One thing we can always be sure of is that markets do not like uncertainty. Negative news relating to the outbreak of the coronavirus is gathering pace and we are seeing significant drops in the global equity markets.
Thoughts on the Economic Impact
As has been widely reported, there has already been a clear economic impact although for how long this will last is uncertain. We can be fairly sure that the first quarter of 2020 will not be good in Asia or for production dependent parts of Europe. We believe that the global economy will avoid a recession in this period. Any impact during quarter 2 and beyond will depend heavily upon how the virus spreads into North America and Europe.
The analysis of our research partner Capital Economics indicates the following:
- Falls in equity prices and bond yields reflect fears that coronavirus cases outside China will mark the start of a wider outbreak that deals a blow to the world economy. For now, we envisage a moderate hit to global GDP growth of 0.5ppts this year, due almost entirely to the impact on China. But the economic effects of this wider outbreak, should it happen, could worsen this position.
- There is still hope that the virus will be largely contained in China. We now expect GDP growth there to drop to -2% y/y in Q1 (compared to our pre-coronavirus forecast of +5%). Since China accounts for nearly 20% of the world economy, the direct effect of this alone will be to reduce world GDP growth in Q1 by 1.4ppts (to 1.6% from 3.0% previously).
- It is unclear how much of the lost output will be recouped, but with many factories now closed and some workers laid off, we expect there to be only partial catch-up at best. We have therefore cut our Chinese growth forecast for 2020 as a whole from 5% to 3%, which will reduce global GDP growth by 0.4ppts from our pre-virus forecast of 2.9% to 2.5%.
- It has always been clear that the virus would have wider effects. There are a number of channels to consider when assessing how the economic disruption might spread.
The first is the direct impact on affected economies due to measures taken to contain the virus. The second is the knock-on effect on other economies due to trade and supply chain links. Third is how people react, and the extent to which they decide to avoid leisure activities such as travel or shopping. Fourth is the financial market impact. And fifth is the fiscal and monetary policy response.
- Nobody knows how far the virus will spread or how severe it will become in the countries already affected.
- It is possible that the governments of the newly-affected countries will ultimately take draconian containment measures similar to those followed in China. But recent experience of only limited shutdowns in Japan and Italy suggests that the economic disruption is unlikely to be as severe. And even if containment measures became more aggressive, this would at least limit the risk of contagion elsewhere.
- Moreover, if cases started to spring up far and wide, without being able to be traced, then the authorities might consider that the horse had already bolted and there was little point in imposing travel restrictions or shutdowns. The direct economic effects would be smaller for each economy than they have been for China as a result.
- But what of the indirect effects? The disruption to supply chains is very difficult to measure. China is the world’s biggest exporter of intermediate goods and hence arguably most important to global supply chains. So far, there is little or no direct evidence in the macroeconomic data of disruption to production outside Asia, although there are various reports that specific manufacturers (of cars in particular) in advanced economies are experiencing problems.
- Going forward, the US will be key to determining any likely supply chain disruption. While trade is a small share of its own GDP, the sheer size of the economy means that it is an important supplier and purchaser of components from other countries.
- The third channel is the extent to which people self-isolate by avoiding public spaces, shops, cinemas, restaurants etc. Such effects are already clearly evident in China, where passenger traffic and car and property sales have slumped. And tourist arrivals to Thailand are down 50% y/y. Clearly, the further the virus spreads the bigger such effects will be.
- The fourth channel to consider is the financial market impact. Again, this has tended to be temporary during previous virus outbreaks and early experience in Chinese markets suggested that this time would be no different. But a further spread and mounting evidence of economic effects would clearly cause further falls in equity prices, with emerging markets likely to be most affected. They would also see their currencies fall. Further falls in advanced economy bond yields would also be possible.
- The fifth and final consideration, which is the likely policy response. So far, this has focused on targeted support for the affected parties, with the Chinese authorities providing subsidies and loans to the worst hit firms and to those involved in prevention and treatment of the coronavirus. Only a few small economies with close links to China have cut interest rates.
Newly-affected economies will probably employ similar targeted fiscal support. Widespread interest rate cuts seem unlikely, but they could be used in the event of severe disturbance to economic activity or to financial markets.
- On the whole, emerging economies seem most exposed to the effects of an escalating crisis. Many specialise in tourism or commodities production and downward pressure on their currencies due to rising risk aversion might well prevent them loosening monetary policy. Turkey and South Africa seem particularly vulnerable in this regard. But some advanced economies are also quite badly positioned, most notably Italy with its limited fiscal space and dependence on tourism. Meanwhile, Russia, Australia and Canada are at risk given the possibility of further falls in commodities prices.
In conclusion, the best-case scenario now appears to be around a 0.4ppt hit to global GDP growth reflecting the damage to China’s economy. This would leave the annual rate at 2.5% in 2020. For now, we are assuming only a small additional hit through indirect effects, in the hope that cases elsewhere will be quickly brought under control. Our global growth forecast is therefore 2.4%. There is of course uncertainty and we will be monitoring to evolving situation very closely.
So, whilst investment markets look to be rattled and portfolios down from their recent highs, we are confident markets will recover once there is evidence that the virus is under control and that trade, tourism and industrial production are returning to normal. We are also confident that central banks and governments will promote stability by reducing interest rates and injecting money into their economies.
Bearing all this in mind, our overall message to clients thinking about their long term investments is that GHC runs a robust investment strategy designed to cope with volatile markets. Our portfolios consist of good quality investments with the aim of producing above average returns over the medium to long term. We are confident of our ability to manage our customers’ portfolios through this uncertain period