Coronavirus: Markets looking at the silver lining miss the dark cloud looming over Asia’s economies
- The consensus view in markets is that the virus is containable, with the collapse in economic activity likely to be short-lived. But emerging markets are more exposed to China than ever before, and their faith in the effectiveness of stimulus may not be repaid
A month has passed since the outbreak of the deadly coronavirus began to move financial markets.
Yet, since the beginning of February, sentiment has improved markedly. Last week, emerging market bond and equity funds attracted net inflows of nearly US$4 billion, taking the cumulative inflows this year to US$17.4 billion, according to data from JP Morgan.
Not only does it show the extent to which traders have become conditioned to treat bouts of turmoil as buying opportunities, mainly because of continued support from central banks, it is also a sign that investors do not perceive the economic fallout of the epidemic as a big enough shock, within China and around the world, to derail growth and severely undermine sentiment.
However, it is still too early to say whether the spread of the disease has been contained and, more importantly from a market standpoint, whether a “V-shaped” recovery is likely. Just a cursory glance at the recent batch of research reports from the big investment banks shows that analysts are struggling to identify indicators to gauge the severity of the shock to China’s economy.
Asia’s emerging markets are most at risk due to their stronger trade linkages with China, greater reliance on its tourists and, crucially, the central role China plays in the region’s supply chains.
As JP Morgan noted in a report published earlier this month, “China’s much greater global footprint and the increased complexity of Asian manufacturing value chains today than two decades ago render undoing [novel coronavirus] damage a stiffer ask than Sars”.
Investors in Asia’s developing economies should, at the very least, be demanding more of a “virus risk premium” for holding regional financial assets. While local currency bonds will benefit from more aggressive stimulus in China and additional monetary easing across the region – Malaysia, Thailand and the Philippines have all cut interest rates over the past several weeks in response to the anticipated slowdown – stocks and currencies are vulnerable.
The equity markets of most major developing economies in Asia are already on the pricey side – the forward price-to-earnings ratio, a popular valuation tool, in Taiwan, Malaysia, Indonesia and Thailand is above 15, compared with 12.5 for the emerging markets index, data from JP Morgan show – and are more expensive than their historical average. Given the uncertainty over corporate earnings across the region, a correction is overdue.
The coronavirus crisis has also helped drive up the US dollar, boding ill for emerging market currencies. The Bloomberg JPMorgan Asia Dollar Index, a gauge of the region’s most liquid currencies excluding the yen, has lost about 1.7 per cent since January 20. Yet, the index is still significantly above its low last August. Just like the region’s stocks, emerging Asia’s currencies are likely to come under more pressure as fears about growth intensify.
However, markets are again choosing to focus on comforting signals from central banks. Investors have been clamouring for more stimulus in China to help support a global recovery that was showing signs of taking root late last year. The economic disruption caused by the epidemic is now viewed by investors as the catalyst for such action.
As long as the speed and efficacy of the containment of the disease are in doubt, the risk of a more severe and prolonged economic downturn will increase. Asia’s emerging markets are at the sharp end of the fallout of the coronavirus crisis. The region’s asset prices, particularly stock markets, ought to be reflecting these risks.
Nicholas Spiro is a partner at Lauressa Advisory
