This might be the quietest Chinese Lunar New Year ever. Restaurants and shopping malls are closed and planned family gatherings are canceled. On the first day of the new year, streets are usually crowded with people greeting each other and watching traditional lion-dance performances. However, this year only a few people rushed in and out of grocery stores, their new year’s smile fully covered by face masks.
The coronavirus outbreak has taken center stage, sparking nervousness around the world and severely hampering business in Asia’s financial centers. While the trends appear to be stabilizing, the number of infected and the death toll continue to increase daily. This has many observers worried about the widespread ramifications to equity markets locally and abroad.
Will History Repeat Itself?
Many have looked to the 2002-03 SARS outbreak for insight on the potential market impact of the current crisis. The chart below shows the four markets (Mainland China, Hong Kong, Taiwan, and Singapore) that were hit hardest by SARS. Unsurprisingly, each country’s stock market index fell immediately following the declaration of the first confirmed case in that country (November 2002 in China, February 2003 in other countries). However, the market declines were short-lived and reversed quickly when the epidemic slowed down in May 2003. But simply looking at index levels barely scratches the surface and provides little context.
It’s a mistake to use the SARS period to predict the market impact of the current crisis because the Chinese economy, market dynamics, and geopolitics have changed dramatically over the last 17 years.
From an international perspective, China’s share of world GDP has leaped from 4% in 2003 to 16% in 2019 according to IMF estimates. Domestically, the economy of China has transitioned from export-led growth to become more consumption driven. While the public stock market was dominated by the Energy and Industrial sectors back in 2003, as of December 2019, Consumer Staples and Consumer Discretionary make up 27% of the market. China remains the world’s largest goods exporter, shipping 17.1% of its U.S. $2.5 trillion worth of goods to the European Union in 2019, 16.7% to the U.S., and 11.1% to Hong Kong according to data from China’s National Bureau of Statistics.
Compared to 2003, China has grown to be the “manufacturing hub” of the world, driving the consumption of raw materials such as crude oil and natural gas. Being the second largest importer in the world (behind the U.S.) implies that a potential slowdown of the Chinese economy will dampen global commodities demand, putting downward pressure on commodity prices. At the same time, a slowdown in Chinese production will disrupt supplies for those who rely on Chinese inputs/exports for their manufacturing processes (e.g., automakers, technology companies, and consumer products). The importance of China in the ever-intertwined global supply chain can’t be overstated.
Who Is Exposed to China?
We analyzed the MSCI AC World index, leveraging FactSet’s GeoRev database to assess China’s significant influence on global markets. As of January 31, 2020, 4.0% of the index weight is domiciled in China, but based on geographical revenue breakdown, over 9% comes from China. By sector, the Information Technology (2.46%) and Consumer Discretionary (1.58%) sectors are most exposed.
Unsurprisingly, the top four countries within IT sectors whose revenues are most exposed to China (including Hong Kong and Macau) are the U.S. (1.80%), Taiwan (0.17%), Japan (0.14%), and South Korea (0.14%). For the consumer discretionary sector, it is the U.S. (0.26%), Japan (0.11%), Germany (0.05%), and France (0.04%). The revenue exposure is even more striking when looking at individual companies.
Besides revenue dependency, supply chain interrelationships are also deeply embedded in the production process, as shown by the number of suppliers/customers/partners count that’s linked to China in the table above.
Average Revenue Exposures to China >20% by Sectors
Being an export-driven economy, Australia has become more dependent on China since the 2003 SARS outbreak. China accounts for 38% of Australian exports compared to just 8% in 2003 according to data from the Australian Bureau of Statistics. The RBA has downgraded near-term GDP projections and warned that spillover effects of the coronavirus could be larger than during SARS. The immediate impact has been felt particularly hard in the education sector and on estimates of iron ore demand.
In all, of the 3,046 stocks on the MSCI AC World index, 2,198 have revenue exposure from China. This number shrinks to 1,466 if we exclude companies that are domiciled or headquartered in China, Hong Kong, or Macau; the average China revenue exposure is 7.53% for these companies. 118 stocks have more than 20% revenue exposure from China (excluding companies domiciled or headquarters in China).
What’s Happening in the Chinese Market Now?
CSI 800 Sector Performance
The current situation is a double-edged sword to different sectors domestically. As one would expect, the Travel and Transportation sectors are suffering. These two sectors are down by 16.67% and 17.17%, respectively, since China started to limit outbound tours as of January 27. The absence of Chinese tourism will have a profound impact globally as travel comprises over 80% of China’s service imports. It is expected that this sharp decline in revenue will persist in the short term.
Like what happened during SARS, healthcare-related sectors are one of the main gainers, stimulated by a mass re-prioritization of health by the Chinese people. For example, the recommendation of a cocktail treatment that includes Ribavirin—an antiviral drug which was used to treat SARS in 2003—has already resulted in a drastic increase in the stock prices of pharmaceutical companies that produce Ribavirin or other relevant antiviral drugs.
Millions of people are confined at home, so what can they do to kill time? Play games! Based on the CSI 800 index, the Games Software sector has gone up 28.51% since the outbreak started. Tencent’s Honor of Kings, a multi-player online game, set a record on January 24 with a one-day gross revenue of CNY1.7-2 billion, representing a 50% year-over-year increase. This trend is likely to continue as most Chinese schools have postponed the start of school until at least late February, and students represent one of the biggest groups among the game’s players.
Stress Testing the Coronavirus Impact
We created three scenarios to model the potential market impact of the coronavirus:
Base Scenario – Events continue like SARS with the coronavirus impact easing within a few months
Optimistic Scenario – The coronavirus will be contained before summer with a continued reduction of new cases
Conservative Scenario – The severity of the virus will increase and impact markets longer than SARS
Several Chinese sector-specific factors are included to reflect realistic sector performance domestically. U.S. market indices have been omitted as U.S. market performance has so far been muted from the crisis due to upbeat domestic economic data. Nevertheless, historical factor correlations will enable the model to calibrate the corresponding impact across different global markets given the shock to the bond market, oil prices, and a commodity export currency.
The table below illustrates the potential impact on some major global market indices (in USD) using the FactSet Multi Asset Class (MAC) risk model. Based on January month-end index data, we see declines in returns for the MSCI All Country World index between 3.6% to 11.3% depending on the duration of the impact of the coronavirus.
Looking at the top/bottom three U.S. sectors impacted by each scenario, it’s not surprising to see that the more defensive sectors such as Utilities and Consumer Staples outperform. While the real estate sector has fallen in China, our model predicts that it will not cause the same decline in the U.S. The countries that are most adversely impacted are predominantly emerging economies with large trade relations with China such as Brazil, South Africa, and Argentina. This is likely due to the fall in Chinese demand for raw materials. From these scenarios, we see that unlike SARS, which impacted mostly countries within Asia, the ripple effects of the coronavirus are likely global.
Uncertainty fuels anxiety and fear. Market sentiment and the herding mentality drive extreme volatility and sometimes irrationally exuberant behavior. Irrespective of the short-term market impact observed in past pandemics, investors need to leverage all the tools at their disposal and exercise great care in assessing their exposure in an ever-entangled world.
Here is the hope that man will triumph over the coronavirus outbreak soon and as the old Chinese saying goes, “Caution is the parent of safety.”
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