By Jolette Persson, Hottinger Capital Partners
There has been a clear spike in corporate profit warnings in the last three weeks. Apple was one the first of many US companies to publicly cut its revenue outlook driven by China’s slowing economy which in recent weeks has dampened further due to the spread of the coronavirus. The profit warning was narrowed down to an anticipated decline in iPhone sales in China and slowing pace in production. [i] Microsoft in parallel also issued a profit warning statement, particularly focused on its Windows and Surface businesses, due to supply chain disruption caused by the virus as the segment relies heavily on production operations in China. [ii] Similar to Apple and Microsoft, companies across geographies and industries are lowering their first-quarter forecasts, most notably in luxury goods, automobiles, leisure, airlines, technology and banks. Just in the UK, more than 100 UK-listed companies have now warned its investors about potential impacts of the coronavirus on their business. [iii]
Concerns over further escalation extends to global governments and central banks. Most recently in an attempt to soften the blow experienced in the US economy in the short-term, the Fed on the 3rd of March decided to reduce rates by 50 basis points. [iv] Bank of England governor, Mark Carney, shortly after signalled that it was also prepared to cut interest rates in an attempt to keep current supply chain disruptions temporary as opposed to a permanent impairment in supply. [v] Economists are not ruling out the possibility of a global recession, especially if global growth in 2020 disappoints from what is already a relatively modest forecast. The recent decline in the oil price, which to a large extent reflects the deterioration in Chinese consumption, has aided our concerns about the global economy. Particularly, as we remain in a close to zero inflation environment. Though, it’s worth emphasising that there are yet clear signs of real economic damage, with unemployment rates left relatively unchanged since the beginning of the year, and consumption still in decent health outside that of mainland China. If a recession was to occur, it will likely hold little resemblance to our last seen financial crisis in 2008 (shockwave in demand) as banks went bankrupt, home prices plunged, and stock markets bottomed. This crisis would more likely evolve around a lack of supply, leading to a slowdown in economic activity.
So far corporate profit warnings have been concentrated around companies whose business is fed by a global supply chain. Companies without direct links to the disease have not experienced the same correction in revenue forecasts and/or share prices, although, potentially, yet to be announced. We will continue to monitor this under the assumption that a global recession may not be as imminent a threat if this remains unchanged. In the meantime, there are some sectors with certain business models that might even stand to benefit from the current “quarantined” situation. With companies and governments encouraging people to avoid travel, work more from home, and self-isolate, companies catering to consumption through domestic internet services such as Amazon, Netflix, online education, online gaming and other home entertainment could be rewarded. These assets might serve as short-term stress reliefs in portfolios. What we as investors are more concerned with, however, is the long-term story.
There is a possibility that the market is overreacting, particularly in areas outside of Asia where the spread of the virus continues to remain relatively low and with stark measures in place for containment. Yet, major indices worldwide have lost trillions of dollars in value over the last few weeks. That said, however, we feel that perhaps markets may still be overvalued with some way to go before getting close to their intrinsic value.
When studying the effects of previous outbreaks of respiratory viruses like SARS and MERS (see figure 1), markets remained volatile in the short-term followed by a longer recovery period. With that in mind, although we do not think we have seen the bottom of the market yet, this could serve as an attractive inflection point, though it is still too early to tell. Markets will typically start to price risk correctly following a period of unchanged fundamentals. Potential positive catalysts include the number of infected people outside of the mainly infected areas decreasing, suggesting that the virus is getting contained, workers returning to their regular schedule and production activity in China picking up. As we are yet to see any of this, the situation remains volatile and impossible to predict.[i] https://www.ft.com/content/ab59aac6-51ce-11ea-8841-482eed0038b1 [ii] https://www.nytimes.com/2020/02/26/technology/microsoft-coronavirus-earnings.html [iii] https://www.cityam.com/132-uk-companies-issue-coronavirus-warnings-as-ftse-100-spirals/ [iv] https://www.wsj.com/articles/federal-reserve-cuts-interest-rates-by-half-percentage-point-11583247606 [v] https://www.ft.com/content/2b0dfbc6-5d4d-11ea-b0ab-339c2307bcd4