Coronavirus “outbreak” fears cause largest falls in shares since the GFC. Property, holding strong for the moment.

Coronavirus “outbreak” fears cause largest falls in shares since the GFC. Property, holding strong for the moment.

Written by Investor Expo

2 March, 2020

Coronavirus “outbreak” fears cause largest falls in shares since the GFC. Property, holding strong for the moment.

At the time of writing, the stock markets around the world are falling in reaction to the outbreak of coronavirus and its impact on economic growth, company earnings and consumer confidence.  As previously reported there are two scenarios – Containment and Outbreak.  When we wrote about the virus in early February there were 20,000 cases worldwide and 425 deaths, all in China.  These numbers have now shifted to 90,000 infections across 60 odd countries, and 3,000 deaths worldwide.

Our analysis of the market’s likely trajectory for the “Outbreak” scenario suggested that stocks would fall, interest rates would drop, as would the $A and oil price.  It is clear that the markets are now thinking Outbreak is in play with many of these forecasts now close to being a reality.

What is concerning markets is the shift in the story to outside of China. The rate of new cases increased at a higher rate outside of China for the first time in late February 2020.

 

Outbreak in the Middle East is of grave concern

Most troubling is the state of affairs in Iran, a less privileged country with a weaker health system, hyper inflation, 17% unemployment, civil unrest and a government that seems to be in denial. The BBC has reported deaths of over 200 people in Iran while the government’s official number is 54.  BBC reported “There are fears in Iran that the government, unsure of how to handle the outbreak, is covering up the extent of the spread of the new coronavirus disease.” Iran’s Health Minister Saeed Namaki naively announced that all schools would be closed for at least three days from Saturday as a precaution. This has since been revised to three weeks.

This is a far cry from drastic measures taken by China when it locked down Wuhan in January 2020.  Whilst the media beat up on China concerning human rights, the Chinese authorities, supported by WHO, were vigilant and military in their efforts to contain the virus.  And this approach seems to have worked.

The head of the World Health Organization’s emergencies programme, Dr Michael Ryan, said on Thursday that the apparent high mortality rate in Iran indicated its outbreak might be more widespread than realised.

If you believe the Iranian government’s official mortality rate of 4.5% it is almost three times the mortality rate of cases outside China and twice the Chinese mortality rate.  If you believe the BBC reports the number of cases could be as high as 10,000 in Iran.

 

Decades of sanctions present Iran’s economy as fragile and vulnerable to pandemic

Underlying Iran’s problem is a poorly prepared and very weak economy following decades of sanctions imposed by the US and others:

  • Iran’s gross domestic product (GDP) contracted an estimated 4.8% in the 2018 and is forecast to shrink another 9.5% in 2019, according to the International Monetary Fund.
  • The unemployment rate meanwhile rose from 14.5% in 2018 to 16.8% in 2019.
  • Iran’s government itself forecasts that oil export revenues will be reduced by 70% in the next Iranian fiscal year causing the Iranian currency to hit all-time lows and pushing the cost of living up dramatically.
  • The Statistical Centre of Iran reported that the Consumer Price Index (CPI) 12-month rate of inflation for households stood at 42% in late October 2019.
  • Food and beverage prices were up by 61% year-on-year and the price of tobacco was up by 80%.

These conditions have caused widespread anger with hundreds of thousands of people taking to the streets across Iran in violent protests late last year. A crackdown by security forces left at least 208 people dead and thousands injured, according to Amnesty International. The government dismissed such figures as “utter lies”.

Under enormous pressure the Iranian government has maintained robust commercial relations with China, Iran’s economic lifeline in the face of US sanctions. Therein lies the link to the Coronavirus outbreak in Iran.

Market Impact

   Scenario (3 mths)
 31/12/194/2/20ContainOutbreak

Latest

01.03.20

ASX 30066476915700060006395
S&P 50032303225330029002954
Shanghai comp.30382735300020002880
Crude oil price$60.7$50.5$55$45$44
US 10Y treasury1.8%1.5%2.0%1.2%1.38%
Residential Property+3%-5%+1.2%
$A vs $US70.167.2706065
RBA rates0.750.750.500.250.75

 

Iranian leaders are not moving quickly to contain the virus

President Hassan Rouhani has ruled out placing any cities or areas in quarantine, despite the head of the joint WHO-Chinese mission on COVID-19 saying such measures had helped “changed the course” of the outbreak in China. There has also been concern about the decision not to close the Shia Muslim shrine of Hazrat Masumeh in Qom, which is visited by millions of pilgrims every year. 

