Is a rebound in 2H20 still likely with COVID-19 now a global issue?

Coronavirus has become a global issue. However, disruption to global growth should be concentrated in first half of 2020. And the key driver for the expected rebound – looser monetary policy.

28 Feb 2020

COVID-19 has become a global issue

Since our last update in late January, investors' fears about the potential impact of the virus on global demand and on global corporate profits' growth have increased sharply.

As the number of reported coronavirus cases outside of China has risen, the prevailing market narrative has shifted: from the coronavirus being a predominantly China issue, to the coronavirus being a global problem. Ironically, investors' reaction to the increase in confirmed coronavirus cases in Korea, Italy and Iran comes at a time when official data shows the pace of new coronavirus cases in China is slowing. 

The growing human tragedy aside, there is considerable uncertainty about how the coronavirus will impact the global economy. This is itself a major contributor to increased investor risk aversion. In recent days, global equities and credit have generally fallen sharply while traditional safe havens such as government bonds have outperformed. At the time of writing, yields on both 10 and 30 year nominal US Treasuries stand at all-time lows.

Exhibit 1: Germany and Italy: Key Indicators and Coronavirus Cases

Sources: 1: Eurostat, 2018; 2: Wikipedia, 2019; 3: World Bank, 2017; 4: Johns Hopkins CSSE, 26th February 2020

Our base case has not changed – impact from coronavirus concentrated for 1H20

Our view coming into 2020 was that global economic growth would re-accelerate as the first half of the year progressed.

That view was largely predicated on the lagged impact of the significant loosening of global monetary policy in 2019 and expectations that easing trade tensions between China and the US would support a rebound in manufacturing and profits growth across the emerging market complex. 

In our view the coronavirus delays, but does not derail, the improving underlying demand trend evident in recent lead indicators and high frequency macroeconomic data that pre-date the coronavirus. 

But that underlying momentum is not likely to reappear consistently in global macroeconomic data in the short-term. We advise caution on drawing major investment conclusions from any single data release as the impact of the coronavirus unfolds.

The recent flash global Purchasing Manufacturing Indices (PMIs) are a case in point. The PMIs revealed some of the largest supply side delays in the history of the series due to the coronavirus. But as such delays have historically been driven by excess demand, rather than by supply side shocks, the development was treated as growth positive by the index methodology.

While not our base case, we should acknowledge the high degree of uncertainty that surrounds the potential global economic impact of the coronavirus - and the possibility that the virus will spread further in Europe and take hold in the US to a degree that could ultimately lead to a more significant slowdown in global activity than we currently expect and to recession.

As the experience to-date in China shows, the coronavirus can spread quickly and lead to major hits to consumer and business sentiment. At a minimum, the rise in cases outside of China clearly lengthens the period during which the virus is likely to impact global growth and remain a source of uncertainty to investors.

In our view, there is a degree of potentially dangerous circularity with regard to the virus and perceived US political risk. Falling equities and any deterioration in economic conditions are likely to boost the chances of a more progressive Democratic Party candidate such as Bernie Sanders winning the US presidency, for which investors are understandably demanding a higher risk premium.

But our base case remains that the disruption to demand growth from the coronavirus is likely to be concentrated in the first half of the year. Driven largely by the drop in offline domestic consumption and services, the hit to 2020 Chinese GDP even on our base case is nonetheless sizeable: we currently estimate that annual demand growth in China will be around 50bp-75bp lower due to the coronavirus.

Major economic impact of the coronavirus via global supply chain disruption

Apart from the material short-term hit to intra-Asian travel and tourism, to which Asian countries including Thailand and Singapore are particularly exposed, we see the other major economic impact of the coronavirus via the disruption to global supply chains - as highlighted in the most recent PMIs.

China's economy has evolved significantly away from its prior reliance on low value add manufacturing. But China is now a much larger economy, and a larger part of the global economy than it was, for example, during the SARS epidemic. In simple terms, China still produces a lot of the world's intermediate and finished goods across economic sectors. With many Chinese businesses not even opening their doors, the reduction in output is creating serious issues for an increasing number of companies outside of China. A recent report (Business Impact of the Coronavirus – Dun & Bradstreet) estimated that at least five million companies globally – and some 94% of the Fortune 1000 – have one or more suppliers in the area of China affected by the coronavirus.

As of February 25th, around 30% of China's SMEs had restarted business, according to China's Ministry of Industry and Information Technology, as China tentatively returns to work. In Chinese provinces away from the current virus epicenter, that figure is likely to be higher. But issues including logistics backlogs and personnel shortages still represent meaningful hurdles to the normalization of business and fulfillment of orders.

