The Coronavirus reminds us that shocks can come from unexpected areas. Previous disease outbreaks such as SARS, MERS, and avian flu, have had limited economic impact and only a short-term impact on markets. The most likely scenario is this will be a human tragedy but have little lasting impact on the economy. However, we can’t rule out the tail risk of more severe scenarios and these could see markets go far lower.
The outbreak of a Coronavirus in China appears to have checked the global equity market rally for now. However, the falls need to be put in to context. The MSCI All Countries index, which includes emerging markets, is still up year to date1. The outbreak has had a particular adverse impact on Chinese equities and global stocks related to transportation. Oil and gas stocks have also been affected.
If the virus follows previous ‘playbooks’, the outbreak will be brought under control, the economic impact will be small and the market will soon rebound. Does that mean markets are over-reacting and this is a buying opportunity? Possibly. The most likely scenario is that buying the dip will look like a smart move with hindsight, but this ignores the tail risk that it the epidemic could turn in to something far worse than previous outbreaks. We cannot of course rule out the possibility that this virus will mutate and eventually prove to be far more virulent than previous outbreaks. The number of official cases already exceeds the official number for the SARS epidemic in China in 2003, although the mortality rate is far lower.
What will the economic impact be? The SARS epidemic in China in 2003 can barely be seen in Chinese economic data. In particular, GDP growth ended up accelerating to 10% in 20031. Some analysts argue that Chinese economic data is massaged and there was a far more severe impact back in 2003 than acknowledged. Furthermore, with China a much bigger part of the global economy and bank credit less likely to expanded to boost the Chinese economy, the global economy may notice this shock in a way that it didn’t notice SARS in 2003. However, China also may be less vulnerable this time. Internet shopping is more prevalent and less likely to be impacted than traditional retail. Households are richer and may spend far more on health precautions. Whether the economic impact is greater or smaller will more likely depend on the severity of the virus and this remains a big unknown.
The latest outbreak does remind us though that since the financial crisis, policy makers have far less ammunition to offset adverse hits to the global economy. As well as the usual lists of dangers that economists compile, shocks can come from completely unexpected sources, and even if this one proves to be a human tragedy rather than an economic disaster, some other shock will inevitably occur at some point soon. Whatever the source, without the ability to offset, the global economy is far more vulnerable to unfavourable shocks than it used to be.
1 Source: FactSet
January 2020, All market data sourced from Factset
The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
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