The coronavirus is hitting the Chinese economy. Right now, we cannot estimate the extent to which the virus will spread, and how quickly it can be contained. Will concerns about the spread of the virus have a greater impact on the economy than the virus itself?
The impact of the coronavirus can’t yet be assessed
The economic effects of the coronavirus are practically impossible to estimate. We know too little about the virus to assess whether, and how quickly, its spread can be stopped. Risks are high in the densely populated areas of countries which do not have China’s surveillance technologies and enforcement powers. What impact might the virus have if it gained a hold in Mumbai, Djakarta, Manila or Cairo? This is among the concerns of the World Health Organization (WHO), prompting that body to declare a “Public Health Emergency of International Concern”.
The new coronavirus will cause at least as much damage as SARS
The SARS outbreak suggests a “conservative” estimate for economic damage which can be checked for plausibility. That event caused Chinese growth between the first and second quarters of 2003 to be 2% lower than it otherwise would have been.
Currently, the virus has paralyzed large parts of China, the main growth engine of the world economy. Chinese tourists spend annually between $200-300bn. abroad, roughly twice as much as their US counterparts. Chinese oil demand has already dropped by around 20%.
A shock to both demand and supply
The coronavirus is not just a demand shock but also a supply one. The virus has spread to Chinese production centers, where many companies have extended their Chinese New Year holiday or closed their production sites indefinitely. An estimated one-to-two thirds of Chinese manufacturing hubs will remain closed for at least this week. A “secondary effect” may well turn out to be a positive impact on inflation rates. But any assessment of the overall impact of the virus depends crucially on the “longevity” of the epidemic’s expansion phase.
Comparing the coronavirus with other health catastrophes
According to the WHO, between 700 million and 1.4 billion persons catch a “normal flu” every year, leading to an estimated 650,000 deaths on average annually.
Some 24,324 cases of the coronavirus have so far been identified in China, which, as of February 6th, has led to 490 mortalities. Thus, the mortality rate for the virus could currently be put at 2%.
For comparison, the Spanish flu of 1918-20 affected 1/3rd of the world’s entire population, leading to between 20 to 50 million deaths. Should the new coronavirus manage to infect 1/3rd the world’s population (a very pessimistic assumption), we could have a worst-case estimate of 40 million deaths.
But the coronavirus could be end up preventing more Chinese deaths than it causes
In such catastrophic events, difficult-to-assess secondary effects can more than offset the more easily monitored, primary effect. On the other hand, they can also work the other way, strengthening the primary effect.
The sharpest near-term impact of the 9/11 attack on American lives came from the subsequent, “irrational” decision of many Americans to use less-safe car transport as opposed to the safer airplane. Incremental road casualties exceeded the immediate death toll from the attack itself. The WHO estimates that in 2016 around 256’000 Chinese died as a result of traffic accidents. (Although the Chinese official estimate is only around 58’000). Thus, on WHO estimates there are some 4926 traffic accident fatalities every week. Using the conservative estimate that there is now 20% less traffic on China’s roads, one could estimate that last week saw a 985-person reduction in traffic-related deaths as a result of the virus.
Fears about the virus could have a stronger economic effect than the virus itself
We are not relaxed about the subject but nevertheless suspect that the view of the WTO, explicitly warning against public policy overreaction and excessive restrictions, will turn out to be correct. Official attempts at 100% isolation, driven by the fear of the virus, are now to be seen in ever more countries. Scaremongering and panic measures are likely to hurt the global economy more than would the more relaxed response of most authorities to a normal flu. One almost has the impression that a sense of proportion is being abandoned in the race to be seen taking the most aggressive measures. The resulting damage is likely to economically significant, though it will be several weeks before this can be estimated. We need more information as to the mortality risks of the virus, the extent to which it can be contained and the speed with which the Chinese economy can manage to recover. It is concerning that the virus has arrived in developing countries, such as India, that cannot match China in surveillance technologies and enforcement measures. If the virus gains a hold in such countries, it may be very difficult to prevent it from spreading further, an issue of much concern to the WHO. Even so, it is likely that more people will die of “normal flu” than of this coronavirus this year. While “nothing” is being done about the flu, attempts to contain the coronavirus have already paralyzed large areas of China’s economy.
Chinese commitments to buy US goods may prove difficult to keep
Given the new situation caused by the coronavirus, the Chinese government may find it difficult to meet the purchase commitments, $200bn of US goods over 2 years, made to the US under the Phase 1 US-China trade agreement. Mr. Trump needs the US to receive these orders as this should increase the chances that the beneficiaries (mainly farmers and industrial workers) will re-elect him.
The Chinese commitment to buy US goods will likely come at the expense of the rest of the world
Investors should remember that purchasing commitments to the US imply a re-sourcing of China’s imports, increasingly from the US and at the expense of other countries in Europe and elsewhere. We think the resulting demand shock could well have a concentration on European economies.
Central bank reaction functions have changed
The Fed, and also the ECB and the People’s Bank of China (PBOC), have shown they are ready to intervene very aggressively to stabilize the economy, markets and the financial system. This Monday (February 3rd), the PBOC lowered its refinancing rates by 10 basis points and pumped around $170bn of liquidity into Chinese markets which had not previously been able to react to coronavirus developments owing to China’s New Year. Nevertheless, the CSI300, which includes the 300 largest Chinese companies, fell by almost 8% on the day.
Full economic impact of the virus yet to be felt
Prior to the outbreak of the virus, economic indicators had actually stabilized on a worldwide basis, with global purchasing manager indices rising to their highest level in 9 months. Given the rapid escalation of the “coronavirus crisis”, it’s now difficult to assess the how far this improving trend can be extended.
Investment recommendation
Given their current high prices, US stocks would have been liable to a correction even without the outbreak of the coronavirus.
We stick with our recommendation to slightly underweight equities and retain our positive opinion on gold.
The current correction may well create good buying opportunities in the future. But we think it is still too early to boost exposure to equities. Given today’s risks, current valuations are simply too high.
Contact: Thomas Härter, CIO, Investment Office
Telephone: +41 58 680 60 44
Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
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