Why Investors Are Looking Past the Worse-Than-SARS Coronavirus

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Three main reasons overwhelm the bears.

After selling in mid-January and asking questions later, stock investors have found plenty of reasons to alleviate their own concern that the coronavirus will hurt stock prices.

Sunday reports said the coronavirus now has killed more people in China than the 2003 SARS virus did. Coronavirus cases have exceeded 40,000, five times the total for SARS.

And on Monday, all three major U.S. indices rose, with the S&P 500 rising as much as 0.6%. From Jan. 17 to 31, the S&P 500 sold off 3.2%, before rebounding to a now year-to-date gain of 3.75%.

In early February, some on Wall Street compared the coronavirus to SARS, which was contained quickly, leading to a bounce-back in U.S. stocks.

But as the coronavirus has spread, investors nonetheless see three reasons for optimism that could overshadow the negative worldwide economic impact from the virus.

Spread of Coronavirus Slowing

The World Health Organization has made clear that while cases are growing, the spread is slowing, aided by the medication breakthrough reported last week.

“Proactive response to the Wuhan epidemic appears geared to contain and limit the virus’ impact to China for now,” wrote Glenmede’s chief investment officer of private wealth, Jason Pride, in a note.

“We see a number of factors that can help to limit downside: increased optimism from investors that the pace of the coronavirus’s spread may be slowing (though the outlook remains uncertain),” wrote Morgan Stanley Equity Strategist Michael Wilson in a note.

Some economists see a hit to China’s GDP growth of more than 1 percentage point and a hit to global GDP growth of just under 1 point.

China exports goods worldwide and accounts for roughly 17% of global GDP. Companies with production halted in China may see sales volumes for 2020 decline. And the growing Chinese consumer sector buys products from everywhere.

But if the virus can be eradicated, 2021 revenue and earnings will be strong compared with 2020.

Liquidity on Tap

Most observers also expect several large countries to inject fresh liquidity if their economies need it.

Investors have asked Canaccord Genuity Chief Equities Strategist Tony Dwyer how concerning the economic impact to 2020 growth will be.

His answer: “The impact thus far has been significant, which means global monetary ease and Chinese fiscal response to kickstart activity is likely to be significant. Remember, it was the Chinese announcement of monetary support Saturday, Feb. 1, that stabilized the global markets that following Monday.”

China spent $19 billion on fiscal programs in that stimulus tranche. It also recently induced monetary stimulus by relaxing bank-reserve requirements. Stimulus in China can boost consumer spending, benefiting U.S. companies, while it can also support industrial activity and output.

As for the U.S., “the liquidity-driven bull market remains in charge,” Morgan Stanley’s Wilson said. The Federal Reserve has made clear it will cut interest rates further if needed, although some bears would say that with the federal funds rate now at around 1.5%, the Fed can’t cut too much more before the U.S. gets to negative rates.

In the EU, “the German DAX and French CAC [stock indexes] barely sold off on Friday, suggesting investors may be thinking a fiscal response is now more likely and looking through it,” Wilson said, pointing out that manufacturing activity in the EU has been poor.

Wilson also noted that even before the virus outbreak, German and French industrial production was seen down 3% and 6.8% for December year-over-year. Investors may be delighted to see fiscal stimulus in the EU, as rates are already sub-zero, especially in Germany.

Stimulus in the EU means American companies exposed to the EU consumer can benefit.

Global-Growth Oriented stocks Already Hit

The third reason the market can maintain steam through the virus is that economically sensitive global stocks have already been hit.

“The correction was small for the S&P 500 at just 3.5%, but it was much more severe for stocks and assets geared to global growth, especially in China,” Wilson said. “Given already weak performance of such assets, they are now discounting a fairly negative outcome.”

Caterpillar CAT which sources materials manufactured in China, is down 13% year-to-date, a move also reflecting poor manufacturing activity in the EU. The iShares Semiconductor ETF SOXX is flat for the year, as many semiconductor companies with production operations in China have had to halt production in the region.

Chinese-consumer-exposed stocks like Nike NKE and Starbucks SBUX are down 3% and 2.2% for the year, respectively.

The U.S. rally has been led by big tech, utilities, real estate and health care. While valuations remain relatively high, these factors give juice to the bull thesis, which so far has won the arm-wrestle with recession-wary bears.

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