In time, companies may seek to de-risk their value chains away from China and turn to other Asian countries including Vietnam and Taiwan for manufacturing fulfillment. But in the meantime, these supply chain issues are starting to be felt at the corporate level globally. Apple, the world's largest company by market capitalization, recently revealed that it would miss its profits target for the current quarter due to supply problems and lower than expected demand in China, both caused by the coronavirus.

Significant as the potential impact is, we do not yet believe that the virus represents a more structural downward shift in potential global growth. Developed world consumption growth remains supported by generally healthy household finances and by low unemployment.

Yes, major geopolitical risks remain a threat to our base case, most notably in the forthcoming US elections and in the ongoing US/China trade disputes. But in aggregate we see the economic impact of the coronavirus outside of Asia as potentially limited. In particular, lower population densities are likely to be a key factor in limiting the spread of the virus in developed countries.

Accommodative monetary policy to drive rebound

But the principal driver to the rebound in global growth we expect later in the year remains accommodative monetary policy. The theory that monetary policy has lost its power is not one we subscribe to. Thirteen central banks across emerging markets have already reduced policy rates in 2020. We expect further cuts to key policy rates globally including in the US, Canada, UK and Australia. The recent fall in nominal bond yields further loosens financial conditions globally.

Should growth fall more than we expect in the short-term, we expect central banks to increase the policy stimulus. Monetary policy is also likely to be complemented by an increasing fiscal impulse in a wide range of developed countries including Japan and the UK that can further cushion growth. While the precise timing of any demand rebound is not easy to pinpoint in the context of the coronavirus, we see sufficient supports to believe that growth momentum will return. It has the potential to do so strongly.

More specifically, the Chinese authorities have the full suite of potential policy measures at their disposal to combat the domestic growth slowdown. Cuts across key market lending rates, the deferral of loan payments for impacted businesses, cuts to social security payments, fee waivers, automatic re-lending and utility subsidies are just some of the measures already put in place to help struggling Chinese businesses.

We expect more to come across all policy channels, but see the Chinese authorities turning increasingly to fiscal stimulus via tax cuts and increased infrastructure spending when the coronavirus dissipates sufficiently to allow local government spending plans to be reviewed and approved.

Views on coronavirus across investment teams

Within Investment Solutions our major views on asset classes have not changed materially. With all the industry comment coming into 2020 over the threat to traditional multi asset portfolios from a structural shift higher in equity/bond correlations, recent days have underlined the critical role that government bonds still have to play in improving the risk-adjusted returns potential of multi asset portfolios.

Within the universe of major global nominal government bonds, our favored market is China. On top of attractive yields on a relative basis, we continue to see Chinese government bonds as a very effective multi asset diversifier in the context of the coronavirus.

Within the global credit universe credit we remain positive on EM local and hard currency debt. Our view that global equities will outperform global government bonds over the coming twelve months also remains unchanged. Relative to bonds, global equities remain attractively valued – and we believe that global growth and earnings will rebound in the second half of the year.

The repricing of growth expectations and risk across asset classes due to the coronavirus has been far from uniform. And while the dislocations across markets are likely to offer opportunities on a selective basis, we remain focused amidst the noise and volatility. In our view, these are markets that are likely to reward staying disciplined and diversified.

Within Fixed Income, we have reduced credit risk and positioned strategies to benefit from increased demand of high quality sovereign and corporate bonds. Our focus is on developed and emerging markets where central banks still have the scope to manage downside risk through further policy accommodation.

For Emerging Markets Equities, the short-term economic impact from coronavirus could be significant, largely because of the considerable precautions taken (particularly in China), like travel restrictions and factory closures.

In China, many large companies and state-owned enterprises have resumed work, but smaller companies face more of a struggle. Coal mining, steel, food manufacturing have seen faster pace of work resumption, while less so for travel, tourism and auto-related sectors. Depending on the sector and progression of the Covid-19 situation, it is estimated that the impact of work disruptions could last for one to two quarters.

As for supply chain, even prior to Covid-19, the move to reduce dependence on China had started and Covid-19 provides an additional impetus to diversify. Favored destinations are South-East Asia (esp. Vietnam), India and reshoring, especially back to North America, Korea or Japan. Restructuring the supply chain is often accompanied by automation, benefitting factory automation companies.

But the outbreak of coronavirus is also accelerating fundamental, long-term changes in consumer behavior within emerging markets. For example, consumers are shifting online for services like after-school tutoring; fragmented industries like real estate and restaurants are consolidating; higher demand for better connectivity is driving investment in IT networks, and healthcare companies are investing in R&D and innovation to deliver new drugs and health services.

Despite the uncertainty caused by coronavirus, we remain confident in these fundamental, long-term changes playing out in emerging markets and our portfolios are focused on quality companies associated with them. That said, we remain cautious and haven't made big moves, but we are holding slightly higher cash reserves should opportunities emerge.

