Andrew Rymer : Schroders
The spread of coronavirus, COVID-19, beyond China has created fresh uncertainty for the global growth outlook and sparked volatility in financial markets.
Outbreaks in South Korea, Iran and Italy have raised concerns that the spread outside of China may be accelerating.
We offer key facts on the spread of the virus, interspersed with views from senior Schroders economists and fund managers.
What has been the impact so far?
The human impact has been significant, with more than 2,800 deaths now confirmed (February 27), the majority in Hubei province in China. This is far greater than the Severe Acute Respiratory Syndrome (SARS) outbreak that killed close to 800 people in 2002-2003.
Chinese authorities have reacted by enforcing quarantines, as well as restricting public gatherings, travel and tourism.
From a financial markets perspective, the response had been fairly muted amid signs that the rate of infection in China had peaked. However, the recent emergence, and acceleration, of cases in South Korea, Iran and Italy has led to fears that the virus could have a far greater impact than markets were initially anticipating. The charts below show how stock markets have been hit while demand for bonds has risen, which has the effect of pushing down yields and increasing prices.
After an initial rebound, global (MSCI World Index) and mainland China markets have seen renewed falls
Among other markets, commodity prices have also felt a disproportionate impact. China is the dominant consumer of many raw materials, particularly metals for use in industry. As a result, the impact on prices has been significant, as illustrated by the S&P GSCI, a measure of broad commodity price performance.
This has implications for countries which are commodity exporters. Latin America, in particular, Brazil, Chile, Colombia and Peru have all seen marked volatility in their equity markets and currencies.
Commodity prices fell sharply as the severity of the outbreak escalated
Why is this outbreak different to previous incidences such as SARS?
China’s place in the global economy has changed dramatically since the SARS outbreak. As Schroders’ economist Azad Zangana recently wrote, China represented 4.2% of the global economy in 2002 and contributed 18% to world GDP growth. By 2018, its share of world GDP had risen to 15.8%, with 35% of global growth coming from China, as highlighted in the chart below.
The impact of weaker economic activity in China will therefore have a proportionately greater impact on overall global growth. After a year in which US-China trade tensions weighed on global growth, market expectations were for an improvement this year. This was predicated on the improvement in trade relations between the two sides over the fourth quarter of 2019, culminating in the signing of the so-called “phase one” trade agreement on 15 January. The coronavirus outbreak has cast significant uncertainty over this outlook.
How China’s share of global GDP and global growth has increased since 2000
Will there be a follow-on impact to global growth?
Our charts below hint at what might be happening to China’s economy. But perhaps the more pressing question is how far will the virus spread outside of China, and will it get a foothold in the US?
Keith Wade, Chief Economist at Schroders, said: “The revival in the world economy has been brought to a standstill in Asia as a result of the virus. The effects are now rippling through the world economy as supply chains become disrupted. There is also the added threat of the virus emerging outside China as we have seen in Italy and Korea.
“Markets are having to revise their assumptions about a return to normal and whilst the virus may be contained in the second quarter, the effect on spending and activity could persist as people will be cautious for some time after. The near-term drag will be sufficient to tip some economies such as Japan and Italy into recession. Nonetheless, as the virus subsides there is scope for a bounce back in activity.
“The risks of a global pandemic have risen. Carriers of the virus can be infectious without showing symptoms, making it harder to detect, isolate and contain. Clearly this would have greater downside risks to activity, especially if the US is hit. The world’s largest economy is relatively less exposed to global supply chain disruption and can support global demand, especially if the Federal Reserve cuts interest rates again as we expect.”
What signs are there of health in China’s economy?
The first point to make is that China’s economy has systemic significance. It accounted for 28.4% of global manufacturing output in 2018, according to the UN Statistics Division, compared to 16.6% for the US. In 2004, the US share was 22.3% when China was at just 8.7%. China’s economy has also become more integrated with the rest of the world.
