Covid-19 going global
There are two important aspects of the virus that epidemiologists now highly suspect of. First is that those infected that are asymptomatic could still be highly contagious. The second and equally alarming is that those who are seemingly cured from the disease can also continue to pass on the virus to others, presumably at an earlier stage of their full recovery. This makes the task of containment very difficult, especially given that symptoms for most are very mild and resemble those of a common cold.
Although the spread of the virus has yet to be defined as a pandemic, this seems only a technicality matter as it is now quickly spreading outside of East Asia with cases being identified in places like Iran, Israel and Lebanon where recognising and containing the disease will prove much harder given the lack of infrastructure and knowhow. Should it spread cross the Syrian and Turkish borders where over a million refugees are living in cramped conditions in makeshift camps, then its safe to say the global efforts to contain the virus is all but lost and we simply have to accept the fact that we have a new strain of Coronavirus that has fully entered our global echo system.
In China, the epicentre of Covid-19, continued changes in definition of those infected, especially in Wuhan, have left the official numbers looking increasingly unreliable with the latest figures adjusted for the virus having struck hundreds in prisons in Hubei province where one can only imagine very inadequate containment measures in place. Although some Chinese officials have vowed to fully contain the disease by end of March, clearly it looks too late to stop its spread outside of China where draconian measures in limiting population movement cannot be implemented as easily, especially in more open societies.
V-shaped recovery hopes more like wishful thinking
As we have outlined in the last two publications, although much about the Covid-19 is now known and understood, and its fatality rate of less than 1% looks thankfully low enough not to cause a global human extinction, its economic impact will be huge and until recently seemed underestimated. With stock market participants starting to doubt a post-SARS-like v-shaped recovery for this year, we are starting to price in a much more prolonged period of slow economic activity.
This dampened mood is clearly reflected by US treasury yields across the curve, renewing their all-time lows of last summer. With hospitals across the US reportedly preparing for the virus outbreak, even the US stock market rally which until now had ignored the spread in Asia is starting to wobble. This said, looking at Chicago Board Options Volatility Index (VIX), we have yet to see the August 2019 highs being tested, suggesting that participants are not panicking, at least not yet.
Plunging economic activity unlikely to be offset by weak yen
However, most of the economic damage outside of China is currently being felt in HK, South Korea and in our own market in Japan where fears of the virus spreading has had a drastic impact on consumer activity with shopping districts seeing visible signs of plunging foot traffic and with hotel and cinema bookings, tourism, theme park attendance and air travel have reportedly fallen by as much as 70% YoY for February.
Given the growing spread of this problem and its economic impact, we feel that any recovery rates in corporate earnings are likely to be more U-shaped and it seems unlikely that we will see any signs of that until summer at the earliest. With this scenario in mind, we suspect that the Japanese stock market is set to correct with Topix likely to fall to its 1600 support line and move sideways from there for the foreseeable future until visibility improves. Although the weaker yen should theoretically be supportive, given the plunging economic activity in Asia, its positive impact on exporters will be very limited.
Another own goal by Japan leaves summer Olympics in jeopardy
Japanese policy makers tend to have an uncanny knack in snatching defeat at the jaws of victory. BOJ’s ultra-low interest rate policy of the past 6 years which has done little for the economy or inflationary expectations and one which has only hurt its financial institutions is one example of this. MOF’s consumption tax hike last October which has clearly hurt economic activity, even before the virus issues emerged is another. Last year’s short-lived and politically motivated introduction of export controls of semiconductor materials to South Korean chip makers, the world’s largest buyers by region, was yet another shining example of Japan’s self-inflicted wounds. We can go on!
Japanese government’s latest virus containment program has been no exception. With hundreds of Japanese travellers on board of virus-stricken Diamond Princess cruise ship having been allowed to simply go home in the past week, and using public transport to do so, concerns about Japan’s poor containment program, first on the ship itself and now outside, has had a dramatic impact on business decisions and consumer behaviour with Abe’s government coming under much criticism for its latest fumble.
We know from the past, especially in its attempts to suppress reports of rising cancer rates in Fukushima, that the Japanese government will do almost anything to keep the summer Olympics on schedule as the games are seen as one of Abe’s big trophies of his long reign as Japan’s PM. However, given the backdrop explained above, there is a growing danger that the Olympics will either have to be postponed, perhaps to next year or relocated, assuming people want to travel elsewhere by then. Indeed, if Japan’s Olympics is kept on schedule for late July, it will probably be the least attended summer games in living memory.