From a UBS Hedge Fund Solutions perspective, fundamental strategies may encounter some near term volatility as hedge funds digest the potential economic headwinds related to containment of the virus, but our relatively low net exposure should help mitigate the risk so we can be front footed after the uncertainties are resolved. Our overweight to macro trading and fixed income relative value should provide the opportunity to monetize the volatility created as markets digest the potential recessionary risk and government policy response to the crisis

For UBS O'Connor, fundamental strategies my encounter some near term volatility as hedge funds digest the potential economic headwinds related to containment of the virus, but our relatively low net exposure should help mitigate the risk so we can be front footed after the uncertainties are resolved. Our overweight to macro trading and fixed income relative value should provide the opportunity to monetize the volatility created as markets digest the potential recessionary risk and government policy response to the crisis.

Coronavirus is a risk to economies and real estate markets, particularly in Asia Pacific, but any impact will be short term if it is contained. There has been a dip in investment activity and share of international capital flows. We have seen interest rate cuts leading to yield falls in some markets, with real estate pricing around average versus index linked bonds. We do not see a big inflation risk and our analysis suggests that real estate offers suitable inflation protection.

More insights

Singapore Retail Investors

PLEASE READ THESE TERMS AND CONDITIONS CAREFULLY BEFORE PROCEEDING. BY UTILIZING THE WEBSITE AND PAGES THEREOF LOCATED AT WWW.UBS.COM/AM-SG ("WEBSITE"), YOU ACKNOWLEDGE THAT YOU HAVE READ THESE TERMS AS WELL AS THE GLOBAL TERMS OF USE (collectively "TERMS") AND THAT YOU AGREE TO BE BOUND BY THEM. IF YOU DO NOT AGREE TO ALL OF THE TERMS OF THIS AGREEMENT, YOU ARE NOT AN AUTHORIZED USER OF THESE SERVICES AND YOU SHOULD NOT USE THIS WEBSITE.

This website is not intended for and should not be accessed by persons located or resident in any jurisdiction where (by reason of that person's nationality, domicile, residence or otherwise) the publication or availability of this website is prohibited or contrary to local law or regulation or would subject any UBS entity to any registration or licensing requirements in such jurisdictions. It is your responsibility to be aware of, to obtain all relevant regulatory approvals, licenses, verifications and/or registrations under, and to observe all applicable laws and regulations of any relevant jurisdiction in connection with your entrance to this website. Each investment product and service referred to on this website is intended to be made available only to residents in Singapore.

UBS reserves the right to change, modify, add or remove content on the website as well as these terms at any time for any reason without notice. Such changes shall be effective immediately upon posting. You acknowledge that by accessing our website after we have posted changes to these terms, you are agreeing to these terms as modified.

The materials on this Website are distributed by UBS Asset Management (Singapore) Ltd (company registration number: 199308367C), which is licensed by Monetary Authority of Singapore ("MAS") in Singapore pursuant to the Securities and Futures Act (Chapter 289 of Singapore). UBS Asset Management (Singapore) Ltd is part of the Asset Management business division of UBS Group AG. UBS Asset Management (Singapore) Ltd together with UBS Group AG and its group companies shall collectively be referred to as "UBS".

The information contained in this Website has been prepared and is intended for general circulation. The information does not constitute advice and does not take into account the specific investment objectives, financial situation, or particular needs of any particular person. The investment services or products referred to in this Website may not be suitable for all investors. UBS recommends that you independently evaluate particular investments and strategies and seek independent advice from a financial adviser regarding the suitability of such investment products, taking into account your specific investment objectives, financial situation and particular needs, before making a commitment to purchase any investment products. Investment involves risks. You should be aware that investments may increase or decrease in value and that past performance is not indicative of future performance.

The information contained in this Website is not an offer to buy or sell or the solicitation of an offer to buy or sell any investment product or to participate in any particular trading strategy. UBS, its officers and/or employees may have interests in any of the investment products referred to on this Website by acting in various roles. UBS, its officers and/or employees may receive fees, commissions or other benefits for acting in those capacities. In addition, UBS, its officers and/or employees may buy or sell investment products as principal or agent and may effect transactions which are not consistent with the information set out in this Website.

You fully understand and agree that, by making available this Website, UBS should not be construed as making: (a) any endorsement of any investment product referred to in this Website; (b) any representation that UBS has performed any due diligence on any investment product referred to in this Website; or (c) any representation that the information in this Website is complete, accurate, clear, fair and not misleading. The use or reliance on any such information contained in this Website is at your own risk and any losses which may be suffered as a result of you entering into any investment are for your account and UBS shall not be liable for any losses arising from or incurred by you in connection therewith. UBS is not responsible or liable for the accuracy and completeness of any such information or the performance or outcome of any investment made by you after receipt of such information, irrespective of whether such information was provided at your request.

