Investment lessons from the coronavirus outbreak

Despite the continued spread of the coronavirus, US and European equities reached record highs last week. Emerging market stocks in Asia have bounced off their lows, but remain some way from their January peaks. China’s CSI 300 index, for example, is 7% below the pre-virus peak.

While markets have recovered, it is still too early to say when the virus outbreak will be brought under control. Chinese factories are set to reopen this week after the extended Lunar New Year holiday, and it will be important to watch how the virus spreads as people resume travel back to work and how long it takes for production to return to full capacity.

While markets have recovered, it is still too early to say when the virus outbreak will be brought under control.

There is still considerable uncertainty, but investors can already learn important lessons from the market response to the outbreak, particularly since reacting to unexpected events in the wrong way can hurt your chances of long-term investment success.

Here are our key lessons:

Stay with your investment plan.

• Selling on knee-jerk market reactions to unforeseen risk events is rarely advisable. Disease outbreaks, like geopolitical events, are by their nature unpredictable, but previous experience can act as a guide. The impact on wider markets from risk events is only rarely significant, and it tends to be short-lived, as was the case after last month’s escalation in US-Iran tensions. How developed market equities have reacted to the outbreak to date supports this view, although a marked acceleration in the virus's spread and an increase in the mortality rate could lead to another leg down for stocks. While it can be tempting to sell out during uncertainty, staying invested through a diversified portfolio to mitigate idiosyncratic risks is the best approach—it ensures a long-term focus in line with your broader financial plan.

Avoid vulnerable stocks.

• Any more lasting effects will tend to be confined to local markets and assets directly affected by the virus outbreak. Sectors likely to be most affected include airlines, casinos, hotels, other travel-related segments, and select consumer-related industries. Investors can mitigate risk by avoiding vulnerable companies in these sectors and favoring stocks likely to outperform, such as those exposed to online consumption as more people stay at home.

Consider phasing into the market.

• With equity markets at or close to record highs, some investors holding cash may be worried about deploying capital amid heightened uncertainty caused by the virus. We recommend three key approaches: investing in bonds first and riskier assets later, committing to a set schedule (aiming for deployment within 12 months, with a plan to accelerate if there is a 5% or 10% sell-off), and considering a put-writing strategy to provide some return if a buy-on-dips opportunity doesn't arise.

Consider gold as a hedge.

• Gold has proved its value as a portfolio diversifier this year—both during the escalation in US-Iran tensions and following the virus outbreak. Gold is up 3.7% this year, and while safe-haven demand is likely to fade as the outbreak is brought under control, the yellow metal still benefits from fundamental support. Muted US economic growth and the sharp drop in bond yields this year mean real rates are likely to stay low, reducing the opportunity cost of holding gold. We also expect the US dollar to weaken in the second half of the year, which, as bullion is priced in USD, supports gold’s price.

Focus on the fundamentals.

• It’s important to filter out the noise from headlines about the disease and focus on its likely economic consequences. The short-term impact on Chinese growth may prove to be significant, but it will also likely be short-lived as pent-up demand spurs a sharp recovery from the 1Q setback. Monetary and fiscal policies are supportive; the People’s Bank of China has already cut rates. And even taking into account the hit to Chinese growth, we expect the growth differential between emerging and advanced economies to widen in the former's favor this year and next.
• We expect earnings growth to be the main driver for equities this year; our base case is for double-digit growth for Asia ex-Japan and emerging markets as a whole, far outpacing developed market peers.

Taking these lessons on board, investors can better navigate the challenges thrown up by unexpected risk events. While we continue to monitor the risks to our positions, we are optimistic that the decisive actions taken by governments will bring the virus under control. We remain overweight emerging market equities, and within our Asian portfolios we prefer Asia ex-Japan stocks.

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