With worrying developments regarding the spread of Coronavirus dominating much of the news, it’s impact on financial markets may not be at the forefront of people’s minds. However, portfolio analysis firm Style Analytics has produced research that suggests the impact of the virus, despite its relatively low mortality rate (thought to be around 3 percent), could have profound effects on the global financial markets.
Damian Handzy, chief commercial officer of the firm, told Fundeye that although it might be natural to compare Coronavirus to previous health scares such as SARS in 2003, in reality a more apt comparison from a financial impact point of view is the Chinese equities rout of 2015.
“The Chinese equity crash of 2015 is a strong enough analogy [to the Coronavirus] as markets are behaving similarly today with the Chinese government flooding the market with cash,” said Mr Handzy.
The Chinese government is also planning to lower interest rates, buy equities and lower its tariffs against US goods in an attempt to shore up its markets.
Style Analytics expertise is in factor or style investing. Some might wonder what this has to do with a potentially devasting endemic but Mr Handzy presents a compelling case. He has produced various scenarios that might follow the outbreak of the Coronavirus although one potential outcome sees no need for investors to use a factor tilt.
If the virus is contained to China, it should be over in around three months and investors shouldn’t have to readdress their factor allocation.
However, if it’s similar to the 2015 implosion of the Shanghai Composite Index, which during the summer of that year saw 30 percent of its value disappear, this will lead to contagion to the rest of the global financial markets.
It should also be noted that when SARS hit in 2003, China made up for less than five percent of the global economy, now it’s closer to 20 percent.
“If there’s contagion to the rest of the world’s economy, low volatility, high dividend stocks will do well. A flight to quality is a standard fear response. Small cap, high volatility, value stocks will suffer if this occurs. There will a rotation back into momentum stocks,” Mr Handzy told Fundeye.
This will come as terrible news to value players such as Orbis, especially as the last quarter of 2019 saw outflows from low vol strategies as value finally seemed to have finally caught the attention of investors.
It is the global contagion scenario that Mr Handzy sees as the most likely. He makes a worrying comparison the Spanish flu epidemic of 2019. While a three percent mortality rate doesn’t sound high, if it spreads globally, this could results in tens of millions of deaths. While making sure a portfolio is defensively positioned as to not be wiped out in the potential disaster might seem a tad distasteful given the humanitarian implications, it is something investors need to think about.
Even if the worse-case scenario doesn’t occur, there will be fear driven response by the markets anyway and safety first is likely to be the order of the day. So a shift into bond proxies may occur, stocks trading on undemanding price-to-earnings multiples while paying generous dividends at the expense of the higher risk but greater reward value stocks.
Even if European and North American investors don’t have any Chinese holdings, in an age of globalisation China can’t simply be ignored.
For those who have been waiting for the rotation into value to come into play, unfortunately that now seems postponed. Indefinitely.