The shrine’s custodian, Ayatollah Mohammed Saeedi, has said that it should be kept open as a “house for cure” and that “people should be encouraged to come”.

Iran is a country of 83 million people and is at the epicenter of the Middle East. Tehran’s City Council was quoted in official media on Friday as saying “it’s likely that between 10,000 to 15,000 people in Iran have been infected with coronavirus”.  We feel this is the tip of the iceberg.

Share markets experienced their biggest falls since the GFC

Share markets suffered their largest falls since the GFC last week as “the factory of the world” impacted supply chains of many of the world’s largest companies.  Many factories are dependent on China’s 300 million migrant workers, a third of whom are still not working because of quarantine rules.  According to Bloomberg Economics, Chinese factories were operating at 60% to 70% of capacity last week.

While it is good news that factories are reported to be coming back online it would be too early to suggest stabilization in share markets. Firstly, it is unclear whether the outbreak is under control.  While China looks to have contained the virus locally there are many parts of the world that are experiencing significant growth in new cases every day.  This includes other economic powerhouses like South Korea, Germany, Italy and more recently the Middle East that supplies a significant proportion of the world’s oil.

Goldman Sachs says the S&P 500 could quickly fall another 7% on coronavirus fears – and warns US firms won’t generate any profit growth in 2020.

Apple, the largest company in the US predicted Q2 revenues to drop from $91 billion to a range of $63 billion to $67 billion due a slowing in iPhone manufacturing and overall Apple sales in China. Microsoft saw $62 billion of its market value erased after it said coronavirus will hit profits this year. Mastercard announced on Monday it would lower its first-quarter and full-year revenue forecasts, citing the virus’ impacts on travel and e-commerce growth. 

Coca Cola reaffirmed its full-year guidance on Friday but warned of an earnings per share hit of 1 cent to 2 cents in the first quarter. The beverage giant said the outbreak disturbed its supply chain.

Royal Caribbean Cruises has issued a number of guidance updates through February as it cut more trips in Southeast Asia. The latest adjustment came Tuesday when it brought the total to 30 cancelled trips. 

United Airlines was the first US airline to withdraw its annual revenue guidance, attributing the decision to heightened uncertainty around weakened travel activity. The company was experiencing “an approximately 100% decline in near-term demand to China” and a 75% drop in demand to its other trans-Pacific routes, according to a Monday regulatory filing.

Interest rates should fall in March or April

According the finder.com.au “85% of our resident rate experts predict the cash rate to hold at 0.75% on Tuesday 3 March 2020”. 

REA’s Chief Economist, Nerida Conisbee, suggest rates will be on hold in March. “The biggest risk to economic growth right now is the coronavirus. If Chinese economic growth plummets for more than one quarter, this will hit the Australian economy. Already our tourism and education sectors are being hit due to their reliance on Chinese consumers. We don’t have much room for movement with interest rates and if things start to get bad, we likely only have one or two cuts left. It is likely that May’s Federal budget will be far more interesting than last year and the Government may need to give up their surplus.”

It is our view that rates will be reduced in March given the dramatic slowing of growth caused by coronavirus.

Australian property prices holding up and should be steady

How will the coronavirus impact Australia’s property market? In the short term the travel and visa restrictions will keep overseas buyer demand down. China may also restrict the flow of funds out of the country to support domestic economic activity. Since the start of 2020, the property market has performed well with clearance rates around 80% in both Melbourne and Sydney. The number of properties selling at auction was also the strongest since 2019, with 1,000 and 800 respectively.

Tim Lawless from Core Logic recently commented “At current rates of growth, Sydney property prices are on track to recoup all of their 15% peak-to-trough decline and reach a new record by the end of May.”

Another rate cut would support the market’s current strength. Affordability may also start to kick in providing a short-term ceiling given sluggish household income growth. 

The balancing argument is that a prolonged disruption to the world economy would impact the Australian economy, consumer confidence and property prices, but not the central scenario at the moment.

Lower immigration in 2020 is likely as a result of the coronavirus and this will impact demand for housing. However, sales volumes are still low compared to peak levels and domestic demand should continue to meet current supply. Beyond 2020 we may see renewed interest from Asian immigrants as the reality of the risks surrounding the 2020 Coronavirus bite hard and people consider where they would like to raise their families.

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Please consult your advisor for specific recommendations.  This general advice does not take into account the client’s objectives, financial situation or needs as we do not and cannot provide personal advice.  Any views written about in this article are the views of the author who has no holdings in those companies or investments mentioned in this article.