I am writing this from my home in Hong Kong, not far away from the border of China and only 900 kilometers away from Wuhan, the initial epicenter of the Covid-19 pandemic. The lockdown since 23rd January in Wuhan has finally been lifted.
As China attempts to restore some normality back to the country, the rest of the world continues to reel from the rapid spread and devastation caused by Covid-19. Inevitably comparisons are being made with the earlier 2003 outbreak of severe acute respiratory syndrome (SARS) in China.
SARS vs Covid-19
Compared to the SARS epidemic outbreak, repercussions of the coronavirus can be felt much more substantially in the global economy. It is estimated nearly 800 fatalities were caused by SARS, spanning across 17 countries over a 6 months period, wiping off over $40Bn from the global markets and causing a significant decline in China’s Gross Domestic Product (GDP). Fast forward to 2020, the Covid-19 pandemic has caused over 200,000 fatalities and is still rising across 150 countries, with the International Monetary Fund (IMF) estimating the cumulative global GDP loss over 2020 and 2021 could be greater than $9 trillion. Fundamentally China now plays a much bigger part of the global economy, accounting for 17% of GDP compared with 4% in 2003 and the fear around global supply chain issues has created greater anxiety among investors. While SARS clearly had a direct impact on the Asian economies, only the ripples were felt in other major economies around the world. In stark contrast, Covid-19 has directly impacted the two largest economies in the world - the US being the largest consumer and China being the largest supplier.
Why is the fear greater this time?
Recently we have been inundated with financial news describing extreme volatility in the financial markets, introduced by the fear of uncertainty by investors. The Cboe Volatility Index (VIX) acts like a fear thermometer for the market being a leading indicator measuring volatility on a broad basis. The VIX is still experiencing significant swings, despite the virus appearing to have passed its peak in source country China (well officially anyway) and the focus has now turned to the US which now has the highest daily death toll of any country. The US unemployment rate has skyrocketed to 14.7%, the worst since the Great Depression, taking the total to over 30 million US citizens now unemployed. This has contributed to the VIX being double the level experienced during the SARS outbreak and even greater than during the 2008 Global Financial Crisis. Countries are coming to the realization that we are looking at a major slowdown in economic growth, with a sharp decline in GDP while mounting larger levels of national debt.
So whilst fear is definitely the prevalent emotion in the market, some economists are feeling optimistic, predicting a bounce back with a V shaped recovery as factories in China reopen and make up for lost time, replenishing supplies and kick starting a recovery globally. Any bounce back of course assumes a quick return of global demand as well. The severe alternative being a much slower recovery and a prolonged global recession.
How are the exchanges coping?
The Statista graph highlights a rapid downward trend across all major APAC markets. Major sell-offs did take place, as panic started to set in with investors, triggered by the World Health Organisation (WHO) declaring Covid-19 as a pandemic in March. The Hong Kong Hang Seng Index closed in the same month, almost 24% lower than its first day of trading in 2020, during this time neighbouring markets also suffered similar double digit % losses.
The volatility in the markets has caused record trading volumes across the major Asian exchanges. One example has been the Hong Kong Exchange which has experienced record daily cash equity and derivatives trading activity exceeding HK$100 billion ($12.9 billion) regularly since the Chinese New Year. Circuit breaks have been triggered at the exchange on multiple days, with trading activity truly stress testing the technology infrastructure of the exchange.
The Australian Exchange (ASX) posted its worst month since 1987 in March, plunging 21.5% amid a worldwide equities rout as the coronavirus pandemic worsened. Trading volumes doubled on the ASX reaching the point where the exchange and settlement function (CHESS) was under such incredible stress due to the number of the executions that the Australian Securities and Investments Commission (ASIC) took the unprecedented action of issuing notices to large equity market participants to reduce the number of trades by 25%.
While some exchanges are struggling to cope, the Singapore Exchange (SGX) has recently reported a 38% jump in quarterly net profit to a 13-year high, as extreme market volatility has boosted equities and derivatives trading volumes and associated revenues being generated. Demand for multi-asset investment and risk management solutions has intensified, especially from international participants trading outside of Asian trading hours. SGX’s expanded geographical footprint has helped to support US and European clients, whose activity has grown to 20% of total derivatives volumes. Other exchanges are also likely to benefit from the rising volatility, although SGX's strength in derivative products and the associated hedging benefits means it is particularly well placed among Asian bourses to do so.
