The Potential for Pandemic and Market Volatility

Concerns about China’s coronavirus outbreak potentially becoming a pandemic has led to a sharp market sell-off as investors grapple with the economic impact. Setting aside the grave nature of this illness and the human toll it has taken and may yet take, we are considering a range of possible outcomes for the market and the earnings potential of our own holdings.

What is clear: In the shorter term, disruption is inevitable. Looking at the demand side in China, there’s been essentially a halt in domestic consumption, particularly in areas like entertainment, transportation, hospitality, retail, etc. On the supply side, we have a combination of labor shortages, logistics bottlenecks, and factories operating well below capacity. What is critically different from the SARS outbreak in 2003 and COVID-19 today is China is a more important player globally, so we will likely continue to see disruptions to our complex, integrated global supply chain for some time. And the longer the disruptions run, the more likely these businesses in China, especially the smaller ones with higher leverage, are likely to suffer.

That’s the near term. The longer-term outlook over the next 5 to 10 years is we still have a rising middle class in China that should, notwithstanding near-term disruptions, continue demanding higher quality goods and services. We don’t believe that the COVID-19 outbreak impacts that secular growth tailwind, which is what our Chinese holdings are largely exposed to. Rather, we are asking ourselves whether this disruption provides an opportunity to direct more capital into both existing and/or new holdings—companies we believe to be part of China’s long-term growth story.

Looking outside of China, whether this epidemic is labeled a pandemic or not, the potential global impact cannot be ignored. However, the range of outcomes are likely to be extremely wide. We know countries vary in their preparedness for a health crisis and the quality of their health care systems. Countries that have reported cases also vary in their importance to the global economy. As we look at our holdings domiciled in and exposed to various countries where the virus has spread or is likely to spread, again we are considering the potential for near-term disruption and whether that represents a buying opportunity in the context of our longer-term theses.

Ultimately, when hit with crises like these, we remain focused on optimizing our portfolio, which despite near-term volatility represents a collection of businesses that generate cash flow and pay dividends. Our process is intended to lead us to companies that have the business models and balance sheets capable of weathering near-term shocks—or perhaps can even leverage such opportunities themselves to reinvest in their businesses or otherwise position themselves more competitively. Importantly, in times like these, we remind ourselves that lower equity prices typically lead to higher long-term returns.