Coronavirus takes hold of stocks, oil and will push interest rates lower
Written by Mark Thomas
4 February, 2020
At the time of writing, the coronavirus was gripping world stock markets as analysts and fund managers come to terms with this shock to economic growth.
There are two scenarios in play 1) contain and 2) outbreak. Both are realistic possibilities. Clearly they would have widely different impacts on world economic growth and investment returns for 2020.
Many are looking to the SARs virus that broke in 2003 as a guideline on world impact. However, much has changed in China and the world since 2003, specifically the newly agreed phase 1 trade deal with the US is at risk of falling over before it even starts.
Short term shares will fall in value and confidence will plummet. A metaphor for the fear index was the 82 percent drop in travel from mainland China to the gambling hub Macau over the Lunar New Year holiday as xenophobia griped the Chinese people.
At this stage it is difficult to gauge nor control the spread of the virus as it has a unique two-week incubation period. As such current detection methods cannot identify people in the incubation stage of the virus.
According to the World Health Organization (WHO), a total of 8,098 people worldwide became sick with SARS during the 2003 outbreak. Of these, 774 died.
So far 425 people have died from coronavirus and 20,624 have been infected. These numbers have more than tripled in the last five days!
While Ebola has a 50 percent mortality rate and SARS killed 10 percent, the new coronavirus’ mortality rate appears to be only about 2.2 percent.
While it is still too early to tell how this deadly outbreak will end up, there is some comfort that the number of patients released from hospital now exceeds people who have died in China (632 versus 425).
The Chinese cannot be accused for their lack of effort, building a 1,000 bed hospital in 10 days and anther 1,600 bed facility is also due to be completed on Thursday with army medics being brought in to treat patients.
It all began in Wuhan, a city of 11 million people and also a crucial transport, steel, and auto manufacturing hub. Wuhan is in lock-down and its buses, trains, and airports closed. An estimated 5 million people left during the holiday, some of them carrying the virus with them to nearby towns, bigger cities, and around the world.
Since then, more areas have been locked down and the holiday has been extended for an additional week in 14 provinces. They include export powerhouses Guangdong, which includes the tech city Shenzhen; Shanghai, home to China’s largest port and a newly built Tesla Inc. plant; and Jiangsu, where Nike shoes are manufactured.
An estimated 60 million people are in lock-down.
These provinces accounted for almost 69 percent of China’s gross domestic product in 2019, according to Bloomberg calculations.
Millions have been told to stay away from their offices when the holiday ends. Given China’s role as factory to the world, the disruption to global supply chains will be significant.
Economists have been looking to the 2003 SARS outbreak to formulate their forecasts.
- China accounts for 17 percent of global GDP these days, up from 4 percent in 2003.
- Many see a larger economic blow this time around because consumption makes up a far bigger slice of the Chinese economy.
- Globally, hotels, casinos, airlines, and retailers are already recording a downturn that could last months.
- About 163 million Chinese tourists made overseas trips in 2018 accounting for more than 30 percent of global travel retail sales.
- In 2003 only 20 million Chinese travelled.
- Hong Kong, already suffering from months of protests and economic disruption will likely see a two percentage decline to growth in Q1 2020.
- South Korea and Vietnam will also suffer given their close proximity and trade with China.
- Japan is scheduled to host the 2020 Olympic Games in Tokyo this coming July. It will be interesting to see who turns up and whether athletes boycott the games given how close Japan is to China.
- Commodity exporters such as Australia and Brazil will also suffer as slower world growth drives down demand for raw materials.
- Chinese growth is expected to slow to 4.5 percent in the first quarter from 6 percent last year and could be lower depending on where Chinese consumer confidence ends up.
- Sagging demand for crude oil, which has stumbled 16 percent in price since China identified the coronavirus, is prompting Saudi Arabia to convene an emergency meeting Wednesday, OPEC officials said.
- China is the world’s biggest oil importer and the locked-down city of Wuhan, where the virus emerged, is one of its key oil and gas hubs.
- Many companies have closed their Chinese offices affecting thousands of employees including Apple Inc. which employs 10,000 people in China, until February 9.
|Scenario (3 mths)|
|Crude oil price||$60.7||$50.5||$55||$45|
|US 10Y treasury||1.8%||1.5%||2.0%||1.2%|
|$A vs $US||70.1||67.2||70||60|
The two scenarios we outline in the above table are Contain and Outbreak. Under the Contain scenario share markets should stabilise at current levels or move up slightly. Oil prices would bounce back and bond markets yields would return to more normal levels as would the $A. Residential property would continue its recovery path and the RBA would drop rates one more time as currently anticipated.
Under the Outbreak scenario share markets would fall quite severely in China, more than 10% in Australia due to our resources weighting and 10% in the US. Crude oil would shift another 10% lower, bond markets would continue to provide safe heaven status and the $A would drop with the weak growth outlook. Residential property would struggle and stagnate in this environment and give up some of last year’s gains, and the RBA would respond by dropping rates to an historic 0.25% or possibly zero depending on the severity of the situation.
Short-term things do not look good for world growth as a result of the coronavirus. By this we mean Q1 or Q2 of 2020. Having said that prior to the coronavirus things were looking very positive as momentum was building in global manufacturing activity as a result of lower interest rates and the US and China trade deal fix (see Surprise: Growth on the up for 2020).
While the imminent growth dip is clearly negative things could turn around quickly if the virus is contained and confidence returns. The other scenario is not so rosy. A protracted disruption to global supply chains, consumer confidence and overall economic growth would hurt economies given the high levels of indebtedness. This seems the lower probability outcome given China’s response and the fatality statistics to date.
Please consult your advisor for specific recommendations. This general advice does not take into account the client’s objectives, financial situation or needs as we do not and cannot provide personal advice. Any views written about in this article are the views of the author who has no holdings in those companies or investments mentioned in this article.