed countries, most notably Japan, Italy, Iran and South Korea. As of now, some of the infections in those countries have no known connection to China. The World Health Organization (WHO) has said the increase in the number of cases in Italy, Iran and South Korea is “deeply concerning.” However, the WHO has not yet declared the spread of the virus to be a pandemic, which is defined as an uncontrollable geographical spread.
Restriction of movement is the primary method authorities are using to control the spread of the virus. In China, tens of millions of people are under some form of quarantine, curfew, or lockdown. Italy’s government recently imposed a lockdown on an area of 50,000 people near Milan, which is the epicenter of the virus in Italy. It has been reported that South Korean officials are drawing up plans for a quarantine in affected areas.
Quarantines, curfews, and lockdowns don’t just impact day-to-day activities, they also limit the number of workers able to get to work. So, for example, reflecting restrictions in China, Bloomberg Economics has estimated that the country’s economy is running at just 50-60% of its normal capacity. That was underscored by the fact that domestic car sales plunged by 92% in the first half of February.
The coronavirus outbreak in Italy centered around Milan is threatening to shut down the richest segment of the economy. Milan alone accounts for 10% of the Italian economy, and the Lombardy region more than double that. The New York Times recently reported that “Milan is not a closed city, but it is a drastically slowed one, after a spike of cases in the region, raising anxiety about a broader slowdown.”
The day after President’s Day, Apple warned it would not meet its first quarter 2020 revenue guidance because of the effects of the coronavirus. The company pointed to demand and supply issues in China. On the demand side, all its retail stores were closed at some point, although some are now open. The stores that have reopened are operating in a limited way, and with very low customer traffic. On the supply side, Apple said all its manufacturing facilities have reopened in China but were “ramping up more slowly than we had anticipated,” leading to iPhone supply shortages.
Supply chain disruptions because of the coronavirus in China have been impacting companies across the globe. China is a supplier of key components essential to a range of industries, particularly electronics and automobiles. However, as noted above, it’s estimated that China’s economy is only running at 50‑60% of its normal capacity.
It’s likely that supply-chain disruptions associated with past crises — such as the 2003 outbreak of severe acute respiratory syndrome (SARS) that swept across Asia, or the 2011 Fukushima nuclear disaster — are not good benchmarks for the current epidemic. For a start, today’s supply chains are global and more complex than they were in 2003, which was before China established itself as a manufacturing powerhouse. And during that period China’s growth represented a much smaller portion of global GDP growth than it does now. Second, the Fukushima nuclear disaster greatly impacted the global supply chain for auto parts, but not many other sectors were affected. Moreover, the damage to the supply chain was relatively short term.
In terms of market reaction to these events, in the six months after the first occurrence of SARS, the S&P 500 posted a gain of 15% (using April 2003 as a base); after 12 months, it was up 21%. In 2011, the year of the Fukushima nuclear disaster, the S&P 500 ended flat for the year.
For the moment, U.S. corporations remain sanguine. A recent Bloomberg study of corporate transcripts of S&P 500 companies revealed that about half said it was too early to gauge how the virus might play out, about a third said the virus would have some impact, and only 5% anticipated a severe blow from the virus.
Financial markets dislike uncertainty. So far, the cases of the virus in the U.S. have all been traceable to overseas travel. However, if cases not linked to travel start to emerge, that could lead to quarantines in the U.S., business shutdowns, and negative earnings estimate revisions. These factors would undoubtedly weigh on financial markets. While U.S. equity markets have declined as fears about the virus have spread, stocks still remain at the high end of the historical range in terms of valuations.
At this time Cornerstone is not recommending tactical shifts in asset allocation resulting from the virus, because it’s still too early to gauge the impact. However, we are closely monitoring potential economic impacts related to the spread of the virus.