It’s not easy to capture the world’s attention. Natural disasters and bombed oil fields distract us for a few days until the degree of damage is assessed and corrective action is taken. Then the next “News Alert” takes over the news threads.
But something open-ended that cannot yet be measured – like coronavirus (or what the World Health Organization has come to call it, COVID-19) – is different. The number of infected people and lives lost are still climbing. And the figures quoted by the Chinese officials are questionable.
Those old enough to have been investors in the days of SARS (2003) and H1N1 (2009) will remember that they affected global markets for a short time. Except for smaller local disruptions, the effects were not catastrophic.
So, what has changed? The size of the Chinese economy, its insinuation into global supply chains, and the buying power of its population.
The World Bank tells us China’s GDP grew from 4.3% to 15.8% of global GDP between 2003 and 2018. Today the Asian supply chain imports about 40% of its intermediate goods from China; the U.S. imports about 10%. And the buying power of China’s own population has grown tremendously.
At the moment, the assessment by some is that the loss to global GDP will be a blip, and China will recover fully by the end of the year. But projections are still undefined, so its economy could still face systemic decline, and global markets could suffer volatility.
How are investors reacting?
Buy-and-hold investors will discount all the reporting as chatter and will hold true to their philosophy that they can weather the market’s volatility. Since no one knows how volatile things will get, the more critical unknown is how long it will take their investments to recuperate from any losses so they can benefit from future upswings.
The rest of the investors are asking themselves – and their advisors – what they should do. More complacent investors figure the financial systems in the U.S. and China are fundamentally strong and will be impacted only in the short term and – as with SARS and H1N1 – the impact will be negligible in the long-run.
Others are seeking recommendations on what investments to sell to free up cash to be ready to buy into equities at new cheaper prices when the market turns back around. They are looking at proactive steps to take to protect their portfolios and they are searching for opportunities to explore.
In short, investors are all over the map.
What are the Talking Heads Saying?
Under normal circumstances, there is so much discord in the recommendations of ‘experts’ that investors eventually pick a couple to follow and ignore the rest. The uncertainty of the coronavirus epidemic has more people looking to these experts for guidance.
But, the lack of consensus is more significant than ever. For every person calling the impact “overblown or exaggerated,” another is calling it a “black swan” event for specific sectors and economies around the world. (A black swan event is an unpredictable one that goes beyond what is usually expected of a situation, with potentially severe consequences.)
Let’s just look at three experts
- Mohamed El-Erian is the chief economic adviser of Allianz and former CEO of Pimco. He sees the impact as a fundamental shock to economic growth in China. In early February 2020, he saw coronavirus as paralyzing China, then cascading throughout the global economy. Central bank policy will not be able to counter it. He said it affects the demand and supply side, disrupts domestic and international activities, and derails the service sector at a time when the manufacturing sector is still weak. He recommends resisting the inclination to buy on the dip.
- Ray Dalio is the founder, co-chairman and co-chief investment officer of Bridgewater Associates. Bridgewater is the largest hedge fund in the world, with over $190 billion under management. He feels there is no way to predict what will happen. In mid-February 2020, on his Twitter feed, he said, “I think the most likely outcome is that this virus will be a larger version of SARS that will have a significant temporary effect but won’t have a big long term influence.” The best bet, he suggested, is to diversify portfolios across geographic locations, asset classes, and currencies.
- Jeremy Siegel is a professor of finance at the Wharton School of Business. His entire focus in mid-February was on what the market will do this year, in five years, and in 14 years. (This year, he expects 5% to 10% in total return. After accounting for inflation, investors can expect an average of 5% in returns over the next five years. And the Dow should double from 30,000 to 60,000 in about 14 years.) His only comment on coronavirus was that it was keeping the Dow from hitting 30,000.
So, who is right?
Time will tell. Meanwhile, let’s look at some more vulnerable markets.
What Markets Might be Vulnerable?
What is happening in China – the epicenter of the coronavirus epidemic – will show us where we can look for its impact.
Bloomberg tells us that the Chinese provinces that account for nearly 69% of Chinese GDP have suffered closures. Factories, shops, and restaurants are shut. Ships are trapped at ports and consumer spending is way down.
Travel restrictions affect many millions, particularly in the crucial manufacturing hub of Wuhan. Trucks, trains, and planes are not allowed to cross provincial boundaries, affecting individuals and freight. Not only are factories shut down in China, but others are also shutting across the globe for lack of parts. Consequently, some global supply chains of major world manufacturers are severed.
Where China is the dominant supplier of a product worldwide, finding alternative suppliers will be particularly difficult.
The Oil Industry
The demand for oil in China dropped by about 3 million barrels per day in early February 2020. China refines much of the crude oil it imports and has had to pull back its production of petrochemical products. (Think of its plastics consumption in nationwide manufacturing: think Walmart.) They are unable to absorb any more stockpiles of unused products. So, as the world’s top importer of oil (at 11 million barrels per day), its source countries of Russia, Saudi Arabia, Angola, Iraq, Oman, and Brazil are being hit.
