(Feb 28): The number of people infected and affected by the coronavirus continues to grow globally. Governments, as well as agencies such as the World Health Organization, are working tirelessly to contain, and ultimately defeat the virus. In China, local governments have locked down cities and businesses and restricted travel while the general public has adopted voluntary home quarantine. In all, the human toll has been steep.
But as with many crises, the repercussions of the coronavirus can also be felt in the global economy and the financial markets. Many observers compare the coronavirus to the 2003 SARS epidemic. While this can provide useful insight, there are differences between the two periods to consider. China is a much bigger part of the global economy and markets than it was 17 years ago. China’s share of global trade also rose to 11% in 2018 from 5% in 2003, based on World Bank statistics. Meanwhile, its share of the MSCI Emerging Markets Index has risen to 34.3% from 7.86% in 2003.
We can dig deeper to understand the economic exposure of individual securities and equity portfolios to China’s economy, based on sources of company revenues. Using the MSCI Economic Exposure database, chart 1 shows that the most exposed developed equity markets are Singapore, Hong Kong, Taiwan, Australia and Korea.
We can also examine the revenue exposure of different industry groups to China. The revenue exposure of listed companies in the developed equity markets to China has more than tripled since 2006. However, this top-level number hides the diversity across different industry groups. Those playing a role in the global technology supply chain or selling consumer goods tend to have higher-than-average exposure to China.
Breaking down performance by factors
How have the Chinese and Asia ex-Japan equity markets responded so far to the coronavirus outbreak? Our analysis focused on industry factors, as we saw the largest impact to industries and relatively little impact to styles which included value and size.
We see that the airlines, marine (airlines and marine are one industry in Asia ex-Japan), consumer services, media and retailing (media and retailing are one industry in Asia ex-Japan) were among the most negatively affected industries in both markets. By contrast, healthcare was among the biggest gainers in both China and Asia ex-Japan. The moves in Asia ex-Japan from Jan 20 to Feb 5 corresponded to more than three standard deviations, while some of the moves in China were near eight standard deviations (we note Chinese markets were closed from Jan 24 to Jan 31).
These observations are hardly surprising. If consumers reduce contact with the outside world, their spending on travel, hotels, entertainment and shopping would likely be reduced, resulting in lower revenues for the associated industries. On the other hand, healthcare would likely benefit if there were increased spending on hospital care and preventive measures taken by the general public.
We see similar, but less severe, patterns in other regions. We observed industries that may have led the market in reacting to the development of coronavirus. Specifically, on Jan 20, the first day when awareness of the virus appears to have had an impact on factors, the overall China market was actually up about 1%, with the first large drop in consumer services of over 3% and a gain in healthcare of over 1%. The following day, the factors again moved more than the market. It wasn’t until Jan 23 that the overall market really responded, with a drop of about 3%, which was the fourth day that we had seen the response in factors.
Implications for global portfolios
Comparing these industry-factor returns with their performance during the SARS epidemic provides further insight. Similar to the current outbreak, airlines, marine and consumer services in the Asia ex-Japan market underperformed, while health care outperformed the overall market during the SARS epidemic. It took approximately four months (to June 2003) to bring SARS under control, and that roughly corresponds to the time it took factor performance to “normalise”. The current episode appears to be playing out more rapidly.
Following the peak of the SARS epidemic, China’s quarterly GDP growth, retail sales growth and revenue from outbound tourism bounced back quickly as businesses resumed operations. One signal to watch is when newly confirmed cases persistently drop below newly healed cases.
As with most market disruptions, there will be winners and losers. As we have stated previously, we have already seen a greater negative impact in sectors such as consumer discretionary and gains in healthcare. In our stress-test scenarios, we assume a flight-to-quality market reaction, which benefits securities such as US Treasurys.
We also assume the Chinese yuan depreciates relative to the dollar, and crude oil continues to decline due to decreasing Chinese demand. We applied a stress test to a hypothetical 60/40 portfolio of global equities and US bonds with the assumptions about broad market aggregates shown in the exhibit below.
Our assumptions of broad market aggregates have been informed by our analysis of historical data (like the 2003 SARS outbreak, for example). However, there is no historical period that exactly corresponds to our assumptions, and the current markets may react differently to the coronavirus outbreak.
We then applied MSCI’s predictive stress-testing framework to propagate the main assumptions to all other risk factors impacting returns. Our stress test shows that a well-diversified 60/40 portfolio, under the scenario with the above assumptions, could lose approximately 2% whereas global equities could lose slightly less than 5%. In addition, Treasury bonds could gain 2%, offsetting some of the losses. When focusing on specific industry groups, the impact spanned from a 13% loss for the global semiconductor and semiconductor equipment industry group to a slightly less than 4% gain for the global pharmaceuticals, biotechnology and life sciences industry group.
The coronavirus epidemic is not the first time that a virus outbreak has threatened to upset financial markets. However, the world is more connected since the 2003 SARS outbreak as global companies’ revenues have become more exposed to China. Investors may want to examine such revenue exposures, as well as the potential diversity in impact across industries and asset classes.
Zhen Wei is MSCI’s Head of China Research, MSCI; Jun Wang is MSCI’s vice president, equity factor modeling research, and Thomas Verbraken is MSCI’s executive director, risk management solutions research.
