23 January 2020
Concern around the potential escalation of the CoronaVirus is dominating global headlines. GAM Investments’ Tim Love considers the impact this could have on emerging market equities.
The outbreak of CoronaVirus has been making headlines worldwide, with 400 plus known cases (and rising) and an increasing number of fatalities. As a manager of emerging market (EM) equities, it is my job to consider how long-term holdings should be positioned to navigate through these types of ‘Black Swan’ events. Ever since the SARS outbreak in 2002/3, I have consistently cautioned that, bar a major tactical (nuclear) war, the potential for a pandemic episode was my biggest global concern for EM equities. In my view, such an occurrence could have more influence on these markets than US dollar movement or cyclical commodity / growth factors.
The nature of increasingly concentrated EM urbanisation, alongside rocketing EM demand for protein sources, has inevitably led to closer interaction between humans and animals. This is particularly reflected in the intensive modern farming techniques / production work being adopted across EMs. This, coupled with the increasingly common cross-usage of normal human antibody prescriptions being industrially incorporated into animal farming techniques, suggests that previously reliable human immunity defences are becoming ever more vulnerable in terms of their effectiveness.
In this vein, it is unsurprising that when a virulent virus comes along, it will test the World Health Organisation (WHO), and additional global response measures, to reduce cross-continent contagion. The ongoing Ebola outbreak in the Congo already has both the WHO and investors on a high state of alert.
Therefore, this current outbreak of CoronaVirus should not be disregarded. Especially as it has its own inherently tricky characteristics, namely:
- It appears to take up to five days for symptoms to appear; this potentially renders global airport response screening checks redundant (as carriers may have travelled prior to feeling ill or before running an identifiably abnormal temperature).
- There has not yet been a formal confirmation of the source (at the time of writing), although the Wuhan food market is considered likely. The exact food chain within the market place is still under investigation.
- Professor Jonathan Ball, from the University of Nottingham, stated to the BBC, "We should be worried about any virus that explores humans for the first time, because it's overcome the first major barrier. Once inside a [human] cell and replicating, it can start to generate mutations that could allow it to spread more efficiently and become more dangerous. You don't want to give the virus the opportunity."
On the plus side, China’s National Health Commission is dealing with this outbreak in a coordinated and transparent manner with its global counterparts. It has also said travellers should avoid Wuhan and residents should not leave the city. In our view, this is first class effective response work.
Moving to the more mundane commercial considerations, how has the investment community responded?
At present, the market response has been very similar to its initial reaction to that of SARS (Asia’s last major outbreak). During that period, the market response remained negative for a lot longer than current behaviour indicates. To us, this points to a potentially material downside (+20%) should it migrate to a global pandemic scenario.
It is our view that the overall market is ripe for consolidation, following strong re-rating rallies in Nov 2019 to Jan 2020, reflecting the signing of the Phase 1 trade agreement between the US and China. Aggregate Asian markets are currently circa 3% below their all time highs.
At the moment, we believe the market is showing optimism, clearly erring on the side of this being ‘a controllable situation’. From a sector perspective, the expected rotations have already occurred: China healthcare and global pharmaceutical / healthcare-related stocks (ie Malaysia's rubber glove manufacturers) have already rallied circa 10-20%.
Conversely, sectors that have benefited from a concentration of people have been negatively impacted: travel companies (such as Chinese online operator Trip), airlines (globally, but China in particular), casinos (Macau’s US owned Wynn) and global cruise liners (Carnival) are all down markedly.
The question for EM investors at this juncture, is should the market double up these responses or unwind them should the WHO measures prove effective? The answer lies in an investor’s risk profile: how should this risk factor be viewed? Is it more of a threat or a regression to normality (ie an opportunity)?
We are presently in ‘watch and wait’ mode until more clarity on the direction of travel appears. Therefore we would advocate caution – keeping liquid by raising some cash provides the option for a quick response when needed and should avoid the prospect of being whipsawed. We believe such a position should not be considered ‘dead cash’ as it opens up the opportunity to be exposed to the attractive investment grade EM currencies during this short-term waiting period.
Clearly much depends on the WHO data releases in the coming days, but hopefully initial panic over this global pandemic risk will subside quickly. Yet looking for high quality stocks that are attractively valued, as has long been our philosophy, is a sensible approach in our view. We believe buying poor quality stocks that play to this theme – ie a knee jerk decision to buy healthcare stock protection at this stage (and at this elevated level) – will only pay off if this threat does expand. Globally, that is neither our hope nor expectation at this juncture.
Risk analysis, as always, is the key here. While the high quality plays may have been identified in either direction and modelling may be pointing to a contrarian stance by buying the oversold sectors most hurt by this outbreak, to what extent can someone afford to be wrong? We believe that should guide the degree and speed of coming out of ‘wait and see’ mode, where these counter cyclical indicators could be selective followed into further weakness.
The nature of this call is never easy.
That is why we have always stated this is a serious area of threat to a heterogeneous asset class of EM equities with their exposure to high urban concentrations, that also span all time zones. Tactically, we will not really have an idea on the true scale of the outbreak until after the Chinese New Year (ie 25 January). At the moment the mortality rate is very low at 1% (which is mostly related to the vulnerable) versus SARS which was 10%. So, in effect given we are data dependent, we believe it is too early to buy quite yet and could be further complicated by the fact that many of the Asian markets will be closed over next the few days.
Hence we plan to stay in watch and wait mode over the short term, but will keep a close eye on the quality regressions that have been damaged in the recent sell off.
Our best wishes and hopes remain with those directly affected by this.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice.