The Potential Economic Impact Of The Reaction To The Coronavirus
Will You Catch Coronavirus?
There is a minuscule chance of contracting the coronavirus if you live anywhere but in Hubei Province in China, and even less of a chance if you live in the U.S. The last time we had something like this (SARS), the public and business reaction wasn’t as extreme. It appears that social media has had a lot to do with this more intense and extreme reaction. SARS infected a total of 8,096 people with 774 deaths. So, the current coronavirus appears to be more contagious, but, perhaps, not as deadly (currently, 259 deaths).
For comparison, according to the Center for Disease Control (CDC), the annual percentage of the U.S. population catching the annual flu bug is between 3% and 11%, with 8% as the average. That means, with a population of approximately 330 million, between 9.9 million (3%) and 36.3 million (11%) people in the U.S. get the flu each year (26.4 million on average). Compare that to the 11,791 cases (almost all in China (9 a.m. Feb 1)) identified so far. Deaths from coronavirus are currently 259. In the U.S., according to CDC, there have been at least 19 million flu illnesses, 180,000 hospitalizations, and approximately 10,000 deaths.
The business reaction is more worrisome. Many airlines have already cancelled flights into and out of China (obviously, demand is way down, but the pilots and crews are also revolting). Some multinational corporations have closed their stores, and it appears that many businesses in China are adding a week to the lunar New Year holiday, meaning operations will be on hold for that extra week. The U.S. has instituted special rules about quarantine for people who have visited Hubei Province waiting re-entry to the U.S. [Doesn’t it seem strange that there has been zero reaction currently, and in the past, to the more-deadly annual flu outbreak in the U.S.?]
In the end, there is no doubt that the over-reaction to the coronavirus is going to impact economic activity. The question is, by how much? Since this is just over a week old, trying to judge the business impact is impossible. But some still try. I’ve seen various estimates for China, all the way from mild (Q1 GDP growth of 5.9%) to severe (Q1 GDP growth of 2.0%; this latter from The Economist).
The World Was Stabilizing
All of this comes at a time when we have begun to see the worldwide economic slowdown stabilize. So. Korea’s and Japan’s Industrial Production rose in December, and Germany had positive job growth. Likely, the coronavirus will throw a monkey wrench into those positives. Even in China, itself, the latest PMI data show Manufacturing at 50.0 in January (right on the cusp between expansion and contraction) vs. 50.2 in December and services at 54.1 vs. 53.5. However, those surveys were taken prior to the coronavirus outbreak. Expect February data to show significant deterioration.
Worrisome GDP Data
Add this to the concerns from the just released first pass at U.S. Q4 real GDP growth. It came in at 2.1% (AR), just as expected. But, the details are worrisome. Looking at the math, 1.3 percentage points of the 2.1 (or 62%) come from an improvement in “net exports,” i.e., exports minus imports. Both declined in Q4! And such decline reflects weak demand, both abroad (exports) and at home (imports). The fact that imports (-8.7%) declined more than exports led to a rise of +1.4% in net exports. And, believe it or not, that is a net positive for GDP growth!
The weakness in both imports and exports is confirmed by a significant slowdown in the growth of consumer outlays (+1.8% in Q4 vs. +3.2% in Q3). The math says that without this strange anomaly, real GDP growth was an anemic +0.8%. On top of that, if we strip out the bounce in government spending (+2.7% total and +4.9% for the defense spending portion), then private sector GDP grew at an even more anemic annual rate of +0.2%, i.e., not significantly different from zero.
Clearly, business is in recession with total business expenditures down at an annual rate of -1.5% in Q4, the third quarter in a row of lower expenditures. Breaking this down further, spending on machinery and equipment fell -2.9% (AR), and non-residential construction fell -1.5% (AR). Housing was the only bright spot with Q4 spending advancing at +8.7% (AR) (Q3 was +8.2%). However, recent drops in pending home sales, new home sales, and permits augur poorly for Q1. (Note: The pop in December housing starts was surely weather related.)
The Bond Market Reaction
The reaction to coronavirus in the bond market has been dramatic, with yields falling precipitously (10-Year Treasury yields fell from 1.69% to 1.50% in the week ended 1/31/20). We now see yield inversions from Fed Funds to the 5-Year T-Note. So, bonds are pricing in the possibility of recession. Markets have now priced in significant odds for at least one Fed easing in 2020 (prior to this week, the odds of an easing were insignificant), and possibly two. The Fed appears confused, hoping that its policies will miraculously cause a rebound in inflation (the PCE deflator now stands at 1.3% Y/Y vs. 1.6% last quarter). The reality is that their money creation simply finds its way into the financial economy.
As far as equities are concerned, volatility increased significantly with the outbreak of the coronavirus. The DJIA fell -454 points on Monday and -603 points on Friday with small rebounds Tuesday, Wednesday and Thursday. For the week, it fell 2.5% or -734 points. This is not surprising. As I have been indicating, when equity valuations get out of kilter, it doesn’t take much of a catalyst to precipitate a retreat. So far, the retreat has been mild. Its severity is likely to be determined by the angst and reaction to corona.
If the business over-reaction continues, there will likely be continued downward pressure on interest rates. Of course, if fears subside, rates are sure to pop back into the 1.6% to 1.7% range for the 10-Year Treasury. The real finesse issue is what the impact of business reaction will be on the already weak world and U.S. economies. The equity market usually shoots first and asks questions later. Thus, prepare for more volatility and downward price pressures for the short-term time horizon.