Coronavirus and the Equity Markets?

“The first casualty of a crisis is perspective” -Prof Aswath Damodaran

Like most years, 2020 has been full of unforeseen events. The unfortunate evolution and the spread of the Coronavirus is a major event with sad social, health and economic consequences. In today’s information filled era, these fears have been amplified on a scale like never before.

The coronavirus originated in China in December and the Chinese government has taken massive efforts to contain the spread of the virus. However, the virus has spread to other countries including Italy, Iran and South Korea.

Impact on the Financial and Commodity markets

The financial and commodity markets have reacted adversely to the spread of the virus with physical and financial assets seeing a slump

• Globally equity markets have fallen with the Dow Jones Index falling by 3000 points from its all-time high in six days. The 11 to 13 % drop across US indices, is the single biggest weekly fall since the financial crisis of 2008
• The Indian equity markets have also seen a fall of 7% across market caps
• Commodity prices dropped with the Bloomberg Commodity TRI falling nearly 7% and Crude Oil has also dropped more than 10% with Brent Crude prices being 50 USD/barrel,
• Even Gold has not been immune to the crisis, with a 5% fall on last Friday

 Understanding why the equity markets have fallen

The markets are shaped by a combination of technical, emotional and fundamental events

• Correction from all-time highs – In Jan 2020, the equity markets were at an all-time high in the US and In India. In fact, even after the correction, 1 year returns are positive and markets have retreated to six month levels. Such technical corrections, will happen in the long-term journey (Between Sept and Dec 2018, the US market had an even steeper correction, followed up a sharp rise in 2019)
• Fear of the unknown – Financial markets dread uncertainty more than anything else. That is why they are willing to pay a premium valuation for companies with certainty in earnings. We are still unsure about how the coronavirus will spread going forward. A lot of the market volatility is because of that uncertainty about the impact on earnings
• China makes up 18% of the worlds GDP – China’s share of the GDP has grown from 4% to 18% globally over two decades. So, a slowdown there will have a global impact
• Supply Chain Disruptions – Certain parts of the world economy (e.g. commodities, supply chains for auto, pharma, electronic components) will see a higher impact. Similarly, firms with large sales in China will see a consumption slowdown

Looking at the history of such events, the impact tends to be short term in nature.

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https://www.schwab.com/resource-center/insights/content/market-volatility

Impact of the Coronavirus on Listed Indian Equities in the Long run

In today’s inter connected world, we cannot escape the consequences of global events. However, as a recent Nomura report highlighted (read here), India might be relatively less impacted by this crisis from an economic viewpoint.

• Limited impact on listed Indian equities – The Indian equity markets have very different sectoral composition as compared to the US. Four sectors – BFSI, Energy, Tech and FMCG make up 75% of our index. We don’t have large players like Apple, Microsoft which have a big China impact (supply chain or Chinese demand related)
• China accounts for only 5% of our exports (and 14% of our imports). Industries like Pharmaceuticals (bulk drug import will be hit), Metals, Electronics and Auto will be impacted. Less than 3% of our foreign tourists are from China
• The steep fall in Brent crude prices and other commodities will benefit India as we are a big importer of these commodities. This will help keep inflation and the fiscal deficit in check which will benefit us
• Select domestic producers in industries like Textiles, Chemicals, Fertilizers will actually benefit from the supply chain disruption. However, their ability to scale up and produce at the same price/quality will determine if there are any long-term gains.

 What should we do now?

As always, our investment decisions (both for existing investments and future investments) should be shaped by our planned asset allocation keeping long term goals in mind. It is extremely important to stick the planned asset allocation through market ups and downs.

In the current scenario, the long-term impact on Indian equities seems to limited (unless things change within India). Over a multi decade investing career, this is not the first (or last) negative event (including epidemics, wars, political instability, commodity price changes) we will be facing.