Source:
https://scmp.com/comment/opinion/article/3048173/three-reasons-coronavirus-outbreak-may-hit-financial-markets-harder
Comment/ Opinion

Three reasons the coronavirus outbreak may hit financial markets harder than Sars did in 2003

  • China today accounts for a much greater share of the global economy and is more reliant on domestic consumption, which has been affected by the trade war and Beijing’s deleveraging campaign
  • Meanwhile, valuations in both stock and bond markets are already stretched
A pedestrian walks in front of an electric quotation board displaying share prices of world bourses in Tokyo on January 27, when global stocks suffered their worst day in almost four months. Photo: AFP

Last Friday, the euro zone economy – one of the main focal points for investor anxiety over the slowdown in global growth – received some encouraging news. According to preliminary data published by IHS Markit, the bloc’s manufacturing sector, which is still contracting, showed further signs of stabilising, with the rate of decline in output this month easing significantly.

As recently as a fortnight ago, increasing evidence that Europe’s manufacturing downturn has bottomed out would have cheered financial markets, underpinning the prevailing narrative that global growth is recovering, supported by an easing of trade tensions and the prospect of a “lower for longer” interest rate regime in the world’s leading economies.

Yet, the sudden outbreak of the deadly coronavirus in Wuhan – which has killed more than 130 people and has spread beyond China’s borders – has punctured the optimism in markets.

On January 27, global stocks suffered their worst day in almost four months, data from Bloomberg shows, while a surge in demand for so-called “haven” assets caused the value of bonds trading with negative yields to rise by US$860 billion, the largest daily increase since Bloomberg began tracking the data regularly three years ago. Commodities have also come under strain, with traders selling oil and industrial metals because of concerns about a slump in demand.

Although fears over the spread of the virus triggered the sell-off, the disease has hit a pressure point in markets, one that has been apparent for some time but has been offset to some extent by central banks’ pivot towards looser monetary policy, led by the US Federal Reserve.

The outbreak of the virus has revived concerns about the lack of growth in the world economy, the Achilles' heel of the current rally.

Ever since global equity markets roared back following a brutal sell-off in the final quarter of 2018 – the MSCI All Country World Index, a gauge of stocks in advanced and developing economies, surged 23 per cent last year – there has been a worrying disconnect between share prices and economic fundamentals.

In a sign of the extent to which equity investors got ahead of themselves, last year’s fierce rally coincided with a further deceleration in the rate of global output, with the JPMorgan Global Composite Purchasing Managers’ Index, a gauge of manufacturing and service sector activity, finishing 2019 at a lower level than at the start of the year.

While output has strengthened over the past few months, even the more resilient service sector is expanding at a weaker pace than a year ago, while manufacturing activity is almost in contraction territory.

Employees work in the BYD electric car factory in Xian in Shaanxi province, China, in October 2019. China’s manufacturing purchasing managers index slumped for a sixth month in a row, according to official data released on October 31. Photo: EPA-EFE
Employees work in the BYD electric car factory in Xian in Shaanxi province, China, in October 2019. China’s manufacturing purchasing managers index slumped for a sixth month in a row, according to official data released on October 31. Photo: EPA-EFE

What is more, persistent pessimism in bond markets suggests stock markets have been too sanguine about the green shoots of recovery. German and Japanese bond yields remain deep in negative territory, while the benchmark 10-year US Treasury yield currently stands close to its all-time low set in July 2016.

The outbreak of the coronavirus has not only heightened concerns about the fragility of the recovery, it has resensitised markets to the most important vulnerability in the global economy: China’s slowdown and its impact on the rest of the world economy.

While parallels are being drawn with the outbreak of severe acute respiratory syndrome in 2003, which spread from China to the rest of the world, causing 813 fatalities, the stakes are much higher this time round.

First, in 2003, China accounted for less than 9 per cent of global gross domestic product in purchasing power parity terms, data from the International Monetary Fund show. Today, it accounts for nearly one fifth.

Just as importantly, back then, the global economy was in the early stages of a strong recovery following the bursting of the dot-com bubble in 2000. The coronavirus outbreak, by contrast, is occurring at the end of a lengthy expansion. In short, China poses a much bigger systemic threat at a time when the global economy is far more vulnerable.

Second, valuations in equity and bond markets have become dangerously stretched, increasing the scope for a disorderly sell-off if worries about the virus morph into a full-blown growth scare.

Third, China is now much more reliant on domestic consumption – the part of the economy most at risk from the fallout from the epidemic – as a key source of stable growth. If Chinese consumers, already under pressure due to the effects of the deleveraging campaign and the trade war, start to fret about the virus, the global economy could take a knock.

Workers sort out packages at a warehouse to be delivered to customers a day after Singles’ Day – the world's biggest 24-hour shopping event – in Beijing on November 12. The coronavirus outbreak will dampen consumption that has already been hit by the trade war and the government’s deleveraging campaign. Photo: AFP
Workers sort out packages at a warehouse to be delivered to customers a day after Singles’ Day – the world's biggest 24-hour shopping event – in Beijing on November 12. The coronavirus outbreak will dampen consumption that has already been hit by the trade war and the government’s deleveraging campaign. Photo: AFP

In a report published on January 24, JPMorgan noted that not only is China “far more consequential” for the world economy and markets, the threat from the epidemic is “focused on Asia and services, the two sectors which have led the global recovery”.

It is too soon to say whether the coronavirus is the trigger for the much-talked-about correction in markets. What is clear, however, is that without stronger growth, the bullishness in stock markets makes little sense.

Nicholas Spiro is a partner at Lauressa Advisory