Lower demand means lower global prices, and many other oil-producing nations will feel the impact on oil revenues if the situation is not resolved quickly. Those countries include Saudi Arabia, Russia, Iraq, Canada, United Arab Emirates, Kuwait, Nigeria, Qatar, and Angola.
Lower export revenues can lead to all sorts of pressures within export nations. Russia, for example, is notorious for acting out to cover for financial pressures at home.
Not even the U.S. would be left untouched. Shale and oil firms are producing record amounts of oil with higher breakeven points than producers in other producing nations. Low prices and a prolonged recovery could result in shutting down U.S. wells, causing layoffs and bankruptcies.
Watching how U.S. oil companies manage these disruptions is just one aspect. Watch companies that have high proportions of fuel or petrochemicals in their cost structure, too. Lower input costs can lead to profit opportunities.
The consumer electronics and video gaming industry will be one of the hardest hit as a result of coronavirus. Microsoft (Xbox) and Sony (PlayStation) plan to release their long-awaited next-generation systems right before the 2020 holiday shopping season. Nintendo’s Switch has already scheduled late deliveries. New consoles only come out once or twice a decade, and they are made in China.
New games are also launched before the holidays. Although most are made in the U.S., Japan, and Europe, much of the game-building process is outsourced to China, including 30-50% of the art.
PC shipments are expected to go down in the first quarter of 2020. Smartphone shipments are forecast to drop 40% to 50% in the same period and the decline may extend further into the year. Foxconn, for example, produces Apple’s iPhone and has had to quarantine workers, which may result in the delay of the next iPhone. (Apple typically schedules launches for each September.)
The launches planned in China for 5G devices are being delayed or canceled altogether as large public events are forbidden at present. All related marketing events are also being cut back.
And it’s not just games and phones. How many home appliances like microwaves and refrigerators are made in China or elsewhere in Asia? How many risk supply disruptions from Chinese manufacturers? How much merchandise on a Big Box store’s floor could be affected? Supply chain disruptions can impact just about everything.
Some auto manufacturers have suspended production in Asia for a lack of parts coming from China. Hyundai in South Korea is an example. Tesla, Ford, Toyota, Honda, and Nissan have shut some production down in China, too.
For now, this may not be a problem. Auto inventories are high, and demand can likely be met with existing supply. Even in China, excess inventory should compensate for the shutdowns but eventually, U.S. and European manufacturers may wish more of their parts manufacturers were still onshore.
The medical supply chain is at higher risk. Most of the world’s supply of respirators and face masks are made in China. Not only are they needed in China – so supply may be cut short outside of China – but there are concerns about their sterility. On the off-chance that the epidemic expands in the U.S., where will it source the respirators and masks it needs?
Many components used in the pharmaceutical industry come from China, too. Again, the two factors come into play: availability and sterility.
This wake-up call should be enough to motivate the increased domestic production of critical medical supplies. Maybe some purchases do not need to be determined by the lowest cost.
The tourism industry felt the impact of coronavirus almost immediately. The drop in the number of Chinese tourists is the most obvious effect. As China has grown its “middle class,” the number of Chinese travelers has multiplied to destinations all over the world. Today, one in ten international travelers has a Chinese passport.
They set a new record for global outbound tourist spending in 2016, with over 135 million people traveling abroad. How will this affect some of their favorite destinations, such as Thailand, Japan, Vietnam, South Korea, Singapore, the U.S., and Italy?
They spend twice as much per day as the average non-Chinese tourist and account for over 20% of the money spent by all international travelers. How might the cut-back in travel affect the profitability of all of the airlines, tour operators, hotels, and restaurants in their top destinations?
The New York Times reports that in greater New York, tour operators, hotels, and travel agents have already been affected. That is not surprising: the city’s convention and visitors bureau reported that nearly 8 percent of foreign travelers who visited New York in 2018 came from China.
Along with tourism comes airline travel. More and more carriers are discontinuing service in and out of China. Some have announced they will not resume until the end of April 2020. Their profits will feel the pinch.
Domestic travelers are being turned off by the idea of spending time in airports and undergoing coronavirus screenings. The thought of recirculated air inside the planes – and the fear of contagion because the virus can live for many days on surfaces – have caused people to change their plans. For the moment, air travel has lost its appeal.
Cruise lines are feeling the impact as well. Coronavirus has already led to the quarantine of entire vessels. Passengers are spending extra days or weeks on board before being allowed to disembark. One cruise liner sitting off a Japanese port has 219 infected passengers. Cancellations abound as future passengers find less ‘constrained’ options for their vacations.
The losses in most aspects of the tourism industry will end when the danger of infection by coronavirus ends. But, it is not so likely to benefit from a sharp rebound as a result of pent-up demand. The opportunity will have passed because – for employees, for example – vacations are linked to specific dates. They will have done something else this year.
How Can Coronavirus Affect the Global Economy?
