There is good and bad news with the COVID-19 outbreak. The good news is that the number of new confirmed cases in China is coming down and that more people are now recovering than getting infected. The bad news is that the number of infections is rising in other countries, such as South Korea, Japan, Italy and Iran. This raises concerns that the global economic impact from the outbreak could be more profound. Moreover, flash February Purchasing Managers’ Index numbers for Japan and the U.S. were surprisingly low. The 10-year U.S. Treasury (UST) yield fell below 1.5% for the first time since September 2019, while the 30-year UST yield fell to a record low of 1.91. The S&P 500 price index lost 3.4% on February 24. Major equity markets across Europe were also down 3-4%.
Economic activity in China is recovering slowly, according to high frequency daily data such as traffic and coal consumption numbers (Exhibit 1, next page). South Korea’s export data for the first 20 days of February also showed a 3.7% decline in exports to China, compared with a rise of 24% to the U.S. and 20% to Vietnam. Some manufacturing sectors are still operating significantly below capacity due to insufficient workers, as quarantines still in place across China have meant workers are struggling to return to work. Factories also need to install the necessary protection measures to prevent infection in order to be allowed to reopen. All these imply it could take some weeks before full production capacity is restored. This would dent China’s headline economic growth in 1Q 2020 further, as well as raise Asia’s downside risk to growth.
The rise in the number of cases outside China could also dampen consumer spending and manufacturing activities. The extent of this damage would be determined by how quickly their respective governments can contain the outbreak and provide economic support. Some Asian central banks and governments are actively providing additional stimulus to the economy. As expected, The People’s Bank of China cut the Loan Prime Rate by 10bps last week. The Chinese central and provincial governments have been waiving value-added taxes, social contributions, rent and other charges to ease businesses’ burdens. In its 2020 budget, the Singapore government is planning to run a fiscal deficit of SGD 10.9billion, or 2.1% of GDP, the highest since 1997. The Hong Kong government has announced a HKD 30billion fiscal relief package to those sectors hardest hit by the outbreak. We could see similar measures from other Asian central banks and governments.
Given policy support and the nature of the outbreak, we expect Asian economies to experience a sharp drop in growth in 1Q 2020, but this should be followed by a prompt rebound once the infection rate comes under control.
EXHIBIT 1: COAL CONSUMPTION
Source: Wind, J.P. Morgan Asset Management.
CNY = Chinese New Year.
Data reflect most recently available as of 19/02/20.
Investment implications
For now, Asian investors should maintain a balanced approach to asset allocation given the uncertain nature of the outbreak. Risk aversion is likely to prevail if more countries see the number of cases rise in the weeks ahead. The rising number of cases in Italy is also focusing the minds of European and U.S. investors on the global impact from rising infections.
Projecting the market reaction from China in recent weeks onto the global markets, share prices for consumer staples, real estate and healthcare sectors are expected to be relatively more resilient. Consumer discretionary, industrials, materials and energy could see greater vulnerability as infection undermines consumer confidence and economic activities. In fixed income, investors are likely to continue to seek yield and income given exceptionally low risk-free rates. Emerging market and Asian central banks have more room to cut interest rates and this would benefit emerging market and Asian fixed income. A low yield environment would also benefit developed market corporate debt, despite tight corporate credit spreads indicating rich valuations. Potential growth concerns from the outbreak could harm high yield corporate debt more than high grade paper.
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