- The economic and market impacts of coronavirus may be much larger than those of the 2003 SARS virus. Why? China is a much bigger part of the global economy than it was 17 years ago.
- From Jan. 20 to Feb. 5, airlines, marine, consumer services, media and retailing were five of the industries with the largest losses, while health care was among the largest gainers. This pattern was relatively consistent across regions.
- A hypothetical 60/40 portfolio could lose approximately 2%, whereas global equities could lose slightly less than 5% under a stress test we conducted. Treasury bonds could gain 2%.
The number of people infected and affected by the coronavirus continues to grow globally. Governments, as well as agencies such as the World Health Organization, are working tirelessly to contain, and ultimately defeat the virus. In China, local governments have locked down cities and businesses and restricted travel. And the general public has adopted voluntary home quarantine.1 The human toll has been steep.
As with many crises, the repercussions of the coronavirus can also be felt in the global economy and the financial markets. Many observers compare the coronavirus to the 2003 SARS epidemic.2 While this can provide useful insight, there are differences between the two periods to consider. China is a much bigger part of the global economy and markets than it was 17 years ago. China’s share of global trade rose to 11% in 2018 from 5% in 2003, based on World Bank statistics. Meanwhile, its share of the MSCI Emerging Markets Index has risen to 34.3% from 7.86% in 2003.
Examining economic exposure to China
We can dig deeper to understand the economic exposure of individual securities and equity portfolios to China’s economy, based on sources of company revenues. Using the MSCI Economic Exposure database, the exhibit below shows that the most exposed developed equity markets are Singapore, Hong Kong, Taiwan, Australia and Korea.
Economic and market exposures to China are not the same as in 2003
MSCI Economics Exposure Database, IMF World Economic Outlook, World Bank
We can also examine the revenue exposure of different industry groups to China. The revenue exposure of listed companies in the developed equity markets to China has more than tripled since 2006 (see the exhibit below, left). However, this top-level number hides the diversity across different industry groups. Those playing a role in the global technology supply chain or selling consumer goods tend to have higher-than-average exposure to China (see below exhibit, right).
Revenue exposure to China has varied over time and by industry groups
Revenue exposure of global stocks to China (left). Exposure of industry groups, as defined by the Global Industry Classification Standard (GICS®) jointly developed by MSCI and Standard & Poor’s (right). The global equity market is represented by the MSCI ACWI Index, while developed markets are represented by the MSCI World Index.
Breaking down performance by factors
How have the Chinese and Asia ex-Japan equity markets responded so far to the coronavirus outbreak? Our analysis focused on industry factors, as we saw the largest impact to industries and relatively little impact to styles (value, size, etc.). The exhibit below displays the cumulative industry-factor returns from the MSCI China A Total Market Model (CNLT) and Asia Pacific Equity Model (ASE2)3 from Jan. 20 to Feb. 5, 2020. The industry-factor returns are measured net of the overall market.4
China’s industry-factor returns
Data from Jan. 20 to Feb. 5, 2020.
Asia ex-Japan’s industry-factor returns
Data from Jan. 20 to Feb. 5, 2020.
We see from the exhibits above that the airlines, marine (airlines and marine are one industry in Asia ex-Japan), consumer services, media and retailing (media and retailing are one industry in Asia ex-Japan) were among the most negatively affected industries in both markets. By contrast, health care was among the biggest gainers in both China and Asia ex-Japan. The moves in Asia ex-Japan from Jan. 20 to Feb. 5 corresponded to more than three standard deviations, while some of the moves in China were near eight standard deviations. (We note Chinese markets were closed from Jan. 24 to Jan. 31.)
These observations are hardly surprising. If consumers reduce contact with the outside world, their spending on travel, hotels, entertainment and shopping would likely be reduced, resulting in lower revenues for the associated industries. On the other hand, health care would likely benefit if there were increased spending on hospital care and preventive measures taken by the general public.
We see similar, but less severe, patterns in other regions. The exhibit below also shows the performance of the China market. We observed industries that may have led the market in reacting to the development of coronavirus. Specifically, on Jan. 20, the first day when awareness of the virus appears to have had an impact on factors, the overall China market was actually up about 1%, with the first large drop in consumer services of over 3% and a gain in health care of over 1%. The following day, the factors again moved more than the market. It wasn’t until Jan. 23 that the overall market really responded, with a drop of about 3%, which was the fourth day that we had seen the response in factors.