Using, copying, redistributing or republishing any part of this Website without prior written permission from UBS is prohibited. Any statements made regarding investment performance objectives, risk and/or return targets shall not constitute a representation or warranty that such objectives or expectations will be achieved or risks are fully disclosed. The information and opinions contained in this Website is based upon information obtained from sources believed to be reliable and in good faith but no responsibility is accepted for any misrepresentation, errors or omissions. All such information and opinions are subject to change without notice. A number of comments in this Website are based on current expectations and are considered “forward-looking statements”. Actual future results may prove to be different from expectations and any unforeseen risk or event may arise in the future. The opinions expressed are a reflection of UBS’s judgment at the time this document is compiled and any obligation to update or alter forward-looking statements as a result of new information, future events, or otherwise is disclaimed.

UBS does not hold out any of its officers and/or employees as having any authority to advise you, and UBS does not purport to advise you on any investment product. Any investment will be made at your sole risk and UBS is not and shall not, in any manner, be liable or responsible for the consequences of any investment.

This Website and its contents are provided on an “as is” and “as available” basis. UBS does not warrant: (a) the accuracy, timeliness, adequacy commercial value or completeness of this Website or its contents, and expressly disclaims any liability for errors, delays or omissions in the contents, or for any action taken in reliance on the contents; (b) that your use of and/or access to this Website or its contents, will be uninterrupted, timely, secure or free from errors or that any identified defect will be corrected; (c) that this Website or any content will meet your requirements or are free from any virus or other malicious, destructive or corrupting code, agent, program or macros; (d) that any information, instructions or communications posted or transmitted by you through this Website is secure and cannot be accessed by unauthorised third parties; and (e) that use of the contents in this Website by you will not infringe the rights of any third parties. No warranty of any kind, implied, express or statutory, including but not limited to the warranties of non-infringement of third party rights, title, merchantability, satisfactory quality or fitness for a particular purpose and freedom from computer virus or other malicious, destructive or corrupting code, agent, program or macros, is given in conjunction with this Website.

You hereby agree to indemnify UBS and any of its officers, employees or agents against, and to keep UBS and any of its officers, employees or agents harmless from, any claims (actual and threatened), settlement sums, liability, loss, damages, costs (including solicitor and client costs and expenses (legal or otherwise)), charges, expenses, actions, proceedings, whether foreseeable or not which we may sustain, suffer or incur, directly or indirectly out of or in the course of or in connection with any the following: (a) any use of this Website or the contents by you, or any part thereof; (b) UBS having made available the Website; (c) any breach of these Terms by you, however arising; or (d) any negligence, act or omission, wilful default, unlawful act, fraud and/or misconduct on your part or violation of any rights of another person or entity by you.

The funds referred to in this Website have been authorised or recognised by the MAS for sale to the public in Singapore (the “Funds”). Copies of the registered Singapore prospectuses ("Prospectuses") referred to in this Website have been lodged with and registered by the MAS. The MAS assumes no responsibility for the contents of the Prospectuses. The registration of the Prospectuses by the MAS does not imply that the SFA or any other legal or regulatory requirements have been complied with.

MAS registration is not a recommendation or endorsement of a Fund nor does it guarantee the commercial merits or performance of such Fund. It does not mean that a Fund is suitable for all investors nor is it an endorsement of its suitability for any particular investor or class of investors. UBS Asset Management (Singapore) Ltd has been appointed as the representative for the Funds in Singapore for the purposes of performing administrative and other related functions relating to the offer of Shares under Section 287 of the Securities and Futures Act, Chapter 289 of Singapore (the "SFA") and such other functions as the MAS may prescribe.

You may not assign your rights under the Terms without our prior written consent. UBS Asset Management (Singapore) Ltd may assign our rights under the Terms to any third party.

No person or entity who is not a party to the Terms shall have any right under the Contracts (Rights of Third Parties) Act, Chapter 53B of Singapore or other similar laws to enforce any term of the Terms regardless of whether such person or entity has been identified by name, as a member of a class or as answering a particular description. For the avoidance of doubt, this shall not affect the rights of any permitted assignee or transferee of the Terms.

These Terms shall be governed by, and shall be construed in accordance with, the laws of Singapore. The courts of Singapore shall have exclusive jurisdiction to hear and determine any suit, action or proceeding, and to settle any disputes, which may arise out of or in connection with these Terms and, for such purposes, you agree to submit  to the jurisdiction of the courts of Singapore. Each party hereby waives any objection which it might at any time have to the courts of Singapore being nominated as the forum to hear and determine any proceedings and to settle any disputes and agrees not to claim that the courts of Singapore are not a convenient or appropriate forum.

© UBS 2020 - the key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

Reset