New information on the coronavirus (COVID-19) continues to arrive daily; however, the peak magnitude of the epidemic and the full extent of the economic implications are still unknowable at this point.
Markets appear to be pricing-in a V-shaped recovery as the base case for the Chinese economy and global growth, though some concerns over the longevity of the economic impact have appeared to affect risk assets in recent days. There are signs that the duration and scope of the economic impacts will be greater for COVID-19 than they were for SARS (Severe Acute Respiratory Syndrome) in 2003.
Notably, China’s economy is massively larger today than it was in 2003—more than eight times the size.1 It is also substantially more integrated into the global economy and more extensively linked into global supply chains. Today, China represents 16% of global gross domestic product (GDP), up from 4% in 2003.2
Supply chains have already started to see the effects of factory shutdowns. Notably, Apple issued a revenue warning this week for its March quarter, due in part to specific factories being unable to open. Around 500 million3 people have been in a virtual lockdown across the country. Hubei province, the epicenter of the virus outbreak and an area under significant quarantine, is a key location for electronics and technology manufacturing.
Consumption and travel sectors within China and regionally continue to be significantly impaired. Additionally, commodity imports into China have been disrupted as factory shutdowns have halted the manufacturing sector’s demand for external resources, such as petroleum and metals.
Of additional concern is the fact that COVID-19 is far more prolific than SARS was, increasing the likelihood that it will persist for much longer. It is highly contagious and has long asymptomatic incubation periods of up to 14 days.
Carriers that don’t know they’re sick can spread the disease to others over the course of weeks. Additionally, a significant percentage of cases only show mild symptoms,4 such as a low-grade sore throat, which carriers may not recognize as COVID-19 and may not accordingly take actions to avoid spreading the virus.
By contrast, SARS could only be spread to others after symptoms appeared, making it less likely to be unwittingly transmitted. The higher severity of SARS symptoms also drew carriers away from the public.
COVID-19 does have a significantly lower fatality rate (2%) than SARS (10%).5 Additionally, only around one in five infected people become severely ill,6 with around four in five confirmed cases exhibiting only mild symptoms.
However, COVID-19 is 20 to 40 times more fatal than the average seasonal flu7 and has approximately double the reproduction rate.8 At this stage, COVID-19 is projected to infect tens of thousands of more people than SARS did,9 with expectations for more than 100,000 confirmed cases.
Consequently, COVID-19 is a far more pervasive and stealthy disease than SARS, which has necessitated a stronger response from the Chinese government, leading to widespread containment efforts and longer quarantine periods. These measures may be justified to stop the spread, but they are also exceedingly disruptive to economic activity, bringing communities and businesses to a standstill.
Some virologists10 have modeled scenarios that show the disease potentially persisting for more than a year. Under such conditions, governments would need to respond with ever-more aggressive containment measures, potentially paralyzing economies beyond China.
At this stage, we are continuing to monitor developments and watching for any signs that COVID-19 has meaningfully permeated communities beyond China.
From a financial market standpoint, we think the tail risks of a more prolonged and higher magnitude disruption from COVID-19 remain underappreciated by markets. We continue to see elevated global risks, and continue to position our strategies to be uncorrelated to overvalued asset classes. The rapid spread of COVID-19 is a stark reminder that unexpected events can occur at any time, and that portfolio diversification remains critical when markets are priced for perfection.
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What Are the Risks?
All investments involve risks, including possible loss of principal. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline.
Diversification does not guarantee profit nor protect against risk of loss.
3. Reuters reported around 500 million people affected by quarantines and travel restrictions, as of February 14. https://graphics.reuters.com/CHINA-HEALTH-LOCKDOWN/0100B5EF3LJ/index.html
4. China CDC Weekly published results of 44,672 confirmed cases as of February 11, 2020. Case severity was observed as 81% of patients having mild symptoms, 14% developing severe symptoms as pneumonia, 5% becoming critical. The observed fatality rate was 2.3%.
5. World Health Organization (WHO) reports the fatality rate of SARS in 2002/2003 to be have been 9.6% of total confirmed cases. WHO estimates the current fatality rate of COVID-19 to be around 2%, as of February 18.
6. China CDC Weekly published results of 44,672 confirmed cases as of February 11, 2020. Case severity was observed as 81% of patients having mild symptoms, 14% developing severe symptoms as pneumonia, 5% becoming critical. The observed fatality rate was 2.3%.
7. Center for Disease Control and Prevention (CDC) estimates around a 0.05% fatality rate for seasonal flu in the Unites States in the 2019/2020 period. The estimated 1% to 2% fatality rate of COVID-19 is around twenty to forty times higher. https://www.livescience.com/new-coronavirus-compare-with-flu.html
8. World Health Organization (WHO) estimates the reproduction ratio (R0) of the common flu to be 1.3. It had estimated the COVID-19 R0 to be between 1.5 and 2.5, as of January 30. A January 29 study by the New England Journal of Medicine estimated COVID-19 to be 2.2.
10. CDC Director Robert Redfield publicly commented in an interview with CNN on February 13 that, “this virus (COVID-19) is probably with us beyond this season, beyond this year. I think eventually the virus will gain a foothold and we will get community-based transmission.” https://www.cnn.com/2020/02/13/health/coronavirus-cdc-robert-redfield-gupta-intv/index.html