Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

Emerging markets in the time of coronavirus

Nick Robinson  |  30 Mar 2020Text size  Decrease  Increase  |  
Email to Friend

When coronavirus first made headlines, in China, then worldwide, global market reactions were complacent. It was perceived as a primarily Chinese issue, reminiscent of the SARS outbreak of the early 2000s. Expectations were for a brief selloff, which would last only until the number of new cases retreated. 

However, the virus has spread far beyond Chinese borders and erupted into a global pandemic. Global economic expectations changed dramatically in early March, and have continued to evolve just about daily since. Global growth forecasts for this year are likely to reach 40-year lows. 

It’s uncertain what lies ahead, but COVID-19 is sure to dominate headlines in the near term, and it presents two big issues for markets. 

The first is on the demand side. As a result of the sudden decline in economic activity, many companies will experience unprecedented declines in revenue. It is unlikely that many companies will be able to adjust cost bases quickly enough to this decline, so we are likely to see increased pressure on balance sheets and cashflows.

This is likely to be an acute problem for small- and medium-sized businesses. These enterprises tend to have less-diverse revenue streams, are more consumption driven, and have less access to financing.

The second issue markets are facing is liquidity. These concerns manifest in two ways: market liquidity and company liquidity. The former is an issue because as markets fall, financial conditions tighten.

This, in turn, drives markets even lower. The latter is problematic because as companies’ cash flows fall, the probability of credit defaults increase, which could threaten the economy at large. If companies go bankrupt, there will be labour shedding and people leaving the workforce, which would be a greater structural threat to the economy than just the current demand for liquidity. 

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

These issues play out in an environment where oil markets are reeling after having received a dual shock. There has been a decline in demand due to the rapid slowdown in economic activity. There has also been a supply-side shock, driven by a price war between Saudi Arabia and Russia. Lower oil prices help consumers, but disrupt the supply chain and investment, which will have economic consequences that could be compounded by the coronavirus situation.

Thus far, central banks have responded by lowering rates and pumping liquidity into markets. Whilse this is an important step, we are still awaiting more fiscal-policy action, which may inspire enough confidence to stabilise markets. However, a lasting recovery will also depend on confidence that the rate of spread of the virus has been contained. 

We may not be able to divine the full future economic effects of COVID-19, but we can look to history as a guide. In China, as a result of containment measures against the virus, industrial production experienced its steepest decline ever (even compared to the global financial crisis). This suggests that economic data around the world will continue to be grim—for now, at least. If we look further back, however, it’s clear that profit down cycles tend to be short and sharp vs. up cycles, in both EMs and the US (Chart 1).

Historic profit down cycles are shorter than upcycles 

Profit cycles

Source: Bloomberg March 2020. S&P500 Unmanaged Index considered representative of the US stocks in developing countries. The index is computed using the net return, which withholds applicable taxes for non-resident investors.

The more governments are able to prevent demand-side problems and liquidity concerns from evolving into structural issues, the better the chance for a strong earnings recovery. All of this also hinges on how quickly coronavirus cases peak. Right now, it’s unclear as to whether the pandemic will continue in waves over a prolonged time, or be stemmed by summer 2020.

In Hubei, the Chinese province where the virus originated, cases peaked in early March, about six weeks after the initial surge. While this may offer some guidance, the Chinese government has farther-reaching powers than many other states, which enabled them to quickly enact extremely strict containment measures. We expect that other nations will require longer lockdown periods because they cannot be as stringent. Because recovery depends on containment, we believe economies will experience a U-shaped recovery once measures are relaxed. 

In emerging markets, the call for liquidity is being answered, which is promising. Additionally,

. Reform agendas, especially in Brazil, also offer encouragement.

While this market rout appears, in many ways, similar to 2008, volatility may present an opportunity for long-term investors to initiate positions in high-quality companies with good valuations that can benefit from these market conditions.

is senior investment manager, equities at Aberdeen Standard Investments.

This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend