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KAR: Coronavirus and Recent Market Volatility

Kayne Anderson Rudnick weighs in on the coronavirus situation, including a look back at the 2002-2003 SARS epidemic for insight on the longer-term economic impact.

An outbreak of a new coronavirus strain in Wuhan, China in December has led to more than 75,000 confirmed infections and over 2,500 deaths to date worldwide. Past viral outbreaks have typically resulted in short, sharp shocks to economic output with a typical slowdown lasting one to three months and reducing one quarter's annualized GDP growth by several percentage points in the most affected countries. However, past cases of viral outbreaks show that gross output typically recovers to its long-term trend two to three quarters after the onset. We do not expect a sustained negative long-term business and market impact at this point.

Over the past few days, markets sold off on the rapidly rising number of confirmed coronavirus cases that appeared in Italy, Japan, and South Korea, sparking fears of a global pandemic. In addition, bond yields plummeted in response to the softening of demand caused by the virus and the 10-year U.S. Treasury yield closing at all-time lows. This gives the potential for the Federal Reserve to cut rates again as the yield curve is inverting again. It is expected that there will be stimulus in other regions around the world as well.

The SARS epidemic in 2002-2003 may provide some insight as to the economic impact of the coronavirus. The number of SARS cases rose sharply in the April 2003 to May 2003 timeframe, leading to a number of restrictions and other measures over this period. As a result, the peak economic damage occurred in early Q2 of that year. With global concern over the current outbreak ramping up very sharply over the past week, it is most likely that Q1 2020 will bear the brunt of the economic impact. The chart below shows a significant, but only brief hit to the Chinese economy from the SARS outbreak in 2003. Furthermore, growth rebounded in the quarter after the outbreak.

SARS Economic Impact 2002 - 2003

SARS Economic Impact 2002-2003

Source: Goldman Sachs Economics Research, February 3, 2020

Various current estimates for Chinese GDP range from 4% to 5% in Q1, down from 6.5% (annualized) before the outbreak. As China accounts for almost a fifth of world output, there will probably be a minor impact on global growth. In recent days a number of corporations have commented on the business disruption due to lockdowns of cities in China as quarantine measures were put in place by the Chinese government. Companies reporting business disruption include: Apple (weaker iPhone sales), Disney (closure of theme parks), Wynn Resorts (closure of casinos), United Airlines (reduced travel), MasterCard (fewer cross-border transactions), and Procter & Gamble to name a few.

In summary, we expect measurable near-term risks to China’s equity markets and the peripheral countries that may be impacted from reduced trade and tourism until the outbreak is contained. However, the coronavirus outbreak does not change our view that global growth touched a trough in late 2019 and that the longer term trend is higher helped by less friction from the trade war in Asia and easing of financial conditions in Europe. As long-term, bottom-up fundamental investors, we can be fairly confident that this situation has nothing to do with the structural competitive advantages that many of our proprietary equity investments enjoy. Volatility is a fact of life in equity markets and we encourage our clients to stay the course. Our focus will continue to be on investing in high-quality companies and our investment strategy will not change as a result of this event.

The commentary is the opinion of the subadviser. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.

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