Mike explains the key uncertainties surrounding the coronavirus outbreak that has sent risk assets tumbling.
The coronavirus outbreak that started in China has sent jitters across global financial markets amid fears of a hit to the global economy. We think it is too early to assess the eventual impact on the economy yet see potential downside risks posed by the outbreak – with its unknown magnitude and duration. This underpins our view that U.S. Treasuries provide a source of portfolio resilience.
The outbreak has sparked a classic risk-off response, albeit one of relatively modest magnitude to date. Emerging market equities, airlines and oil prices have declined since Jan. 20, when the Chinese government confirmed the virus can spread from person to person. Perceived safe-haven assets such as U.S. Treasuries, as well as their inflation-protected peers, have gained. See the chart above. The VIX index, a gauge of U.S. stock market volatility, shot up to the highest level since October. Yet the risk-off sentiment has so far been relatively limited, with modest pullbacks in high yield credit and U.S. stocks, even after Friday’s sell-off. The impact from worries about the outbreak may have been partially offset by positive results in the current quarterly earnings season that so far are in line with our expectation for global growth to edge higher this year.
What can we learn from past global disease outbreaks? Economic growth and markets have historically responded with a V-shaped pattern. The temporary hit to economic activity results in pent-up demand, which eventually helps fuel the rebound in economic activity. This recovery is typically led by retail and manufacturing sectors, since lost revenues are harder to recoup in the services sector (think of tourism).