Stock Market Impact of coronavirus
Yuichi Murao, Senior Investment Officer – Japan Equity
Takahiro Nakayama, Senior Investment Officer – Global Equity
Published 11 March 2020
US and Japanese stock markets have declined by 10.6% and 17.0% since February
On Monday March 9, the S&P500’s plunge of 7.6% reflected not just mounting concerns about the global spread of coronavirus, but also the failure of the OPEC Plus ministerial meeting to agree cooperative production cutbacks. However, the Japanese stock market (TOPIX) on Tuesday March 10 saw a 1.3% rebound, partly in reaction to the steep price fall on March 9. However, with a renewed downturn on Wednesday, the market had fallen by 5.0% by midweek.
In March and since February, the US stock market has declined by 2.4% and 10.6% respectively, while the Japanese stock market has registered falls of 7.5% and 17.0% respectively (closing price of March 10 for the US and March 11 for Japan).
New coronavirus spreading economic contagion
Given the extent of the decline, we should assume that the global stock markets have already priced in the near-term impact of the coronavirus epidemic on the macro economy and corporate earnings. However, there is now a growing concern that it could have a longer lasting economic impact than initially anticipated not only in Japan and China but also US and Europe, so the heightened risk awareness of the possible extent of the economic downturn may have triggered these larger market declines and increased volatility.
For the Tokyo markets, the negative impact of the strong yen on Japanese corporate earnings will compound the effects of disruption to normal economic activity due to containment measures. Currently, most of the investors are using the projected yen exchange rate of 110 yen against the US dollar for forecast earnings for the next fiscal year. If the exchange rate settles around its current level of 103 yen for the rest of this year, earnings results would have to be revised downward significantly, particularly for exporters.
The market as a whole could see profit growth rates in fiscal 2020 start to level off, overriding initial expectations of a high single-digit growth rate. Much of the stock price sell off in the past few days, in addition to the deterioration in corporate earnings, is due in particular to fears about short-term funding conditions for SMEs. These risks are becoming a reality, with inexorable downward pressure on spending on goods and services, the drying up of corporate cash flows, and the increased threat of bankruptcy. In response, the Japanese government is now expanding its funding support measures.
On the other hand, in the US, some policies and data that have been released since late February could be beneficial to the stock market. Specifically, the Federal Reserve implemented an emergency rate cut of 50 basis points, proving its ability to implement policy measures responsively as the situation requires. Further support came from Senator Joe Biden’s rising approval rating since the Super Tuesday polls for the Democratic presidential nomination. Economic indicators such as February employment statistics and the ISM Non-Manufacturing Indices also exceeded expectations, although they reflect the phase prior to the coronavirus outbreak.
Market outlook – stocks now look undervalued
As for the market outlook, it is too early to estimate when the epidemic might be brought under control, while other unexpected events such as the Saudi-Russian OPEC Plus dispute are also likely to have a magnified impact. Therefore, from an economic policy perspective, it will be important to see the government response – for example, will they seek to alleviate the temporary adverse economic impact by providing financial backing to viable companies with deteriorating cash flows?
We will also focus on future changes in the labour market. Deteriorating labour market conditions are likely to lead to weaker personal consumption, in which case the risk scenario of an economic downturn is likely. On the other hand, stocks are becoming increasingly undervalued, as we can already see indicators such as free-cash-flow yields of blue-chip companies becoming more attractive relative to current bond yields.
Japanese stocks flagged a significant valuation indicator when they were sold down to the point where share prices fell below a PBR (Price to Book Ratio) of 1 as of 9 March. Considering that Japanese companies can maintain an ROE of approximately 8% over the medium term, this shows that stock prices have now become undervalued. A market recovery is likely to depend on several conditions – bringing the coronavirus under control, implementation of adequate policy measures for cash flow management, and stabilisation of global credit markets.
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