While uncertainty remains, we still expect a transitory economic impact from the coronavirus. In a best-case scenario, authorities' measures help reverse the trend within weeks, with containment by the end of Q1. In a base-case, the 2-week incubation period leads to serious international contagion, but the fatality rate stays low. Meanwhile, travel restrictions and a better understanding of the virus lead to a resolution by the summer. Finally, an unlikely worst-case scenario sees both contagion and death rate soaring as authorities become overwhelmed by the sheer number of cases; travel bans multiply and manufacturing disruptions emerge with deeper impact on global growth.
The coronavirus could take a greater toll on Chinese consumption than the 2003 SARS outbreak (the closest proxy for now), as all this is unfolding over the peak holiday season, and the hit to spending from the lockdown might be deeper. On the positive side, authorities reacted faster and today’s virus seems less deadly – though more contagious. The impact on global growth is likely to be transitory and policymakers still have fiscal and monetary ammunition to counter the fallout.
Market reaction has been measured so far, focusing on sensitive segments. DM markets receded -3%. Chinese equities were hit -8%. USD, JPY, CHF rallied at the expense of EUR and EM FX. DM govies yields dropped about -20 bps. Sector-wise: energy, materials, consumer cyclical, and value suffered the most, with safe haven utilities, growth and healthcare faring better.
Hedge funds trimmed their most exposed positions but are looking for entry points. Global Macro managers have marginally reduced their risk and added treasuries but have not significantly altered their portfolios. Market reaction is considered exaggerated by some managers as it implicitly prices Chinese growth below 5%. CTAs have marginally increased their overall risk, through US and Asian equities, hedged with US treasuries and more gold exposures. They are now short energy but remain neutral on base metals. A majority of L/S Equity managers shaved off their exposures to the consumer discretionary, base material, energy and airline sectors, as well as most sensitive Asian stocks. Otherwise, portfolios were widely unchanged. With more affordable valuations, most managers are waiting for entry points. In particular, we find that Chinese Equity Ucits lost about -6% and were highly correlated. They marginally increased their exposures, suggesting oversold equity conditions in China. Event Driven managers broadly stayed put with no meaningful changes to their portfolios.