Consumer services fell and health care gained. Both moved before the China market.
Coronavirus vs. SARS
Comparing these industry-factor returns with their performance during the SARS epidemic provides further insight.5 Similar to the current outbreak, airlines, marine and consumer services in the Asia ex-Japan market underperformed, while health care outperformed the overall market during the SARS epidemic. It took approximately four months (to June 2003) to bring SARS under control, and that roughly corresponds to the time it took factor performance to “normalize.” The current episode appears to be playing out more rapidly.
Asia ex-Japan’s cumulative return for the coronavirus vs. SARS outbreaks
Data from Jan. 20 to Feb. 5, 2020, for coronavirus, and from February 2003 to June 2003 for SARS.
Following the peak of the SARS epidemic, China’s quarterly GDP growth, retail-sales growth and revenue from outbound tourism bounced back quickly as businesses resumed operations. One signal to watch is when newly confirmed cases persistently drop below newly healed cases.
Implications for global portfolios
As with most market disruptions, there will be winners and losers. As we have stated previously, we have already seen a greater negative impact in sectors such as consumer discretionary and gains in health care. In our stress-test scenarios, we assume a flight-to-quality market reaction, which benefits securities such as U.S. Treasurys. We also assume the Chinese yuan depreciates relative to the dollar, and crude oil continues to decline due to decreasing Chinese demand. We applied a stress test to a hypothetical 60/40 portfolio of global equities and U.S. bonds6 with the assumptions about broad market aggregates shown in the exhibit below. Our assumptions of broad market aggregates have been informed by our analysis of historical data — i.e., the 2003 SARS outbreak. However, there is no historical period that exactly corresponds to our assumptions, and the current markets may react differently to the coronavirus outbreak.
|Sector/asset type||Applied shock in USD|
|MSCI China Health Care||30%|
|MSCI China Consumer Discretionary||-25%|
|MSCI China Information Technology||-20%|
|10-Year US Treasury yield||-30 bps|
We then applied MSCI’s predictive stress-testing framework to propagate the main assumptions to all other risk factors impacting returns. The results shown in the exhibit below are generated based on this methodology, using MSCI's BarraOne®.7
Our stress test shows that a well-diversified 60/40 portfolio, under the scenario with the above assumptions, could lose approximately 2% whereas global equities could lose slightly less than 5%. In addition, Treasury bonds could gain 2%, offsetting some of the losses. When focusing on specific industry groups, the impact spanned from a 13% loss for the global semiconductor and semiconductor equipment industry group to a slightly less than 4% gain for the global pharmaceuticals, biotechnology and life sciences industry group.
Potential implications for a 60/40 equity/bond portfolio
Source: IHS Markit, MSCI. Bond sector is presented by Markit iBoxx indexes. The equity market is represented by the MSCI ACWI Index.
The coronavirus epidemic is not the first time that a virus outbreak has threatened to upset financial markets. However, the world is more connected since the 2003 SARS outbreak as global companies’ revenues have become more exposed to China. Investors may want to examine such revenue exposures, as well as the potential diversity in impact across industries and asset classes.
The authors thank Shuo Xu, Wei Xu, George Bonne, Jay Yao and Juan Sampieri for their contributions to this post.
1“Coronavirus Death Toll Climbs in China, and a Lockdown Widens.” New York Times, Jan. 23, 2020.
2The 2019-nCoV coronavirus is spreading faster than SARS at its peak, but appears to be less fatal. According to published statistics, the number of confirmed cases in China has been steadily increasing, with the mortality rate at around 2%.
3The ASE2 model covers 18 countries in the Asia-Pacific region, including developed, emerging and frontier markets. It models Japan separately from the rest of the region.
4The equity-model industry factors are based on GICS, but are not always identical to GICS industries. They may be equal to or combinations of one or more GICS sectors, industry groups, industries or sub-industries.
5We set day zero for the SARS epidemic as Feb. 7, 2003, which was the last business day before the World Health Organization was notified of an outbreak of a “strange contagious disease” in China. For the purposes of this analysis, we set Jan. 17, 2020, as day zero for the coronavirus.
6Our hypothetical multi-asset-class portfolio has a 60% weight in equities, 20% weight in U.S. Treasurys, 15% in investment-grade corporates and 5% in high yield.