China’s coronavirus response highlights investing risks

The breakout and then spread of the coronavirus (or Covid-19, as it is officially known) is an example of a black swan event at its finest.  

After first emerging in Wuhan, China at the beginning of the year, the virus has spread extremely rapidly. In doing so it has had a deleterious impact on the economies of almost all of north Asia, and is now hammering countries worldwide as governments begin implementing policies to socially isolate their citizens and mitigate the disease's spread.

The efforts are having mixed results. The number of new victims in China appears to be abating, in part because of the government's draconian crackdown on Hubei province (in which Wuhan is located) in February and March. It also seems like the numbers of infected are slowing in Korea, Hong Kong and Singapore too. But casualties are still rising in countries many other regions, in particular Italy and the US. The number of victims and deaths across the world now exceed those in China .

The disease is likely to linger for months to come – and perhaps over a year, which is the time it will likely take to produce a vaccine. Expect to see self isolation efforts being rolled back, only for more virus victims to emerge. The period of containing the virus is over.  

Against such a pernicious and potentially longlasting threat, there are few real precautions that institutional investors can take. But the onset of the virus underscores some home truths about investing. 

First, diversification is key, be it geographic of by sector. Investors in China and Hong Kong saw local stock indexes tank at the start of February, then regain these losses over the next month. Then the US and UK’s stock markets nose-dived in early March, as the virus spread. Meanwhile the most recent drastic rate cuts by the US Federal Reserve have served to cut bond yields.  

Secondly, the need for illiquid private assets has only been made more evident. It's sometimes a good thing to have sizeable sums of money locked up in a private equity or real estate fund that won’t mature for another few years, particularly when stock values are cascading downwards. 

There’s also a third takeaway. Transparency – and the lack of it – are important considerations to take into account when investing. 

China’s Communist Party remains highly defensive about its grip on power, and continuously clamps down on criticism and perceptions of internal vulnerabilities. But as the coronavirus reveals, that approach can cause small problems to metastasise. 

INERTIA TO CLAMPDOWN

Reports of a new virus in the city of Wuhai in Hubei province began emerging at the beginning of the year. Yet they were initially downplayed; one doctor who raised the alarm was arrested for “spreading rumours” – and later died after catching the virus. 

Only in late January did Beijing finally begin a mass response to the spreading disease.  This laggardly reaction almost certainly allowed the virus to quickly spread, to the point that Beijing reacted in an unprecedented manner, placing travel restrictions on approximately 780 million of its people. 

Beijing’s early response raises questions about the political risks of investing in a country so focused on quashing perceived criticism

Observers have spoken with awe about the ability of the government to successfully do so, and the extreme measures have almost certainly helped slow the spread of the disease. But the economic impact of this clampdown was been very large.

Brutal quarantining is also not the only way to gain control of the virus's spread, as Korea's mass-testing and the voluntary social distancing efforts of Hong Kong's populace reveal.

For now many economies will be most focused on their own efforts to slow the spread of Covid-19. They will have little immediate time to consider other factors. But, as the virus hopefully begins to abate in the coming months, investors and companies alike may well begin to consider the extent of the world’s dependence on China for essential products.  

The country is now the world’s second-largest economy, and it is responsible for producing many key components in global industries, from vaccines to facemasks to rare earth materials to clothing fabric. It’s integral to much of the world’s economy. Unfortunately, China has also proven to be susceptible to outbreaks of disease. 

OPPORTUNITY VS. RISK

As the coronavirus slowly dies down, China’s economy will rebound – helped, no doubt, but state fiscal measures. But once it does so, some international manufacturers will contemplate their dependency on Chinese products. It is likely that some will opt to shift some of their component needs to elsewhere. 

Banks, fund managers, insurers and pension funds will immediately focus most on how best to weather what is likely to be a global recession, but after weathering the immediate volatility they will also have to assess the extent of China in their longer-term growth and investing plans. Most will likely conclude the opportunities in the country outweigh the risks, particularly given Beijing’s willingness to push fiscal policies to get growth back on the move. China’s GDP should resume growing once it is certain the virus has truly abated.

But long-term investing depends on certainty, transparency and regulatory fairness. And Beijing’s early attempts at concealment – along with its decision to expel US journalists on Wednesday (March 18) – raises questions about the political risks of investing in a country so focused on control and quashing perceived criticism.  

The coronavirus is abating in China, but Beijing could find the concerns it raises about its priorities are harder to quell.