Correction, not bear market
We wrote in early February about the extent to which coronavirus (which causes the respiratory disease Covid-19) might impact markets, and we would wish to reiterate that view:
Regarding the impact of such outbreaks or pandemics on stocks – we think what is important to understand is the base from where we started. Equities had a very good year in 2019, so a natural correction seemed possible – markets just need a catalyst, and Coronavirus is it.
For coronavirus (2019-nCoV), our base case is that a 5% – 10% correction in equities could be merited. This is based off the short term growth impact of the virus coupled with already inflated equity prices due a retracement.
What has changed since then?
Since our note in Early February, the number of new cases being reported in China has slowed considerably – this led to markets recovering some, if not all, of the losses associated with the outbreak. The speed and effectiveness of China containing the outbreak surprised many. However, in recent days, the media has focused on new cases occurring throughout the world, with a focus on Italy. Markets have reacted to this news with a strong sell-off on Monday (24th Feb). Equities are down around 3% on the day, with safe haven assets rising (e.g. Gold +2.5%).
Our view is that if China – with a large and dense population – was able to contain the spread of coronavirus, we expect other nations (developed or otherwise) to be as effective. Of course, as it spreads globally, this does have an impact on trade and confidence. There is no doubt that the coronavirus outbreak has and will have an effect on China and global GDP in Q1. And it is still possible that it becomes a materially worse global pandemic. Our base case remains that a natural correction (5% – 10% from mid-January peak) in equities is merited, with emerging market equities potentially falling up to 15%. For reference, the UK market is down nearly 6% from its January high.
We would see this and further weakness as an opportunity to add selectively to equities, with gold remaining an anchor in portfolios. Our greatest conviction is in the UK market and increasing domestic exposure. Alongside this, opportunities are arising in Emerging Markets and Japan (where one also gets the defensive characteristics of the yen), although a more cautious allocation would also be prudent.
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