Stock markets started the new year with some strong activity but fear and uncertainty surrounding the coronavirus outbreak in China quickly muted that early enthusiasm.
As a result, U.S. equities ended January 2020 flat while international stocks posted losses. Emerging markets, which are at the center of the coronavirus outbreak, fell 4.7% for the month. International equities weren’t spared, either, losing 2.1% over coronavirus concerns.
With stocks falling ill to coronavirus fears, investors sought the safety of bonds — which outperformed stocks in January. U.S. bonds gained 1.9% in January followed by emerging market bonds, which rose 1.5%. International bonds also posted gains of 0.8% during the period.
Source: Morningstar
Still, market volatility has remained unusually low considering the circumstances. We wouldn’t be surprised to see a market correction between 5% and 10% at some point — especially if downward earnings revisions materialize as the impacts of the virus on global sales and supply chains are quantified.
US Economy to Prove Resilient
Uncertainty surrounding the ongoing coronavirus outbreak has continued into February and we likely won’t see any relief until the end of the first quarter. That said, coronavirus effects are expected to cut into U.S. economic growth in the first quarter by as much as 0.4 percentage points, with Q1 growth estimated to be just 1.6%.
Despite the tight economic relationship between the U.S. and China, we believe few areas of the U.S. economy will be hard hit by the coronavirus outbreak outside of travel, hospitality, tourism, and manufacturing.
U.S. sectors and firms that rely on revenue and production in China will experience a much more direct impact on their business. These sectors include airlines, automotive, retail, gaming, media, and commodities. Electronics manufacturers already are feeling a pinch due to the shutdown of Chinese factories and quarantine of millions of workers in the country. For example, tech giant Apple Inc. announced recently that supplies of iPhones would be temporarily constrained as its Chinese operations come back online more slowly than anticipated.
Despite the impacts in Q1, we expect a rebound in U.S. economic activity to boost second quarter growth by 0.3 to 0.4 percentage points — limiting the drag on full-year growth.
Severe Losses Expected in China
While the U.S. economy will prove resilient to any short-term effects from the coronavirus outbreak, it’s another story in the Far East. We believe the short-term impact on China as a whole will be relatively devastating with sharp declines in retail sales, oil imports, and car sales.
Q1 growth in China is forecasted to fall 1.6 percentage points but, like in the U.S., a quick rebound is expected — especially when China's healthcare measures start to demonstrate their effectiveness (possibly in Q2). China’s annual growth outlook will likely be revised downward to the range of 5.5% to 5.8% from the general market consensus of 6%.
Containment Issues Could Extend Impacts
Containment of the coronavirus is expected by the end of the first quarter — followed by a sharp economic recovery in the second quarter as fears abate and consumers and businesses return to normal activity levels.
If efforts to contain the outbreak falter, however, global supply chains could become more constrained and companies that depend on Chinese imports may likely face temporary production delays. Permanent economic loss in China will inevitably spill over to the U.S. given that China makes up 24.5% of the U.S. supply chain.
Investors Hold Steady
At this time, though, we do not plan to make any major investment changes to our portfolios. Given our current positioning of late-cycle volatility and non-cyclical exposure, our portfolios are situated to weather the oncoming short-term disruptions.