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Domino effect

The trigger has been a sudden rise in cases outside of China – where new cases do indeed appear to be slowing – prompting concerns that the containment efforts that have suddenly put the brakes on the Chinese economy will be needed much closer to home. Italy has become the European epicentre of the virus – hardly a picture of economic health already, control measures could, it is feared, tip Europe’s sick man into recession. The worry is that this marks the first falling domino that leads to a much broader economic shock, as activity slows everywhere as trade and travel seize up. 

The big question for investors is what to do next, especially as it would appear rather too late to fully put into practice the diversification strategies we have regularly discussed in this magazine over the years – and which as James Norrington shows on page 16 will have hugely cushioned the blow. For those of you that have, the sensible approach would seem to be to sit tight, because for all of the disruption an extended lockdown may bring, it is likely to be temporary, and that means spending delayed now will still be spent in the future. 

How long into the future remains anyone’s guess, though – and for certain service-based industries it may never come back. As we write on page 9, airlines have been hit hard, but ever-fragile tour operators have fared worse still. So, as I wrote last week, we should perhaps weed out overstretched – and overvalued – companies that may not be able to hang on for very long if the outbreak cannot be contained quickly, or if economically-damaging quarantines persist. Even quality companies such as Diageo, which warned that operating profits will be hit by up to £200m, face heavy selling pressure – its shares have lost a tenth of their value in three weeks, but are still rated on 22 times forward earnings, well ahead of their long-term average.

Of course, for every doom monger there is an optimist spying an opportunity to ‘buy the dip’. Yet a dip of 8 per cent from record highs hardly takes markets into bargain territory, as they arguably were when Sars struck in 2003 and Swine Flu in 2009, when large chunks of the global economy had already been mauled by the financial crisis and investors were already in risk-off mode. And as Chris Dillow says on page 21, looking backwards isn’t always helpful in markets – in fact, in today’s risk-on market, driven not by earnings growth but by rerating momentum, it could prove positively dangerous for those seeking bargains prematurely.