There are inevitably more differences than similarities between the current coronavirus COVID-19 epidemic and the outbreak of SARS in 2003, but there are still lessons to be learned. To begin with, 17 years ago the US was building up to its invasion of Iraq and concern about the impending war was the primary market driver.
While SARS broke out in November 2002, it did not begin to affect markets until March 2003. Hong Kong equities started to underperform global equities noticeably after the World Health Organization (WHO) issued a global alert about a new infectious disease in Vietnam and Hong Kong.
Even though the crisis was declared over by summer, the factor that turned equity market performance around was the Hong Kong government’s announcement of a USD 1.5 billion relief package to boost the domestic economy. The local market subsequently outperformed global equities over the next several weeks.
The equity indices which did the worst not surprisingly concerned those markets most tied to the travel and leisure industries, and to retail demand. Given that SARS hit the local market when global equities were rallying, US Treasury yields were rising and gold was falling, there was no obvious safe haven trade.
The best performing of the Chinese domestic industries was pharmaceuticals: it gained 11% on anticipated demand for medication.
Once the broader market rebound began, three out of the five worst-performing sectors moved to the top-5 of the best: airlines, diversified financial services, and software.
The remaining top performers – metals & mining and chemicals – had not fallen by as much during the downturn.
The current COVID-19 outbreak is taking place at a time when there are few other big factors for the markets: GDP growth is generally steady, central bank policy is broadly on hold, and the latest company earnings reports have provided few big surprises.
Moreover, equity markets had already rallied sharply since early October and valuations had become stretched. Arguably, markets were just looking for a catalyst to correct. In contrast, early 2003 saw markets falling in the lead-up to the Iraq war and price/earnings ratios (P/Es) were average.
These differences may explain why the COVID-19 epidemic has had a more typical risk-off impact, with safe havens rallying globally (see Exhibit 1).
Exhibit 1: The returns of safe-haven assets such as government bonds have risen as the coronavirus spread
Data as at 25 February 2020. Graph shows returns from 17 January to 25 February 2020. Source: FactSet, BNP Paribas Asset Management
Equity losses have again been concentrated in industries sensitive either to domestic consumption or transportation (see Exhibit 2).
The key question is now whether by the time equity markets bottom, stock multiples will have dropped to levels that can be considered truly attractive for investors or will have just moved a bit closer to the average (particularly in the US).
Exhibit 2: Travel and other industries offering discretionary goods and services feature among the worst-performing asset classes since the outbreak of the coronavirus – graph shows returns for the MSCI Zhong Hua equity index (covering China and Hong Kong) from 17 January to 25 February 2020
Data as at 25 February 2020. Source: FactSet, BNP Paribas Asset Management
It will take time before investors can assess the impact of this epidemic on corporate earnings and hence valuations. The drag on profits, however, should only prove temporary as demand is either simply delayed (e.g., for tourism and luxury goods) or it is offset by fiscal stimulus (steel) and new sources of demand (pharmaceuticals).
During the SARS outbreak, trailing earnings for MSCI Hong Kong index components fell by 8% from peak to trough, and by significantly more for exposed industries such as hotels and restaurants.
However, both had recovered within a few quarters. While equity markets (over)reacted quite readily to any factor that could depress earnings, the long-term profitability of the companies concerned was essentially unchanged.
As for the timing of a turn in the market, in the case of the SARS outbreak, the catalyst was the stimulus package for the Hong Kong economy. The Chinese government today is also taking significant measures to boost economic growth.
The timing of the package in 2003 was important, however. By the time it was announced, the total number of new cases was levelling off. Similarly today, the pace of new reported COVID-19 cases in China also appears to be stabilising, but experts anticipate an acceleration elsewhere (see Exhibit 3).
We will likely again need to reach the point where the rate of new infections globally is falling before markets rebound.
Exhibit 3: Markets can be expected to start discounting relief measures and support for the economy once the number of reported cases begins to level off – graph shows cumulative number of reported cases of SARS (Hong Kong) and COVID-19 (global) in thousands
Data as at 25 February 2020. Source: World Health Organization, Worldometer, BNP Paribas Asset Management
Though the number of reported cases for COVID-19 is already much higher than for SARS, the parts of the equity market most sensitive to the epidemic have so far fallen by less.
A month from the beginning of the sell-off, local airline indices are down by 16% compared to a 20% drop during the SARS epidemic. For the broad market, the returns are -6%, in line with the returns during SARS. In 2003, notably, this was the point at which the markets bottomed.
Given the efforts of governments to contain the virus and to offset the economic impact, we believe markets will turn higher reasonably soon.
While Chinese GDP growth will be depressed in the first quarter of this year, we are still looking for a V-shaped rebound. There is nonetheless the risk that it is more U-shaped, something the markets do not currently have priced in.
The key determinant will be whether Beijing believes its objective of doubling GDP by 2020 (which implies a 6% real annual growth rate this year) must be met at all costs. If it decides to ease off on this ambition, growth will be lower.
There will likely be longer-term impacts on global supply chains as companies reassess their China exposure. This was already underway because of the US-China trade war. However, this will be to the benefit of those countries which see increased investment.
In our multi-asset portfolios, we remain overweight equities (US and emerging markets) as the medium-term macroeconomic outlook is positive and central banks appear ready to support their respective economies as needed. The US fed funds futures market has again begun pricing in further interest rate cuts this year.
Those equity sectors that we would expect to rebound the most include transportation, tourism, leisure, and luxury good-related businesses. US Treasuries may well sell off the most given that yields have fallen to all-time lows. Current levels imply a near-term recession, which we believe is unlikely.
However, timing is as always the key. The obvious uncertainty over how widely the virus will spread means investor sentiment may remain depressed for a while longer yet.