In the short term it is expected volumes in trading will continue to be high, correlated with volatility in the markets caused by fresh news. Longer term the threat of a potential collapse in IPO primary listings could have an adverse impact on the overall financial health of exchanges and wider ramifications for the economy in terms of capital raising in general.
Any early signs of recovery?
Potentially the tide is turning. Since the start of April the Hang Seng Index has slightly recovered by regaining 12% and the rest of the global markets are starting to rally. What could be causing some early signs of recovery?
One explanation could be that invaluable lessons learnt during SARS which has led to a much more rapid response by the Chinese authorities to the Covid-19 outbreak which appears to be working in terms of bringing Covid-19 under control in China. During the SARS epidemic, China was heavily criticised for a much slower reaction and lack of transparency which contributed to a longer period of sell-off and uncertainty in the markets. The increased dissemination of information provides essential transparency, making the markets more efficient, as it prices in the news much more effectively.
This time many companies in the APAC region have been much quicker to activate extensive Business Continuity Planning (BCP) in comparison to other countries and exercise social distancing. The major APAC Stock Exchanges have remained fully operational with the majority of employees already accustomed to working remotely from home. APAC Regulators and exchanges have invested significantly in comprehensive BCP, specifically designing pandemic plans introduced post SARS.
We are talking about an 18 points handbook issued jointly by the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) and adopted by Hong Kong Stock Exchange (HKex). At Itiviti, being a hosted broker supplied system (BSS) provider, we have conducted several BCP mock tests in the last few years to ensure that our solution can cater for a potential upsurge in transaction volume in the event of clients switching to using electronic channels. Recent protests in Hong Kong during 2019 have also meant BCP has been tried and tested for many months in the run up to the first Covid-19 case being announced.
Another contributing factor to calming the financial markets has been the timely announcement of stimulus packages by governments. China announced $79Bn to boost economic growth and the US has injected $2tn (a record size stimulus package) into their economy. Markets also have reacted well to the “unimaginable” amounts of liquidity being pumped into the financial system, and even though the news is not becoming incrementally better, green shoots are appearing as investors start to look for opportunities. With the equivalent of 3% of the world’s GDP in liquidity being pumped into financial markets globally to stem the tide of the Coronavirus, markets are starting to trust that the response from central banks and governments will work.
What will be the long term implications for the markets?
There are clearly significant differences in terms of magnitude when it comes to comparing Covid-19 with SARS in relation to the markets, with China playing a much bigger role in the global economy. The economic cost that has been paid to reduce the infection rate is unprecedented. The drop in employment is faster than anything we have ever experienced. Entire sectors of the economy are shut down. It’s inconceivable for oil prices to ever go negative but it has for the first time ever, with oil drums costing more than its contents. It is important to realize that this is not just the result of government policies restricting activities. When people hear that an infectious disease is spreading widely, they change their behavior, not necessarily being predictable even after governments loosen restrictions.
Further stability in the markets will only resume once Covid-19 is perceived to be brought under control globally. Until then though any unexpected spikes in terms of confirmed Covid-19 cases or deaths in the world will continue to scupper attempts of any long term market recovery. In the short term, the entire world’s eyes are on the nearly reopened city of Wuhan to see how quickly the global supply chains can resume for businesses such as PepsiCo, Siemens, IBM, and French carmaker Peugeot Citroen, who all have major manufacturing operations in Wuhan.
Longer term undoubtedly lessons will be learnt from China by other countries having dealt with two pandemics in the last decade, however governments and companies will also reassess their China exposure and look to significantly diversify in the future. Experts predict we are years away from a vaccination, during this period companies will reassess the benefits and costs of globalisation specifically within manufacturing and distribution industries. Globalisation has had a profound effect on the global economy bringing huge benefits but with it comes systemic risks which only materialise during a crisis - be it financial or medical. We are already witnessing an increase in what might be termed economic nationalism by countries due to the vulnerabilities of global supply chains. I am left wondering if the ‘made in China’ label will merely become an artifact banished to the history museums in years to come.