Developed market equities have rebounded (100%), while emerging market equities have recouped 50% of their losses since the outbreak of the coronavirus
Global equity markets posted a V-shaped recovery in the past week, with the S&P500 climbing to a record high, despite the fact that confirmed cases of the coronavirus continue to increase (albeit at a slower pace). Consensus appears to price-in a large but short-lived slowdown in Chinese economic growth. Limited spillover is expected to the rest of the global economy -- with the exception of EM Asia. The spillover effects mainly consist of reduced spending by Chinese tourists (150 mn overseas visits in 2018 vs 20 mn in 2003) and lower exports to China.
Indeed, Chinese real GDP estimates for Q1:2020 have been revised down to +4%/+4.5% yoy from +6% yoy before the outbreak, as consumer discretionary spending and industrial production is expected to slow considerably. Note that a significant number of factories (70%-80% of national industrial production) have not re-opened since February 2nd, while retail shopping, travel and leisure activities have been hit especially hard. Any delay in re-openings beyond the current week would further depress activity significantly.
In our view, it is too soon to signal the all-clear, particularly taking into account China’s increased role in the global economy. Note that the Chinese contribution to global growth rates has increased to 1.2 pps from 0.8 pps in 2003 (SARS), despite the deceleration of absolute Chinese real GDP growth rates from 10% to 6%. In purchasing parity terms, China accounts for 19% of the global economy, up from 9% in 2003.
Nevertheless, developed equity markets have recouped much of their decline since January 20th, posting record highs on Thursday in both the US (S&P500) and Europe (Stoxx600). On the other hand, emerging equity markets and spreads, as well as oil and industrial metals, remain well below their pre-2019-nCOV outbreak levels (see Graph below).
As a result, EM asset valuation has cheapened, but only slightly, during the current correction, with the MSCI EM Asia 12-month forward P/E ratio at 13.3x vs 13.6x (January 20th) -- a +1.1STDEV above its 15-year mean (88% percentile). Similarly, spreads have widened both in EM $ sovereign (by 30 bps to 276 bps) and EM $ corporate debt (by 10 bps to 292 bps). Both EMBI and CEMBI spreads are at the 54% and 86% percentile, respectively, where a higher percentile means spread products are more expensive relative to their 15-year distribution history.
By contrast, US equity market valuations are elevated. The S&P500 12-month forward P/E rose by 4x points during 2019 due to aggressive easing by the Fed and easing trade tensions, resulting in 30% gains for the index, with EPS flat at $162. At 18.9x (100% percentile), S&P500 valuations now match their early 2018 levels (see graph page 3). However, with limited room for additional valuation (P/E) expansion i) as the bar for further rate cuts by the Fed remains high; and ii) US election uncertainty could weigh at least until November, earnings growth become the key support, with mid-single digit gains for equity prices, at best.
Consensus estimates for S&P500 2020 $EPS are circa $176 (+8% growth vs 2019), albeit recall that historically, consensus revise down their annual EPS estimates by 4% in the course of each year (see graph page 3).