The full impact of the virus coming to light but normalisation could take months
Although we had predicted that stock markets would bottom out within the first two weeks of February, once the impact of a less deadly virus than what was initially feared becomes much better understood, even we didn’t think that the markets would be renewing their recent highs so early in the month. Indeed, the true economic impact of the virus on China’s consumption and the disruption to the global supply chain is only now coming to light. Given the extent of the public panic in China which has gripped almost the whole of the nation, shutting down entire industries across the country, we think the country’s plunge into a recession in the current quarter looks inevitable.
It is important to note that although we feel that the much of these short-term negatives have been largely factored in by financial markets and the likely initial economic damage caused by the virus is discounted, the recovery period could be more prolonged than what the markets seem to be currently hoping for. Moreover, the growing concerns about the spread of the virus outside of China, namely in HK and Singapore is likely to further complicate matters and could lead to no-fly zones and businesses paralysis being extended to elsewhere in Asia. We thus need to remain highly vigilant of how related events unfold as we continue to feel that no other issue is currently as relevant until we pass this climate of fear.
Encouraging facts about current conditions of patients in China
The good news is that the draconian government measures taken in China, including most recent ruling of banning public gatherings has dramatically reduced the probabilities of the contagion spreading as fast as it has thus far. Indeed, recent data analysed by WHO officials suggest that not only over 80% of those infected are only feeling very mild symptoms and are most likely not to be in the official tally but the official growth rates of those who have contracted the virus and have shown more severe symptoms have started to stabilise in the past few days.
As we have also noted in our previous publication, although 2019-nCoV has proved to be far more contagious than SARS, fatality rates look to be far lower than even the official 2% level, possibly as low as 0.5%. We are also encouraged by the recovery rates in China which suggests that those recognised patients recovering from more severe symptoms are currently around 4.5% of total. We think the probabilities are very high that this recovery rate should rise dramatically from here. It is also worth mentioning that the current rush by pharmaceuticals to develop a vaccine for human trials will not only help contain the spread but will have a hugely positive psychological impact on the public behaviour and greatly help lessen the panic.
Growth likely to outperform value given very poor visibility
As underlined above, we suspect that economic normalisation could take many months after the current panic subsides. This especially so as travel restrictions could not only expand to other Asian countries in the short term but lifting the flight bans could ultimately take much longer. We thus feel that Japanese corporate earnings are likely to face heavy headwinds for much of the first half of this year, possibly spilling over to Q3 of this calendar year, especially industries reliant on inbound and outbound tourism. This realisation could keep the stock market treading water for now, especially after the most recent gains.
Nevertheless, we remain optimistic about the direction of Japanese stock prices in the medium-term, given their very attractive valuations relative to those in other DMs. We are also very encouraged to see the fast changing corporate governance structures striving to improve efficiencies, divestments, making core subsidiaries wholly owned units as well as raising shareholder returns through buybacks and dividend hikes. We remain comfortable about the secular growth trends in technology and automation segments which we feel are likely to see their business environment normalising more quickly than other cyclical segments. We thus suspect that growth will continue to outperform value, especially in this unusual environment where visibility has deteriorated rapidly.