Guernsey not immune from coronavirus economic shock

The spread of coronavirus from China (the original source) into Asia, Europe and beyond has the potential to significantly weaken the growth outlook and raise the risk of recession through the impact on consumption, investment, supply chain disruption, confidence and overly-leveraged companies. It is a potential ‘black swan’ event.

It is clearly too early to make any high-conviction predictions about the full impact of the virus on either economic activity or financial markets – partly because it is still spreading and we do not have any clarity on how long it will last.

However, it is clear that the economic and financial costs, as well as the social and health consequences, will be significant and not just for China.

An economic shock such as this starts off being localised and then tends to cascade gradually through the wider economy. The virus initially paralysed economic activity in the Wuhan province but has now disrupted demand and supply in the rest of China and then more globally.

Examples, which are increasing daily, include the collapse of demand in China, the decimation of Chinese tourism and the growing disruption to global supply chains, which could very soon force factories and offices in Europe, the UK and the US to close.

It’s no surprise that a growing number of companies have already highlighted that their prospects have been negatively affected by the virus, including Apple, which relies on China to supply components for its products, and LVMH, which generates significant sales from China and Asia. We are now starting to see these warnings spread to other stocks including Diageo, Unilever, Nike, Disney and Visa.

Global stock markets have reacted negatively to this news as they attempt to price-in expectations for future downgrades to revenue and profit forecasts. Government bonds, on the other hand, have risen strongly in anticipation of central banks embarking on further interest rate reductions and additional quantitative easing in order to counter slowing growth. The oil price has also fallen significantly on the back of reduced demand whilst the gold price has risen materially as a perceived ‘safe haven’.

Given this background, we expect markets to continue to exhibit increased volatility over the next few weeks as investors attempt to assess the longer term economic and financial impact from the virus. If the situation deteriorates further, then it is very likely that policy-makers will react in an effort to restore confidence and shore up activity. In addition to any policy easing from central banks, governments would also likely consider some fiscal stimulus such as tax cuts, increased spending or even forms of direct free money to consumers (‘helicopter money’).

Indeed, Chinese authorities have already acted aggressively and will continue to lead the way. There are no guarantees that any such actions will stabilise the outlook any time soon, but based on similar precedents such as the Sars (severe acute respiratory syndrome) epidemic in 2002-03, we are hopeful that the virus will soon be contained and that the longer term financial fallout will be limited as economic activity gradually returns to normal.

From a Guernsey perspective, we are not immune to the economic and financial fallout unfortunately. A UK or global economic slowdown or recession will impact businesses, investment, consumption and activity in the island. If the virus reaches our shores, then naturally the repercussions will be magnified as individuals are quarantined, events cancelled, travel abandoned and consumption postponed. We may also see disruption to the supply of many of our imports.

On a positive note, if the Bank of England cuts interest rates (which is very likely), this will help stabilise our economy. Also, the UK Government looks set to embark on significant fiscal easing, which will help stimulate activity in the UK and will indirectly benefit Guernsey through our close economic ties. If things get too bad, we may even have to contemplate our own fiscal easing.

Whilst we are hopeful that the outlook will soon improve, we are not complacent and will be monitoring the situation very closely.

Historically, macro-economic events such as this have proved to be good opportunities to add to attractive investment ideas, especially when human emotion has played a part.

It is also very important at times like this to reconsider your long-term investment rationale and objectives to see if anything has changed.

Our view at Ravenscroft is that it is too early to commit cash to equity markets yet given the uncertainty, but we may be looking for opportunities to do so over the coming weeks.

Alternatively, if the situation deteriorates significantly, leading us to downgrade our longer-term forecasts, we will look to adopt a more defensive strategy.