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Market review: Coronavirus dominates headlines

Richard Dunbar

In his first market review for us, Richard Dunbar, Head of Multi-Asset Research at Aberdeen Standard Investments, looks at the impact the coronavirus is having on global economies and markets. He also considers what Brexit talks and policies may mean for the UK economy and the economic outlook for the world’s third-largest economy, Japan.


The impact of coronavirus continues to grow

The initial reaction of markets to the outbreak of the coronavirus was slight (in some cases non-existent). It looked like investors assumed this was a “mainly Chinese” problem, and were willing to look beyond what they expected (or hoped) would be a short-term problem for the global economy.

But we’ve now seen outbreaks in more than 50 countries, with more serious outbreaks in countries such as Japan, Italy and South Korea. It’s now clear that the economic damage from the virus will be much more serious than the initial fairly sanguine view. Markets have been very quick to price in these materially reduced expectations, with equity markets experiencing their worst few weeks since the financial crisis began in 2008.

The new environment will be a testing one, even if it’s relatively short lived. Clearly, the economic impact will be more considerable than many imagined earlier in the year. The world is much more “enmeshed” than in the past, and China, which has been in virtual shutdown for several weeks, now accounts for a much larger share of economic activity than it did in the past. Companies’ inventories are low and supply chains are extremely complex. In addition, the precipitous fall in some commodity prices and the increasing caution of consumers across the globe may lead to cashflow problems for some companies – particularly those with a little more leverage.

All this means that data will certainly get worse before it gets better. But it isn’t yet clear how bad the overall economic impact will be.

Authorities move to act

Some of the world’s major central banks have shown their monetary firepower and promised to take action to help lessen the impact of the virus on economies and markets. The Bank of England has announced a cut in the base rate to 0.25%, and we’ve also seen the US Federal Reserve cut its benchmark interest rate by 0.5%.

It’s worth remembering that many governments in both the developed and developing world have scope to boost their economies via fiscal policy as well. The big question is whether the market falls of the past few weeks are merely a correction or the start of a more significant downturn. Global bond yields suggest that markets are starting to price in a full-blown global recession. But it isn’t yet clear whether this recession is inevitable.

At Aberdeen Standard Investments, we’ll be blocking out the noise and doing the hard work of research. That should lead to a considered assessment of whether the coronavirus outbreak is likely to lead to a recession or merely a short-term slowdown. In turn, that will help us adjust our portfolios appropriately and we’ll continue to keep our clients informed as our thinking evolves.

What’s also important to remember is that in a world of modest growth, inflation and low interest rates, growth assets, such as good-quality equities, are likely to regain favour in due course.

UK economic growth likely to remain subdued

The recent Purchasing Managers’ Index showed that business activity in the UK is continuing to expand at a steady rate. This confirmed the pick-up in UK economic activity following the last quarter of 2019, where the Brexit impasse, followed by the General Election perhaps not surprisingly stalled activity.

But, while we do have some economic growth, we don’t have very much of it. The Bank of England downgraded its view of the potential growth of the UK economy from 1.5% to 1%, which certainly doesn’t indicate plentiful growth. The impact of the coronavirus has already led it to cut the base rate to 0.25% and further monetary easing is likely, given this rather anaemic growth outlook, coupled with the impact of the coronavirus outbreak.

As regards Brexit trade negotiations, we believe it’s likely to be a year of ebb and flow of good and bad headlines as talks progress. Increased friction in the trading relationship with our nearest neighbours seems inevitable, with the longer-term benefits less certain. But a mutually acceptable agreement, which does the least amount of damage to both sides, still seems a reasonable possible outcome – even if there are some significant risks around it.

Two thirds of FTSE® 100* earnings are sourced from outside the UK, so a fair chunk of the constituents of the index are less exposed to these risks. However, we believe that even those companies more exposed to the UK will adapt and change as necessary. They also do business in a country of around 65 million consumers who will still be there – irrespective of the deal struck by politicians.

New immigration policies could increase focus on minimum wage

The UK government’s immigration proposals shouldn’t be a surprise, given that the promise of ‘Get Brexit Done’ was always likely to include a more restrictive immigration policy. What I think is interesting is not just the view on immigration, but what I believe is a broader view that as a society we’re not paying high-enough wages to those described as “low-skilled”.

The continuing rise in the minimum wage chimes with the view from governments of various political hues that the state shouldn’t always have to top up low private and public sector wages via the benefit system. It’s interesting that in its lengthening history, the minimum wage hasn’t proved as problematic as many economists had suggested it would be to either employment or inflation.

That said, the changes outlined by the government are significant. We’ll need to monitor them carefully for their aggregate impact, as well as for their sectoral and regional impact.

Retailers get some good news at last

Last month, my colleague Andrew Milligan highlighted the gloom affecting the UK high street. However, the Office of National Statistics (ONS) announced that retail sales actually rebounded in January, with the largest monthly rise since March 2019.

Sales were probably boosted by the removal of some uncertainty surrounding the Brexit impasse and the General Election result. Unfortunately this may be somewhat short lived, with the coronavirus likely to have an impact on footfall and spending in the current period, even in the current tough environment.

Online retailers continue to outperform their high street peers – a trend that doesn’t seem likely to change any time soon. That said, there are plenty of examples of successful brands on the high street, demonstrating that if you bring good products at competitive prices to the right consumers, it’s still possible to prosper.

UK inflation rises but it’s likely to be temporary

UK inflation rose from 1.3% in December to 1.8% in January – the highest for six months, with the rise in prices of gas, electricity and fuel major contributors to this according to the ONS. This was a little higher than expected, but it remains below the Bank of England’s 2% target. Additionally, with the recent fall in energy prices, the expectation is that inflation may fall in the months ahead.

And finally, Japan teeters on the brink of recession

The preliminary estimate of Japan’s fourth quarter growth was disappointing. However the slowing growth of the world’s third-largest economy had been expected, given both the increase in the consumption tax over the period and the disruption to household spending following the typhoon damage early in the quarter.

The 13.2 trillion yen stimulus package announced in December should give a fillip to growth. But the duration and impact of the coronavirus is now likely to be a more important driver over the next few quarters.

The information in this article should not be regarded as financial advice. Please remember that the value of your investment can go down as well as up and may be worth less than you paid in. Information is based on Aberdeen Standard Investments’ understanding in March 2020.

*FTSE International Limited (‘FTSE’) © FTSE 2020. ‘FTSE®’ is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence.