What Coronavirus Means for Investors

Wednesday, February 05, 2020   /06:30 PM  / By WSTC Research / Header Image Credit: africacenter.org

The world economy was taken aback by the outbreak of the coronavirus, a respiratory illness that comes from animals. Some of other troubling viruses that come from animals include ebola and flu. In this report, we try to understand the implications of the coronavirus on the global economy and financial markets. We also try to see how the spill-over effect of the coronavirus in China can shape the market narrative in Nigeria.

As of February 5, 2020, according to the China's National Health Commission, there are about 24,324 confirmed infections, with the death toll at 490. Outside China, there have been 203 confirmed cases across 25 different countries, with top confirmed cases in Japan (33), Thailand (25), Singapore (21), South Korea (15), Germany (12), United States (11), and Vietnam (10). A similar virus that happened in the past was the Severe Acute Respiratory Syndrome (SARS) which started in November 2002 and lasted for eight to nine months, killing 774 people. The SARS disease spread across 29 countries.  Just like the SARS disease, the coronavirus is especially dangerous due to its contagion. The virus incubation period could be up to two weeks before an infected individual shows symptoms, which makes it very easy to spread the virus. Secondly, the air-borne nature (cough, sneeze) of the disease also makes it very easy to contact.

Gravity

So far, there are about 24,324 confirmed cases in China and about 409 patients have died. Using the SARS outbreak as an insight to what to expect, according to the World Health Organisation (WHO), there were 774 deaths recorded out of about 8,000 reported global cases. By implication, the fatality rate was 9.6%. Although each illness has its own unique components and considerations, the coronavirus appears to be less severe than the SARS even though it might be more contagious. The treatment of the coronavirus is deemed difficult, as there is currently no proven cure in sight. This makes the disease deadlier and adds to investor uncertainty.

Economic and Market Implications

The direct impact of the coronavirus outbreak was felt on crude oil prices, which had fallen by 15% to $55 per barrel since the announcement of the first death of the coronavirus on January 11, 2020. The global stock markets also recorded sell-offs of varying magnitude over concerns of threat to global economic growth, induced by the coronavirus.

Earlier during the year, global oil demand was projected to rise by 1.3mn barrels per day while oil supply was projected to rise by 1.6mn barrels per day. Of the 1.3mn barrels per day increase in global oil demand, China was expected to drive 39% of the growth. The 0.5mn barrels per day increased demand of oil expected from China was on the back of demand of oil to power new petrochemical plants in China. Also, the economic shift from an industrialising economy to a more consumer and service-oriented economy was expected to drive the spur in oil demand from China.

How the coronavirus hurts China and the crude oil market

The spread of the coronavirus meant that the Chinese Lunar New Year holiday had to be suspended. Also, travel restrictions were put in place. Factories, offices, and shops remain shut with many multinationals temporarily closing factories. By implication, this results in lower economic activities and consumption in the Chinese economy. Already, the Chinese economy is reeling from the impact of the trade war that had put pressures on the Chinese economy (GDP grew by 6.1% in 2019 -  slowest rate in three decades). With a lower consumption anticipated for the Chinese economy and considering the significance of the Chinese economy to the global economy, the world output growth faces a genuine threat.

More importantly, China is one of the largest importer of crude oil, with about 14% of global demand coming from China. According to Bloomberg, the daily oil demand from China has declined by 20% since the coronavirus outbreak. This implies that the forecasted growth in demand of crude oil in world is not going to materialise, given the current state of things. Specifically, it means that one of the world’s biggest importer which typically consumes an average of 14mn barrels per day needs a lot less to power machinery, and fuel vehicles. Hence, this creates a supply gap in the market, and expectedly crude oil prices crashed based on the forces of demand and supply.

Specifically, we summarise the implications of the coronavirus on the financial markets:

1. Fixed-income market: The Nigerian foreign exchange policy is a relatively fixed exchange rate regime. Noting the significant implication of the exchange rate and price stability, the CBN will most likely attempt to hike rates to put both the demand and supply sides of the foreign exchange market in check. Consequently, yields in the fixed-income are expected to rise. 

2. Equities market: Already, the foreign investors have lost appetite for Nigerian stocks. The coronavirus might exacerbate foreign investors' concerns about investing in Nigerian assets due to the relationship between crude oil prices, exchange rate, and the currency risk faced by foreign investors. In addition, a lower crude oil price and external reserves might prompt higher interest rates in the economy. As a result, valuation of stocks will decline (resulting from a higher discount rate/required return)/cost of equity). The domestic institutional investors (PFAs, asset managers, corporates and other fund managers) who have been showing renewed interest in the equities market could also pull out funds in favour of higher-yielding fixed income instruments. Furthermore, a higher interest rate environment increases the cost of financing for firms, thus resulting in lower profitability and lower values for firms.

3. Foreign exchange market: A higher rate on Nigerian assets, depending on the risk premium it offers, might be an attraction for foreign portfolios investors to bring in inflows into the Nigerian economy. These inflows are expected to be used to back the Naira. Meanwhile, the relationship between the coronavirus epidemic and the exchange rate is positive (the more the disease persists, the lower the crude oil prices, and the lower the external reserves. Supply of dollars in the economy declines relative to a constant or rising demand, thus, the price (exchange rate) rises).

Our view

We note the risks posed by the coronavirus to global economic growth, emerging markets economic growth, and the Nigerian economic growth. However, in our view, we believe that based on the ongoing efforts made by the Chinese authorities, the coronavirus could be contained much sooner. Nonetheless, we expect that pressures in the global economy might exist in the first quarter of 2020, at least.

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