Chasing the metal rat

Thoughts on the Lunar New Year

The Lunar New Year ushers in the year of the “Metal Rat”, which combines the first animal (Rat) and the fourth element (Metal) of the Chinese astrological calendar. Together, they symbolize careful planning, wealth and vitality. Since the Rat is the first sign in the 12-animal cycle, 2020 represents a year of new beginnings. Just as investors were waving goodbye to a year of tremendous geo-political volatility and celebrating the 2019 rallies in the stock and bond markets, another exogenous shock has occurred—Novel Coronavirus. Since the first few cases were detected in Wuhan, China in December, more than 200 people have died and more than 10,000 are fighting the symptoms¹. Thus far, the estimated fatality rate of Novel Coronavirus has been lower than that of SARS in 2002-03, but new cases have been spreading at a faster rate and have been detected in over 20 countries.

The outbreak of Novel Coronavirus reminds us how extraordinarily connected the world has become. It also highlights the importance of the Chinese economy on the world stage. China now accounts for approximately 20% of the world GDP, up from 7% twenty years ago (in PPP terms). Looking back, the SARS outbreak lasted six to eight months. The impact of SARS on global financial markets was negative in April 2003, yet within six months of the outbreak stock markets had more than made up their losses. The impact on retail sales and hotel occupancies varied across Asia Pacific, but generally recovered 3-6 months after the WHO announced that the virus was contained. Also, the impact on travel was much less severe in Europe and the Americas.

Nevertheless, the economic impact of the coronavirus outbreak poses another downside risk to China’s growth this year, when forecasters expected world growth to slow to its lowest level since 2009. It is far too early to say with any certainty whether the coronavirus will be a trigger for a downside scenario beyond the natural slowing growth rate of the global economy. The probability of a global recession has been reduced as populism de-escalates, or is contained, in various parts of the world – the signing of the U.S.-China Phase One deal, the reduction of tensions in the Middle East, and finally, the European Parliament’s blessing of the Brexit deal. On the other hand, these geo-political risks are not off the table permanently; to some extent, they are just beginning.

As long-term interest rates stay at historically low levels, real estate continues to attract investor capital. In particular, demand for core real estate is strong amid “risk-off” behavior and a flight to safety. Logistics and multifamily continue to be the darlings among core investors. Additionally, demand for value-add offices remain strong. Office rent growth is forecast to moderate over the next 3 years, yet still be positive in the world’s major office markets. Retail remains the least favorable sector due to structural challenges and the recent exogenous shock will not help.

The effectiveness of further monetary easing is much reduced compared to 2003. Central banks have less room to maneuver and so many are calling for fiscal policies to ramp up private consumption and economic growth in 2020. Wherever fiscal stimulus occurs, it will certainly spur real estate demand. In summary, real estate is likely to maintain strong support from asset allocators. This means that high valuations for core assets can be maintained indefinitely as long as risk-off sentiment and low interest rates persist. The coronavirus and heightened risks of a China slowdown exacerbate this “safe haven” mentality. The exercise wheel approach to 2020 may result in portfolio managers working hard to stay in one place…but they will be fitter for having done so.

^[1] WHO, as of January 31 2020.