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Will the coronavirus signal the end of the bull market?

How various sectors will be affected, and some stocks to watch.
The outbreak is sure to have a pronounced short-term impact on the global economy. Image: Shutterstock

The key question on investors’ minds is how long it will take for the coronavirus to be contained and to what extent it is priced into assets.

We add to the debate by further questioning if the coronavirus is the only thing bugging the markets.

Getting correct answers to both questions is critical for short-term traders and those investing for short-term goals while long-term investors only have to focus mostly on the latter. For those with time in the market – real long-term investors such as pension investments – we believe this is the time to be disciplined and remember Warren Buffett’s wise words to be “Fearful when others are greedy and greedy when others are fearful”.

While it is not possible to predict with any real confidence at this stage how long and to what extent the coronavirus will affect global growth – and in turn, the end user demand for products produced by companies – the real opportunity for long-term investors would be if there are short-term price overreactions to the impact of the virus that allow long-term investment opportunities in quality companies that have strong balance sheets.

Keeping in mind that markets have had a strong run over the past decade and 2019 was a very strong year with the S&P 500 up about 30%, we believe investing through exchange-traded funds (ETFs) that track the whole market will become particularly challenging over the next few years. The opportunity is more likely to be found in selecting high quality companies that become cheaply valued due to short-term concerns as well as sectors that are long-term structural gainers.

Here are our views on certain sectors and stocks that are likely to be affected the most as well as those that might present attractive long-term opportunities.

The global technology sector

Several high frequency data points out of China clearly indicate that the disruption from the coronavirus will significantly impact China’s economic growth rate in the first quarter of 2020 as a number of industries are experiencing trading activity levels 20% to 50% lower than normal. However, some industries such as consumer internet are seeing pockets of increased activity levels as restricted human movement skews attention to services or goods that can be consumed through online platforms.

Naspers and Prosus currently derive all of their profits from Tencent and the latter derives almost all of its earnings from online services in China.

Tencent is therefore likely to have seen relatively less of an impact from the spread of the virus.

Tencent and other related global technology shares have clearly benefitted from loose global monetary policy conditions as well as relatively resilient earnings growth in a weaker global growth environment. Current sector valuations are therefore not factoring in a prolonged global economic impact from the coronavirus and if a prolonged impact were to materialise, this could be a short-term risk to Tencent and Naspers/Prosus shareholders.

However, we believe other, more cyclical sectors could be affected more severely than secular growth sectors.

The consumer sector

This sector is likely to experience temporary challenges in light of the high level of trade with China – not only from a supply chain disruption perspective, but also from an economic growth perspective.

China’s clothing manufacturing industry feeds into the global fashion industry.

With factories closing temporarily and travel restrictions preventing buyers from their usual business activity, we can expect that this will be disruptive to retailers. There is an indication that this may be inflationary for retailers but considering how short the lifecycle of fashion trends and clothing is, we can expect that businesses will rebound quickly in the event that China rebounds quickly. That being said, the fragile state of the South African economy means that retailers may have to absorb the unexpected increase in costs.

Regarding the food industry, the most vulnerable companies are those that sell produce into China or those that compete with companies that export to China. Oceana produces fishmeal and fish oil. The demand for these two products was already low due to the African swine flu that had significantly affected China’s pork industry and now, with travel restrictions in place, the Chinese aquaculture industry may follow in reducing its feed imports. Although Oceana does not export directly, the global fishmeal and oil industry will have to find other places for their supply and hence may depress global prices.

Regarding luxury goods, it is worth noting that roughly a quarter of Richemont’s sales are in China, including Hong Kong.

Global Chinese tourism as well as global tourism in general is also an important contributor to luxury goods sales, hence reduced travel to Europe would impact sales exposure on top of the direct China exposure. Richemont is therefore at higher risk of a short-term profit impact from the accelerated slowdown in Chinese economic activity.

The commodities sector

China remains the largest buyer of commodities and materials used in the construction and manufacturing sectors. Chinese economic growth has steadily been slowing over the past decade and the coronavirus as well as trade disputes with the US may accelerate the slowdown over the next few years.

While this will have an impact on all stocks in this sector, we believe the following shares are likely to be affected the most:

  • Glencore sells and trades in various metals and minerals as well as energy products. Copper, coal, zinc, nickel and oil are important contributors to the group’s mining and trading profits. Chinese demand for these commodities represents a material demand driver of their price. If the coronavirus were to lead to a meaningful and prolonged decline in commodity demand, it may affect the prices of such commodities, which may have a negative impact on Glencore’s profits in addition to ESG concerns that have significantly affected the share over the past few years.
  • Kumba sells iron ore to various global customers including the Chinese steel industry. Chinese steel demand is the main demand driver of the price of iron ore. If the coronavirus were to lead to a meaningful short-term decline in steel demand this may affect the price of iron ore, which may have a temporary negative impact on Kumba’s profits.
  • Sappi’s key product is dissolving wood pulp, some of which is sold on the spot market into China. Dissolving wood pulp is mainly used in viscose production, much of which is used in China in the textile manufacturing industry. Again, if the coronavirus were to lead to a meaningful short-term decline in viscose demand in China this may affect Sappi’s dissolving wood pulp prices and profits negatively.

Overall, it is clear that coronavirus headlines will be with us for a while and it will surely have a pronounced short-term impact on the global economy.

Authorities will come up with various measures such as fiscal and monetary policy to mitigate the impact but it is important to remember that markets have enjoyed a very strong decade of gains, and selecting good quality stocks at reasonable prices is likely to deliver better long-term wealth outcomes for investors.

In short, we do not expect the virus necessarily to spell the end of the bull market.

Peter Takaendesa is head of equities at Mergence Investment Managers.

The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.

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I am not aware of any bull market in South Africa recently, although admittedly I do not follow the South African markets that closely anymore. But looking at the past 5 years (Thanks Moneyweb) all major local indices were relatively flat or even negative. If you are talking about the bull run experienced in the US markets (since you mention the S&P500) then you should be expanding on the likelihood of the bull run ending by referencing US sectors and companies.

End of comments.

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