The temptation is to compare the coronavirus epidemic to SARS, although China’s economy played a much smaller role in the global economy then. There was a dip in growth in the months during and right after the containment of the SARS epidemic, followed by a rebound. Consumer durables, software, hotels, restaurants, and airlines were among the activities hardest hit after SARS broke out.
Some Chinese economists estimate that China’s GDP growth may drop to 5% or lower in the first quarter of 2020. Others predict an overall decline in China’s GDP for the year, after a technical recession in the first half of 2020.
The effect of China’s sharp drop in industrial activity can be disruptions elsewhere. It is normally the largest and most voracious consumer of raw materials, fuels, and foods from the world over.
What is the worst-case scenario for coronavirus? While not likely, a broader and longer outbreak of the virus with time will affect financial markets, the flow of capital, global value chains, and price levels. It will affect firms and households alike.
However, Larry Kudlow, the U.S. National Economic Council Director, does not see an economic disaster for the nation. The diverse American economy and its robust economic indicators will help buffer any effects. In fact, he feels this may spur investment in and development of production, plus a diversification of supply lines by bringing them back to the U.S. While the ultimate impact of coronavirus is unknown, that diversification could prove to be a longer-term benefit to the U.S. economy.
What We Can Learn from Coronavirus that Can Help in Our Investing?
Regardless of how far coronavirus extends worldwide and how disruptive it becomes – even if only marginally, with a quick resolution – it can become a teaching moment for investors. This can be particularly valuable for those who do not have access to a financial advisor like HCR Wealth Advisors, or who usually are less hands-on with certain investments.
Retirement Savings Accounts
Among the latter group are the millions of Americans who have their retirement savings invested in retirement accounts such as 401(k)s, 403(b)s, or IRAs. The company that handles the highest number of such accounts manages 27.2 million 401(k)s and IRAs. That represents only 1.6% of the 1.7 billion accounts – with many people holding multiple accounts.
Many of those account holders have turned to managed accounts for their 401(k)s and IRAs, paying fees to have professionals manage them. They may allocate their 401(k) contributions into target-date funds, balanced funds, or model portfolios. Or they may take a riskier self-directed route. In the case of IRAs, the service providers may make similar recommendations. And for many, that’s good enough. They see their accounts as “set-it-and-forget-it.”
But fees could run 0.07% to 0.82% per year. That might sound insignificant, but on the higher expense ratios of actively managed funds, you are restricting the growth of your retirement savings. Imagine compounding that cost over all the years your savings are invested. A simple portfolio of low-cost index funds may do just as well or better. You might want to know how to check.
All the talk about coronavirus and how it will impact the world economies can be the motivation for you to “look under the hood.” With a newfound understanding of how such an event can impact different markets, you might want to go into your 401(k) or IRA reports and identify the funds in your portfolio.
Learn to look up each fund in the free resource, Morningstar.com. What may look intimidating at first is very structured and easy to understand. Build yourself a simple spreadsheet with the headers:
- 5-letter symbol
- Category [such as Small-Cap, Emerging Markets, Multi-Sector or International]
- Yield in %
- Net expense ratio
- Lipper score
- Holdings [top 10 companies in the fund]
Identify the name of each fund in which you are invested. Look inside each fund and fill in your spreadsheet for each one. Once you’re finished, look at the individual companies that make up the fund. See if they are invested in categories, countries or sectors that appear most vulnerable.
If so, and if you find another fund with similar or better yields and fees – but with safer individual investments – think about changing the fund. Your service provider should be able to do that for you at no cost.
Even if you decide not to change anything, there is tremendous value in knowing the nature of your investments. Suddenly, they are no longer a “black box.” And what is going on in the world has more relevance to your successful retirement.
If part of your portfolio includes self-directed individual investments in companies or ETFs. For example, understanding the factors affected by coronavirus can add a new dimension to your analyses of existing and future holdings.
Before, market movements may have seemed too subtle to engender enough conviction amidst all the noise. But, those triggered by the coronavirus epidemic could be bold enough to point out opportunities for you to play the market short and long.
About HCR Wealth Advisors
HCR Wealth Advisors is a client-focused wealth management firm dedicated to providing its clients with personalized wealth management and financial planning advice. HCR Wealth Advisors does this by building trust and lasting relationships with its clients, some of whom have been with the firm for decades.
HCR Wealth Advisors places significant importance on being transparent, honest, and forthcoming with its clients. All in the name of helping clients while they go through some of life’s most financially challenging transitions, including marriage, divorce, retirement, and yes, economic downturns.
With the recent coronavirus epidemic tossing another challenge into the ever-complex world of finances, HCR Wealth Advisors’ client-first focus is exactly what current and potential clients, and worried investors, need: a firm that will sit down with them, take a holistic view of their financial situation, and advise them on the best course of action moving forward.
Contact HCR Wealth Advisors to understand more about how HCR Wealth Advisors can advise clients in uncertain times
HCR Wealth Advisors is not affiliated with this website. This article is provided for informational purposes only and should not be interpreted as investment advice.