As of Thursday, February 27, 2020, there are over 82,000 people infected with the novel coronavirus (COVID-19) worldwide, with nearly 3,000 deaths resulting from the illness. The outbreak has been concentrated in mainland China, but the virus has spread to more than 45 other countries as well. Wuhan, where the outbreak originated, and other large areas of China and other parts of Asia are under quarantine, many employees have been told not to go to work, children not to go to school. Some of these restrictions have begun to ease over the past week.
Given China’s importance to the global economy—accounting for 16.9% of real global GDP in 2019—the COVID-19 outbreak in China is impacting many sectors and geographies around the world. The main impacts will be felt primarily through reduced demand for exports by China (and to a lesser extent the broader Asia Pacific region), supply chain disruptions (via bottlenecks for imports from the region), reduced tourism and business travel, and the potential for a crisis of confidence to emerge. Now that the virus has spread, it is unknown how these effects may be felt across a variety of countries.
All eyes are on the financial markets. U.S. and European equity markets which had been mostly resilient since the outbreak, are now starting to price in greater downside risk. In the last few weeks, we’ve observed wild negative swings in virtually all global stock market indexes including a 1,000-point-drop in the Dow on February 24, 2020. The outbreak has also prompted a flight to quality, driving investors into the bond markets which has in turn put upward pressure on the U.S. dollar. Ten- year government bond yields in the U.S., UK, across most of Europe and Japan, are currently approximately 40 bps lower since the beginning of the year. The drop in rates is creating more attractive debt/refinance options.
In Europe, the global impact will put countries that are more reliant on trade and manufacturing—such as those in the CEE region, the Netherlands and Germany—more at risk. Italy also stands to be impacted given the recent uptick in infections. Supply chain effects are already surfacing, from equipment manufacturers that are unable to maintain normal production rates to some auto manufacturers that are unable to find alternative component sourcing. Indeed, with China as auto manufacturers’ largest consumer market, the auto demand impact is expected to take a toll in the near term. Despite this, the outlook for broader logistics remains unadjusted as eCommerce continues to expand structurally and reorganize supply chains to enable faster and more cost-efficient delivery. Retail and hospitality, reliant on both tourism (leisure and business) and goods sourced from Asia, will be viewed with caution. Office occupiers may pause on expansions in the near term until the services sectors prove their resilience in the face of weaker near-term global demand. Overall investment and deal-making may be delayed on the margin, but no pullback in annual activity is expected.2 Only 1.6% of the total capital invested in the EMEA region over the last five years was from China and 2.7% when Hong Kong is included; that share climbs to just 5.7% when Asia Pacific is included. However, many investors from Asia have a physical presence outside of the region. Further, in recent years, China specifically has been less active in Europe and the U.S. as a result of multiple capital controls.
The U.S. is more insulated: 70% of the U.S. economy is driven by domestic spending and it generally has less exposure to Asia Pacific than do other global regions. However, the U.S. and China also have the largest bilateral trade relationship in the world – so the U.S. is far from bullet-proof. For now, it is too soon to say what the office sector impact will be, but more caution and unique challenges for the tech industry specifically indicate that some leasing activity may be curtailed in the near term as firms grapple with larger supply chain issues.
The hotel sector is the industry most obviously impacted by the sharp decline in Asian tourism. Around three million Chinese tourists visit the U.S. each year, according to Neilson. During the SARS (severe acute respiratory syndrome) epidemic in the early 2000s, the number of visitors from China and Hong Kong declined 25% between 2002 and 2003, according to the U.S. National Travel & Tourism Office (NTTO). The impact from COVID-19 is already tracking to be much worse, as Chinese travel and tourism to the U.S. has come to a virtual halt. This weakness is being captured by the U.S. hotel REITS, which are down 21.3% as of February 27, 2020.
The global economy was gathering momentum heading into 2020. Assuming infections globally will abate by mid-year, and with more government stimulus now going in, market conditions will be primed for a robust rebound as pent up demand is unleashed.