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It’s too early to be too gloomy about stocks

It’s too early to be too gloomy about stocks

07-02-2020 | Monthly outlook
The coronavirus has given the world a financial scare as well as a health shock – but there’s no need to put equities into quarantine.
  • Jeroen Blokland
    Jeroen
    Blokland
    Portfolio Manager

Speed read

  • Coronavirus outbreak hits Chinese and global growth
  • Recovery ability leads three positive factors for equities
  • Multi Asset team does take some risk off the table though

That’s the view of Robeco investor Jeroen Blokland, who says there are still many positives for stocks, despite the outbreak of the deadly virus in China that is now spreading across the world.

“The unexpected and unfortunate coronavirus outbreak is putting pressure on the sustainability of the improvement in global growth momentum,” says Blokland, senior portfolio manager with Robeco’s Multi Asset team, which has reduced its exposure to equities as a precaution.

“The fact that the uptick in momentum had only just started makes it relatively vulnerable to any negative shocks. In addition, the significant amount of uncertainty related to containing the virus as well as its economic impact require an appropriately cautious stance on risky assets.”

“‘Appropriate’, however, does not imply getting too gloomy too early, as other factors remain positive for risky assets, and for equities in particular.”

The coronavirus, which began in Wuhan, has now spread across and outside China. The government has reacted by putting Wuhan into lockdown, severely restricting movement in other Chinese cities and extending the Chinese New Year holiday to stop people traveling.

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Drastic measures

“The measures, which might seem drastic, are likely to increase the odds of containment,” says Blokland. “At the same time, however, they are also likely to impact Chinese growth, and therefore also global growth.”

“From this angle, comparisons to the outbreak of the SARS virus back 2003 are futile. The Chinese share of global GDP has more than tripled since then, and China has become the marginal buyer of virtually every commodity. Its sheer size means other emerging countries in the region will face at least a temporary setback in growth as well.”

“It is the combination of a growth shock in China – by far the most important country in terms of share of global GDP – and the uncertainty of how long and how deep this shock will be that has made us erase our overweight to equities in our Multi Asset fund. However, this does not mean we have become outrightly negative on equities.”

Retail sales rose after the 2003 SARS outbreak and may do so again. Source: Bloomberg.

Reasons to be cheerful

Blokland says there are three reasons to be cheerful about equities. “First, when compared to ‘similar’ events, economic activity that is lost during a viral outbreak is largely recouped once it is contained,” he says. “For example, during the SARS outbreak, Chinese retail sales growth briefly halved before making a strong comeback after the virus was brought under control, making up for most of the sales decline.”

“Other parts of the economy such as construction were hit as well, but they also recovered once the spreading of the virus started to decline. We expect to see a similar pattern this time, and do not forecast a major interruption of global supply chains.”

“Second, the global economy showed numerous signs of improvement prior to the outbreak. One example is the global manufacturing PMI, which rose to 50.4 in January, its highest level since April 2019. The ISM Manufacturing Index is also back above 50, following a much bigger-than-expected rise in January.”

Positive surprises

“The Citi Global Economic Surprise Index has turned positive and risen to its highest level in almost two years. Export growth in very open economies such as South Korea has improved markedly, revealing that the downward pressure from the China-US trade war is abating.”

“And roughly halfway through the US company reporting season for the fourth quarter of 2019, earnings surprises are the strongest they have been in the last three quarters, with sales surprises the most upbeat in the last four quarters.”

“Earnings revisions have improved significantly on the outlook of better global growth. And in emerging markets, they are now higher than in the US, suggesting earnings momentum is broadening.”

Earnings per share of companies in the MSCI World Index are improving. Source: Bloomberg.

Accommodative central banks

Finally, investors should bear highly accommodative central bank policy in mind, Blokland says. “Short-term interest rates remain low or even negative, with central bank balance sheets growing again,” he says. “In addition, central banks have made it very clear that the hurdle to monetary policy tightening is very high.”

“Both the US Federal Reserve and the European Central Bank are ‘rethinking’ their monetary policy, with a very likely outcome that they will allow inflation to overshoot the target to make up for lost inflation in the past. At the same time, their willingness to increase stimulus is high if a negative shock like the coronavirus were to endanger the global economy.”

“The Chinese central bank already injected a massive amount of liquidity once markets reopened after the Chinese New Year. Global liquidity remains enormous, and will grow even larger in the coming quarters.”

Market implications

In all, it’s too early to be too gloomy about equities, he says. “Proportionate cautiousness concerning the coronavirus is warranted; obviously the fact that it originated in China – by far the largest growth engine in the world – is of importance here,” he says.

“We would like to stress, however, that other more constructive forces for equities are also at play. Given the fact that events such as the coronavirus tend to have a temporary rather than a structural impact on growth and earnings, we refrain from becoming outrightly negative on equity markets.”

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