Invest / 4 February 2020, 09:14am / Stephán Engelbrecht
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 3million to 5million cases of severe illness and between 290000 and 650000 respiratory deaths per annum. 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 about 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 the 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 about 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 (70million 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 4.3percent to 16.3percent; the number of Chinese travelling abroad has increased from 16.6million in 2002 to 162million by 2018, and China’s role (particularly 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.
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. 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 has a massive impact on tourism spent and luxury goods sales, but also on the transportation of goods across the world. If this outbreak escalates, the crew of large cargo vessels will be banned from travelling and this will restrict the free movement of goods.
The oil price is already down almost 10percent since January 17 (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 petrol) 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.
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 struggling economy.
Although the threat of this virus is real, history has taught us that markets tend to exaggerate negative newsflow aggressively and that periods of greater uncertainty are good buying opportunities. Our advice to investors is to be brave and to collect some high-quality businesses in a prudent manner at attractive valuations.
Stephá Engelbrecht is a fund manager and investment analyst at Anchor Capital.