At the start of this year, the global macroeconomic outlook seemed to have improved. Growth appeared to have bottomed out, as monetary easing and the phase-one US-China trade deal brought relief to markets. But the outbreak of the coronavirus has clouded the outlook.
While the virus has spread beyond China, the world’s most populous country will bear the brunt of the impact. Chinese GDP is expected to be 0.2-0.4 percentage points lower than it would have been in 2020, and it is likely that output will contract in Q1.
Chinese output is currently frozen: the Chinese New Year holidays have been extended for a week, which means that companies accounting for 70% of GDP are closed. It is still unclear whether there will be a full resumption of activity next week – at the moment, this seems unlikely.
While the crucial assumption is that the epidemic will be successfully contained in six to eight weeks, in reality we know very little about the likely length and severity of the virus. Comparisons are being drawn between the current outbreak and the severe acute respiratory syndrome (SARS) outbreak in 2003. SARS provides an indication of how global epidemics can affect growth, with an initial hit to the economy followed by ‘v-shape’ rebound in activity.
But this exercise has its limits, mostly because coronavirus is likely to have a far more global impact than SARS did. China now accounts for 16% of the world economy, compared to 4% in 2003. Global growth – though improving – still remains sluggish and vulnerable to external shocks.
Much hinges on Beijing’s response to the epidemic. The government is likely to unleash substantial stimulus into the economy and Chinese banks will be asked to rollover loans, cut interest rates and extend more credit to keep disrupted small-and-medium enterprises afloat.
In the long run, there are longer term and potentially more potent risks to the global economic outlook, including protectionism and climate change. While the coronavirus poses headwinds, the overall impact on global GDP – a reduction of 0.1-0.2 percentage points – is material, but manageable in the long term.
And while global growth may take a hit, credit is likely to weather the storm better than equities in the first instance. Regardless, the virus will still have a near-term effect on different industries that our credit analysts cover. Below, we detail their views on how the epidemic will affect a range of sectors.
Energy: lower prices mitigated by hedges and OPEC’s willingness to act
Oil prices fell by 15% in January in response to concern about slowing demand in the world’s largest importer of crude oil. China’s oil demand has fallen by 20% – or 3m barrels per day – which represents 3% of global consumption. Given that activity and travel has stalled in China, it is not unreasonable to assume that the temporary drop in demand is even higher.
The effect of this is somewhat mitigated by the willingness of the Organisation of Petroleum Exporting Countries (OPEC) to act. OPEC is considering a collective reduction of 500,000 barrels per day or a temporary cut of 1m barrels per day until the crisis is over.
Also reassuring is the fact that most of our oil-exposed holdings have 45%-50% of their oil production hedged for 2020, with hedge prices currently above the value of oil. In addition, elevated oil volatility has become a normal aspect of business over the past five years.
Over the long term, the majority of oil producers in our portfolio are low-cost producers with long-term strategic objectives to reduce leverage and improve generation of free cash flow – something that should provide support during any turbulence.
Audra Stundziaite CFA, Deputy Head of Credit Research
Industrial metals: government stimulus should offset lower prices
China accounts for over 50% of global demand for industrial metals, which means the impact of the virus has been severe – especially in markets like copper and iron ore, where China is a net importer. The price of both metals fell by around 10% across January.
While SARS has been used as a proxy for what could happen to markets, it is worth considering that China represented a smaller proportion of total metal demand in 2003. This time, the effect of the epidemic has the potential to be much larger.
However, China is likely to support the economy with stimulus, which is typically supportive of metal consumption. While the near-term outlook is negative, we see the possibility of a sharp recovery once the virus has been contained.
We have a positive view of the sector’s longer-term fundamentals but also have a number of defensive trades across our flexible strategies, investing in the credit-default swaps of selected miners that have exposure to copper and iron ore. This should help us withstand further weakness in these industries.
Anna Chong, Senior Credit Analyst
Autos: the epidemic worsens the outlook for the flagging sector
China is the world’s largest car market, with Wuhan, the country’s fourth-largest auto producer, known as the nation’s ‘motor city’. Although January and February are usually quiet months for the Chinese auto industry, the production halts will have a significant effect on output for the year.
2020 was already expected to be a feeble year for industry, with a continuation of the slowdown seen in 2019 and very little chance of recovery. The epidemic simply adds to our negative view of autos and we have taken out defensive positions in certain companies, while remaining positive on more robust firms which we think should be able to weather the storm.
Ilana Elbim, Senior Credit Analyst
Gaming: travel restrictions will affect industry revenue
Chinese travellers represent 80% of Macau’s gross gaming revenue, which means that the precautionary measures placed on travel should have a significant impact in the short term.
In addition, the virus broke over Chinese New Year – a period when visits to the island usually double. This year, visits were down 78% and revenue per available hotel room was 40% lower. The Macau government has now announced that casino operations will be suspended for two weeks.
Ilana Elbim, Senior Credit Analyst
Technology: factory closures may delay orders and affect revenue
Given the high concentration of manufacturing operations in China, the prolonged shutdown of factories poses a threat to the technology sector.
Wuhan is home to a number of large semiconductor factories and also acts as a key transport hub for the delivery of these products. As such, the closure of these factories poses a threat to the technology sector.
Chinese semiconductor imports absorb more than 50% of global supply, with large global non-Chinese manufacturers generating anywhere between 25%-50% of revenue from within the country. Disruptions to manufacturing could result in delayed orders or, at worst, lost revenue in the near term.
Over a longer time horizon, we still think that semiconductors benefit from a number of structural drivers that remain intact and will survive the virus.
Joe Howes, Credit Analyst
Telecommunications: network upgrades and production under threat
Like with technology, factory closures pose the greatest risk to the telecommunications industry. US-China trade tensions mean that companies have built additional flexibility into their supply chains, but their ability to cope will depend on the severity and length of the outbreak.
Developed-market operators benefit from limited geographical exposure and strong relationships with European and US supply-chain counterparties. The recent US government ban on the network equipment of a large Chinese telecommunications firm also means they are less likely to experience delays in deploying 5G network upgrades.
However, emerging-market firms are still completing 4G upgrades and are more dependent on the large Chinese operator. Although the Chinese government has let critical equipment manufacturers resume production, an acceleration of the virus could lead to more shutdowns. This could force firms to source more expensive equipment from outside China, or risk delaying critical network upgrades.
There is also the possibility that operators could delay production of smartphone handsets. However, there will likely only be an adverse impact on profit and loss until supply issues are resolved.
Joe Howes, Credit Analyst
Real estate: the epidemic should depress sales targets
The coronavirus is expected to affect the Chinese property market’s contracted sales. If the epidemic is brought under control, the effect may be limited as January and February are traditionally low seasons – it is worth noting that Chinese developers reported an 8% year-on-year decline in sales last month.
We expect the real-estate sector to be subject to more conservative sales targets for this year and to adjust capital expenditure on land purchases and construction in order to preserve cash flows. Larger Chinese developers with stronger liquidity profiles and sufficient saleable resources on hand should be better positioned to withstand a prolonged outbreak.
Robin Usson CFA, Credit Analyst