By Robert Ducker
The outbreak of coronavirus in Wuhan, China, has been a major talking point for investors over the past few weeks. Financial markets sold-off sharply on the news that the virus was spreading in the last week of January, but recovered in the weeks that followed as the People’s Bank of China injected liquidity into the financial system, while banks were instructed to lend more and not call in loans to companies located in the most affected regions. The near term impact on the Chinese economy is expected to be significant, bearing in mind the virus outbreak coincided with the Chinese New year, the peak travel (and spending) season for Chinese nationals.
It is still too early to quantify the impact on the global economy from the coronavirus as the number of cases is still rising. According to the BBC, the number of deaths stands at 1,368 at the time of writing, already surpassing the number of deaths recorded during the SARS outbreak. The current expectation is for the number of cases to peak this month, and be over by April.
The SARS outbreak in 2003 is being widely used as a benchmark to gauge the possible impact on the global economy. This comparison is far from perfect as the Chinese economy is bigger and weaker today than during the SARS outbreak. Today, China is the second largest economy in the World and a significant contributor to global demand. This is vastly different to 2003 when its GDP contribution stood at just circa 4% (vs. 16% in 2018 according to the World Bank). There is no doubt that persisting weakness in the Chinese economy will have a pronounced impact on the global economy. This is especially true for Europe, with China accounting for circa 10% of the revenues generated by companies included in the STOXX 600 index.
Notwithstanding the limited comparison, it is worth looking at how economic data fared during the SARS outbreak. The Hong Kong Composite PMI fell from 50 in February 2003 to 35 in April 2003, which represents a significant decline. A similar impact today would have a major impact on global aggregate demand, at least in the short time. The European composite PMI fell slightly, from 50 to 47 during the same period, when the region’s economy was less dependent on Chinese trade.
There are also some fundamental differences when looking at the situation from a financial market perspective. At the time of the SARS outbreak, equity markets were coming out of a three year bear market where the STOXX 600 fell by circa 60% from a peak in August 2000. In addition, the European Central Bank (“ECB”) had just cut rates in December 2002 providing some economic stimulus. Currently, equity markets are close to all time highs while the ECB’s room to manoeuvre is limited, with benchmark rates at -0.50% (compared to 1.75% at the start of 2003).
The base case for the virus is that it will be a temporary shock to the global economy, with weakness in the first quarter to be recovered in the following quarters, leaving consensus growth expectations for 2020 unchanged. Economic data in the coming weeks will most probably start to reflect the impact from the virus, which could lead to some market jitters. In the meantime, focus on the virus has overshadowed some positive macro data, more specifically the strong new orders in the EU and UK PMI while the US reported solid employment numbers last week with wage growth above 3% for 16 consecutive months. There is little doubt that the US economy is going to face the impact from the coronavirus on a strong footing, albeit also impacted by the Boeing 737 Max debacle.
Notwithstanding, we suggest some degree of caution in the short term for the following reasons: (i) There is still a high degree of uncertainty over the virus and how long it will persist; (ii) economic data is lagged and we expect things to get worse before it gets better; (iii) valuations are high (iv) the possibility and space for additional Central Bank support remains limited.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.