In China, the COVID-19 Coronavirus crisis appears to have eased somewhat with many manufacturers getting back to work. However, the global spread, particularly through South Korea, Italy and Iran has raised fears of a potential pandemic. Globally, there have been 80,000 confirmed cases with nearly 3,000 deaths recorded. It appears likely that the number of confirmed cases greatly understates the number of people who have been infected. So far, from an economic and market perspective, it is the measures taken to try and halt the spread that are causing more problems than the virus itself. The closure of factories, the quarantining of people, the reduction in travel and tourism will undoubtedly have a negative impact on earnings. However, how long this will last and the long-term economic impact is much less clear. A vaccine is in development, but is unlikely to be available over the next few months. There have been encouraging stories about treatments becoming available which may ease the symptoms. While the manufacturing situation in China is improving, whether other countries will enact the draconian measures China has done is yet to be seen.
Over the last week, we have seen many equity markets fall over 10%. On the positive side, government bonds have rallied as markets move to price in rate cuts. Long-term equity market valuations should be based on the future stream of earnings. The current situation has cast a shadow over the earnings in the next year, but ultimately companies are likely to return to profitability. If you value equities on the discounted future earnings, then some correction for the disruption appears rational. However, if you look at the bond market for your discount rate, the fall in long-term yields continues to make equities look attractive. Since the start of this year, the 10-year gilt yield has almost halved from 0.83% to 0.43%. Equally, in the US, the 10-year Treasury yield has fallen from 1.92% to 1.22%. All other things being equal, these moves should have provided a strong support for equity markets. However, the uncertainty caused by the virus and the measures to halt the spread are increasing uncertainty about the outlook, subsequently causing the market to fall. This becomes self-fulfilling as stop losses cause more selling and computer trading kicks in. Market makers are reluctant to take on inventory, further reducing liquidity for risk assets. The media coverage delights in making as much as possible of the market moves, thus increasing the fear in people's minds. At times like this, it is important for investors to keep an eye out for the long-term returns and look through the short-term volatility.
We cannot be sure when the news on the Coronavirus will improve or how much further the selloff will go, but we encourage investors to take a longer-term view and remain invested. If we look for reasons to turn the market then it may look for fiscal and/or monetary stimulus from governments and central banks in the days and weeks to come.
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