It is hard to precisely gauge the extent to which factories have managed to re-open after the Lunar New Year on 25 January, and at what level of production capacity. Migration data produced by the Chinese tech company Baidu, shown in the chart below, suggests that a large proportion of workers are yet to return. Wuhan, which is where the epidemic is believed to have originated, has seen the fewest workers return. Non-essential business for Hubei, the wider province of which Wuhan is the capital and is home to around 60 million people, remains closed for non-essential business until 11 March.
The percentage of workers returning post the Lunar New Year relative to 2019
A quick review of coal consumption at six independent power plants, shown in the chart below, underlines the drop-off in activity. Coal consumption is seasonally lower around the Lunar New Year, but usually begins to recover within 15 days.
Coal consumption of six independent power plants after the Lunar New Year
President Xi has now urged people to return to work, but indicated that this should be subject to regional health risks. Quarantine measures and restrictions on movement will likely continue for a number of regions, presenting further logistical challenges to exporters. The greater the duration of the outbreak and the longer measures to prevent its spread remain in place, the greater the ramifications for global supply chains, global trade and growth.
The Baltic Exchange’s Capesize Index has turned negative
The majority of world trade is transported by ship. With container companies cutting back sailings to China, owing to coronavirus concerns, backlogs at Chinese ports have increased. Should these persist or continue to mount, total global trade, in terms of both volume and value, could fall.
Those economies which are more exposed to trade, including the majority of Asia but also Australia and Europe, may feel the chill. South Korean car manufacturer Hyundai has already had to close several of its plants in South Korea due to a shortage of parts which are imported from a company in China.
The Baltic Exchange’s Capesize Index (which covers those ships too large to pass through the and forms part of the Baltic Dry Index, a tracker of global shipping rates) turned negative for the first time ever earlier this month, as the chart above illustrates.
Other effects have included cruise ships in several Asian ports falling under quarantine, with passengers restricted to their cabins for 14 days. Those economies more reliant on tourism more broadly may be impacted, in particular those with a high dependence on visitors from China. We will be exploring the impact on sectors in further articles on Schroders Insights.
The impact on Asia
Toby Hudson, Head of Asia ex Japan Equities, said: “Predicting the ultimate scale and impact of the outbreak is near impossible. Despite the tragic loss of life, our base case is that this event will not represent a structural change in the growth outlook for the Chinese or regional economies, but more of a short, sharp cyclical slowdown that lasts a few months.
“The economic impact will be felt most immediately in those sectors linked to tourism, travel, off-line entertainment and discretionary retailing, both in and outside China. There may also be logistical challenges for the manufacturing sector in the short term as employees struggle to return to work after Lunar New Year given quarantine restrictions, and this may present challenges for some supply chains. More generally, the heightened uncertainty is likely to negatively impact consumer and business confidence, and in turn spending and investment decisions.
“If as with other recent outbreaks, the spread of the virus is contained within the next few months and confidence gradually returns thereafter, then economic activity should rebound fairly quickly in the second half of the year, helped by the release of some pent-up demand. Earnings forecasts for 2020 will need to be adjusted downwards in some areas, but critically this should have far less carry-through impact into next year and beyond – and as such the impact on fundamental fair values for the stocks we own should be modest.”
Global view from a multi-asset investor
Johanna Kyrklund, Group Chief Investment Officer and Global Head of Multi-Asset Investments, said: “Until we see a peak in the coronavirus infection rates, efforts to contain the virus will significantly dampen economic activity. Markets also have to digest the likely impact of supply chain disruption on corporate earnings. Investors can expect a rocky ride in coming weeks, but markets are underpinned by the fact there is plenty of money swashing around on the sidelines that could be invested. And of course bond yields remain very low, making equity yields more attractive.
“One area to watch is emerging markets where value is starting to emerge in some of the equities and currencies.”
The table below shows the latest asset views from Schroders Multi-Asset Team.