Given the growing influence of quants, you might imagine that the social and psychological forces that play on financial markets would gradually be dissipating, but markets have suddenly become febrile. Last week, the MSCI China and Hong Kong’s Hang Seng indices pulled back sharply as fears gathered over the spread of the coronavirus. Things may seem a little grim in the year of the rat, but do events in Wuhan mask a buying opportunity?
From a clinical perspective, matters certainly aren’t reassuring. The number of cases linked to the disease continues to mount, along with the incidence of infection outside of China; a probable consequence of people travelling to celebrate the Lunar New Year with relatives abroad. History shows us that health professionals and public administrators cannot afford to be complacent when faced by a mutating viral strain. (The Spanish flu pandemic which spread at the end of the Great War eventually carried away more people than the war itself.) Much depends on the severity and duration of the outbreak, but it is bound to have an economic impact beyond the tragic cost in human lives.
Elsewhere in these pages, you will be able to find out how the outbreak is likely to affect various sectors from aviation to luxury goods, together with its possible impact on certain key commodities such as Brent crude and copper. Although the possible impact on economic activity shouldn’t be ignored, it also pays to keep a sense of perspective whenever we are faced by global events with the potential to seriously disrupt trade and undermine equity indices. Remain dispassionate in the knowledge that people are probably losing their heads all around you. At any rate, you can take heart from index performance in the wake of similar outbreaks.
You would imagine that infection rates are set to rise further, but media coverage could peak as soon as those rates begin to slow. That would be in line with events in the wake of the 2003 severe acute respiratory syndrome (SARS) outbreak. The performance of the MSCI Hong Kong index demonstrated an inverse relationship with the volume of media coverage during that earlier flu outbreak, underscoring the undue influence of mass media. Once coverage died down – as opposed to any definitive clinical breakthrough – Hong Kong shares retraced fully within a month and were up by just under a fifth within three months. We usually associate irrationality with market bubbles, but it works the other way, too.
Should you be buying when there is blood on the streets, or even on a Kleenex for that matter? I suppose that in the event of a worst-case scenario, none of us will be paying too much attention to the risk-free rate of return anyway. But if the current outbreak – in keeping with that of SARS – is managed effectively by Chinese authorities, then it could be a good opportunity to gain exposure to a (still) fast-growing economy, which is transitioning from an export-led model in favour of one driven by the discretionary spending power of an expanding middle class.
Pestilence aside, how is China faring? The standard of economic data from the People’s Republic has always been open to question, but the Caixin China General Manufacturing PMI survey is up for the sixth month in a row. The broader view is that although growth has slowed over the past couple of years, it is primarily due to temporary capital controls from Beijing in response to spiralling debt levels – a problem that is not peculiar to China. The impact of the trade war with the US is difficult to gauge, although relations between the two superpowers could become a little less fractious following the recent signing of a deal aimed at calming trade tensions.
There is no shortage of vehicles to gain exposure if you’re convinced that the herd instinct remains in the ascendancy. For example, the value of Fidelity China Special Situations (FCSS) is down 10.9 per cent over the past week, giving a 12-month average premium discount of 8.96 per cent, yet the trust has appreciated in value by 63.1 per cent over the past five years, while supporting an average dividend growth rate of 28.1 per cent. There are numerous other examples I could cite, but assuming we’re not all staring into the abyss, I would say that, despite issues over debt and questionable corporate governance, broad-based exposure to China is supported by the transition towards a mixed economy, together with a strengthening focus on income generation.
