A “Black Swan” event is now potentially unfolding and we have seen the market react to this most recently with falls across the globe last week. I am talking about the Coronavirus.
The Australian government has cancelled all travel by Chinese people to this country, apart from those with relatives, and off course those who are Australian residents. The Chinese government quickly took the unprecedented step of preventing travel out of Wuhan and by last weekend, 30 of China’s 31 provinces have declared a top-level emergency. Eleven airlines have stopped flying to China. Within China, people are staying away from public places causing further disruption with regards to trade.
Governments, including Australia’s, have been mounting “rescue missions” to get their citizens out of the country and into quarantine at home.
With the number of cases and fatalities still growing, and no sign yet of a cure, the world’s second largest economy is basically cut off, internally and externally, and the world’s greatest country of travelers aren’t going anywhere. For how long? It’s hard to tell.
However, there is collaborative efforts globally in looking for a cure. And we should keep it in perspective: there were 59,000 lab confirmed cases of influenza in Australia in 2019 and close to 100 deaths; in the United States there are about 200,000 per year and apparently around 35,000 deaths. But the problem with the Wuhan virus is that little is known about it yet. The latest number of infected was around 17,200 with about 362 deaths. All the deaths bar one has been in China. These sad statistics are as of Sunday evening.
It is too early to predict a recession on the back of the epidemic, but it’s pretty clear China’s economic growth is going to take a big hit due to a sudden collapse in consumer spending. Australia will also be affected as is evidenced in our currency woes most recently due to our dependence on China with regards to trade, tourism, education, etc.
It is likely that equity markets will react negatively to further increase in both the infections and fatalities and are likely to drop further.
However, as with all Black Swans events, it’s impossible to assess the extent of the problem while you’re in the middle of it. The rate of infection could start dropping tomorrow and the quarantines and travel bans could start getting lifted next week, but right now it’s too early to tell.
We are continually assessing the impact of this on our portfolios. Our biggest enemy is uncertainty. Long-term asset allocation and diversification will, in the end, help buffer the market volatility. However, it will not completely shield us from a downturn.
What we don’t want to do is make a rash decision to reduce equity exposure across the board. This could prove costly if a cure is found for the Coronavirus (hopefully) and the infection spread decelerates causing markets to rebound and improve.
We have been erring on the side of caution in our last quarter portfolio reviews with a slight overexposure to defensives. We have also been cautioning a market correction purely based on valuations and the recent market uptick. The coronavirus adds further downside risk to our assumptions. We will continue to monitor the situation and, during our review cycle in 2020, look at what changes, if any, are warranted to ensure further cushioning from the market.