The Coronavirus and its possible impact on SA equities
JOHANNESBURG - The erratic share price movements on the JSE and world markets in general, have been a stark reminder to investors how integrated the global economy has become.
The outbreak of a new strain of the coronavirus (2019-nCoV or Wuhan Flu) in China has caused share prices on the JSE to move down sharply.
These moves raise some interesting questions for investors: Why are the share prices of companies operating in SA, thousands of kilometres away from China, impacted by the Coronavirus? Are these moves justified? Is this a buying opportunity? While we do not necessarily have the answers to all of these questions, we are going to attempt to shed some light on why the local market is reacting in this way.
First, we believe that it is very important to view this outbreak in context. The World Health Organisation (WHO) provides us with this context in its latest update on the outbreak.
According to the WHO, seasonal influenza results in 3mn to 5mn cases of severe illness and between 290k and 650k respiratory deaths p.a. In our view, the number of cases of the virus to date is not the main issue, but rather the gestation period and how contagious the virus is.
Over the past week the number of cases increased approximately fifteen-fold, with the average gestation period being c. 10 days and, more importantly, the virus appears to be contagious even before symptoms appear. This suggests to us that we won’t have an accurate sense of how far it has spread and how deadly it will ultimately be until well into February.
Unsurprisingly, many pundits are comparing the spread and severity of the Wuhan Flu to the early-2003 Severe Acute Respiratory Syndrome (Sars) outbreak. While this is a good starting point, with both having occurred around Chinese New Year (the period for the biggest migration of people on the planet by far), there are also important differences, including the not-so-immaterial fact that the US was coming out of recession and was about to invade Iraq in early 2003.
On the positive side, China appears to have responded far more decisively this time around. The living standards in China are also far higher today than c. 17 years ago, which is likely to have improved general hygiene awareness, and the country’s capacity to react quickly on the medical front. China has in recent days locked down 10 cities (70mn people), extended the Chinese New Year holiday by three days and banned package travel.
The downside, however, is that China is now much more important to and far more integrated into the global economy than it was in 2003 - China’s share of global GDP is up from 4.3% to 16.3%; the number of Chinese travelling abroad has increased from 16.6mn in 2002 to 162mn by 2018, and China’s role (especially as a consumer) in commodity markets is also far bigger.
The Sars outbreak had a large short-term impact on the Chinese/Asian economy (the hit lasted around 3 months), but less of an impact at a global level. Currently, however, while the impact is once again likely to be concentrated on Asian consumption (travel and thus tourism-related shares will be hard hit), the increased importance of the Chinese economy suggests a bigger global drag.
The impact on financial markets in 2003 was significant, but short lived. It is however impossible to disentangle these significant movements from the Gulf War.
Locally, the All Share Index started to fall in mid-January 2003 and troughed in late-April. Over this period the All Share Index lost 23% of its value. This was approximately two months before infections peaked in June 2003.
Commodity markets are far more difficult to compare as the unrest in the Middle East far outweighed the impact of the SARS virus. The price of Brent Crude oil, in particular, was extremely volatile during this period.
But why do markets react so aggressively to these types of outbreaks? Other than for the obvious reason of markets hating uncertainty, it is the impact on global trade and thus economic growth in general which causes market volatility when these events happen
The region of Wuhan is China’s main manufacturing hub, and thus effectively that of the world. Everything from batteries to toys to fibre cable to locomotives (to name a few) is manufactured in this region. The fear of market participants is that the lockdown of this region will impact manufacturing and thus global trade in general.
The other facet that may impact global trade is the restriction on global transport, not just of people during the Chinese New Year, which of course has a massive impact on tourism spent and luxury goods sales, but also on the transportation of goods across the world. Should this outbreak escalate, the crew of large cargo vessels will be banned from traveling and this will restrict the free movement of goods.
Thus far, we have not really touched on why a virus outbreak in China has such a significant impact on the FTSE JSE All Share Index. Global economic growth is one of the key drivers of commodity prices and when market participants start to question these growth rates, commodities and companies producing these commodities will come under scrutiny.
The oil price is already down c. 10% since 17 January (the International Energy Agency says China is the world's second-largest oil consumer), while CNBC reports that refined petroleum products (jet fuel, diesel and gasoline) have been hit “by fears that the virus will slow global transportation” and impact commerce and travel within China. Locally, Sasol’s profitability is likely to be impacted by the lower oil price.
Similarly, the sales of luxury goods items are highly correlated to tourism and particularly Asian tourism and travel. This means that global (and local) luxury goods shares (including Richemont, LVMH, Kering etc.) are in the crosshairs of the virus as one of the sectors being most exposed to a drop-off in Chinese demand. Royal Bank of Canada estimates that a 10% drop in 1H20 Chinese consumption would translate into a 2% reduction in the revenue of luxury goods firms, and a c. 4% impact on annual profits. We note though that it is obviously relatively tricky to forecast what might happen to sales given that the situation is recent and unfolding
But it is only in the case of the aforementioned companies and sectors where there is an identifiable direct link between the outbreak of the virus and the companies’ bottom lines. For most other local firms, the impact is more the indirect. South Africa is part of the global economy and if global growth slows then our already stuttering economy will struggle even more down the line. In addition, a worse-than-expected spread of the virus and a longer-lasting impact could fuel risk-aversion among international investors which would mean that investor appetite for emerging markets and other riskier assets will be diminished significantly. A move that would further negatively impact our already struggling economy.
Although we acknowledge that the threat of this virus is real, history has taught us that markets tend to exaggerate negative newsflow far too aggressively and that periods of greater uncertainty are very good buying opportunities. So, our advice to investors is to be brave and to collect some high-quality businesses in a prudent manner at very attractive valuations.
Stephán Engelbrecht is a fund manager and investment analyst