In an Insight published on its website, Danske Bank says that the coronavirus spreading increases uncertainty on the negative effects on the economy. The bank says it still expects the impact to be temporary and it is maintaining a slight overweight in equities.

The insight notes that the coronavirus outbreak in northern Italy is what is particularly worrying Europe. Here, the number of infections surged over the past weekend. Several northern Italian towns are in quarantine, schools are closed and public events have been cancelled across much of Italy.

“Up to now the coronavirus has primarily been considered a Chinese and Asian phenomenon, but suddenly an outbreak has erupted in Europe,” said Danske Bank’s chief strategist, Henrik Drusebjerg. “From an economic perspective, investors now fear the spread to Italy could be a problem for European growth, both because Italy is a major EU country and because free movement in Europe may mean the illness being able to spread more easily. Fears include the service sector taking a hit if consumers in Europe stay at home instead of shopping, eating out and visiting the cinema.”

Evidence from China is scary 

Investors also fear that some places may be forced to close down economic production for a time to halt the spread of the virus.

“We have seen this in China, where we expect the combination of reduced consumption and the temporary shutdown of workplaces could result in a marked downturn in economic growth in Q1 2020,” said Drusebjerg. “The fear is we may experience something similar in Europe. Hence, it is not so much the illness itself that is feared, but the ‘treatment’ to limit the spread of the disease, which will hit the economy and the financial markets.”

Fears the slowdown could drag on 

So far this year, equity markets have been relatively unaffected by the coronavirus, but seeing a pronounced effect now comes as no surprise, according to Drusebjerg. The escalation in virus outbreaks in South Korea, Iran and Italian shows, namely, that containing the virus may take longer than previously expected.

“To date, a widespread perception has been that the coronavirus will follow a ‘V’ shape, with a pronounced slowing of the economy in the short term and then a speedy recovery in economic activity,” Drusebjerg commented. “But given the spread of the virus and rising fears, investors now see an increased risk of a ‘U’- shaped development, where we experience a slightly longer period of decline before we see a recovery. The relatively violent reaction in equity markets should be viewed in this light.”

Maintaining an overweight in equities 

Nevertheless, Danske Bank still expects to see a strong recovery once things look brighter. The uncertainties are when this will happen and how large the dip will be before the economy will pick up again.

“Generally speaking, we still expect the coronavirus to prove a temporary challenge for the economy and the financial markets,” commented Drusebjerg. “Making cocksure announcements on precisely when we might be over the worst and see a recovery would be a frivolous venture by me, but history shows us that investors should be wary of selling out when markets are gripped by fear. In the vast majority of cases, the negative reactions are relatively short-lived, and this is also our main scenario here. We are therefore sticking to our strategy at Danske Bank. We continue to have a slight overweight in equities - in other words, a slightly higher share of equities in our portfolios than we expect to have in the long term.”