Welcome to Finance and Fury

Today – want to run through Coronavirus –

Is it market noise or is it going to be an economic doomsday?

  1. First – It is too early to quantify the potential impact of the coronavirus on China. Much will depend on the attack and case fatality rates of the virus
    1. Coronavirus first emerged in the city of Wuhan, China – based on media reports – could affect growth in China and the rest of Asia-Pacific – spreading to the rest of the world –
    2. The severity of the impact of the coronavirus will depend upon the attack rate (the proportion of the population that falls ill) and the case fatality rate (the proportion of deaths)
    3. At this point, uncertainty about the nature of the virus is so high that it renders quantitative assessments pretty meaningless – but it may be helpful to think through how the virus could affect the economy – to do this – let’s have a look back on the impact of previous episodes of pandemics
  2. But the Impact of Past Pandemics Has Been Mixed – most commonly cited are the Spanish flu of 1918-1920, the Asian flu of 1957-1958, the Hong Kong flu of 1968-1969, the severe acute respiratory syndrome (SARS) of 2003, and the avian flu of 2004-2006.
  3. The attack and fatality rates, measured at the global level, vary widely across these episodes reflecting the nature of the condition and the speed with which vaccines can be produced.
    1. The Spanish flu was the most severe – health experts generally agree that most events have seen attack rates of 25%-30% and case fatality rates of less than 0.2% – but more recently for SARS, the avian flu – attack rates have been much lower, well below 0.1%
    2. For the coronavirus – Health authorities indicate it may be too early to assess these statistics for the new coronavirus.
  4. Nobody really knows how many are affected or what the death rates are – there are reports – but guess –
    1. What is reported – Less than 500 people have died from this –
    2. Before we go through the potential market effects – Time for some perspective – 1,700 people per day die from the flu – around 600k p.a. – why are people so afraid? The media
    3. 1.2m people drown every year – so should we be more afraid of swimming than the flu? You might be if the media told you to be
  5. There are two elements to the coronavirus which are being balanced –
    1. Humanitarian. The bigger the shutdowns, the greater the preventative measures, the fewer people get infected and potentially die.
    2. Economic. The bigger the shutdowns, the greater the preventative measures, the more significant the economic impact will be.
      1. The focus is not on minimising the economic impact – focus is about preventing the spread of the disease. Or, for politicians, at least been seen to be trying. The economy is no longer the issue – which is why markets are responding with volatility –
  6. This being said – I’m not a virologist, and I’m not pretending to be – have no expert knowledge if the measures in what works to prevent the virus from spreading
    1. But the economic measures to date are significant and the world is not well-positioned for an external economic shock
    2. Again – looking historically SARS killed fewer than 800 people and had been attributed to decrease China’s GDP growth by about 2%. The rest of the world was fine. The issue – The containment measures already in place are far greater than the measures for SARS. They may have a significantly greater economic impact.
    3. China is more than 4x larger than it was at the time of SARS. At the time the effect on the world economy was relatively negligible
    4. Retail, restaurants and tourism are a significantly larger part of the Chinese economy now, and these are more likely to be affected.
    5. Also – SARS was basically at the bottom of the global economic cycle. Debts were low. China still had productive investment. The world was about to launch into the mother of all housing booms. Economic circumstances in 2019 are very different – Central banks have exhausted conventional measures and Corporate debt is at cycle highs.

Economic effects will come from Government policies of quarantine and limited trade –

  1. Any economic hit will be felt most by industries exposed to household spending, especially activities that take place outside the home. Risk aversion and tighter financial conditions could amplify the impact, including on investment.
  2. The Uncertainty around the coronavirus Adds to Economic Uncertainty – last thing financial markets need right now is panic and uncertainty
    1. Past events – economic outcomes from the assessment of the avian flu pandemic of 2006 – from the Congressional Budget Office (CBO) assessment – potential hit to the U.S. economy – they looked at two scenarios
      1. One mild and one severe with U.S.-specific attack rates of 25% and 30% and case fatality rates of 0.1% and 2.5%, respectively – estimated the overall short-term hit to U.S. GDP to be 1% and 2.3% percentage points respectively – but these estimates turned out to be too pessimistic
    2. With Coronavirus – these are just guessing – no way to truly tell – best that can be done for now is to identify the potential channels through which the virus could affect the economy.
  3. Potential channels that the economy may be impacted –
    1. Household consumption – Consumers are likely to avoid public spaces to lower the probability of infection. These effects could be compounded by travel restrictions – so catering, entertainment, and travel services are likely to be most affected if this is the case
      1. These segments are typically regarded as luxuries rather than necessities, consumers are unlikely to compensate by spending more elsewhere – especially in Australia – more likely to continue mortgage repayments – would dampen overall consumption
    2. Company capital expenditure – Capital expenditure plans of companies are meant to be highly sensitive to expectations for demand – so if there is a prolonged slump in consumption – could, therefore, affect investment (impacting GDP growth)
      1. But – firms are unlikely to react quickly unless the virus is confirmed to be substantially more potent than recent episodes when the effect on demand was relatively short-lived – likely to be brushed off by markets if this is the case
    3. Government consumption – Higher spending on the response to the outbreak, including health personnel, emergency services, and vaccines, could moderately offset the hit to consumption – but likely to have little effect on the overall economy
    4. Trade – Travel, and tourism would be the most heavily affected as individuals seek to reduce the probability of infection. This could be compounded by Wuhan’s strategic role in China’s country’s transport network.
    5. Supply disruptions – Restricted movement of people and, in a worst-case, a high infection could curtail output in some industries. This would affect both manufacturing and service industries and could trigger temporary production outages or a drop in activity.
    6. Finally – the Potential Economic Impact On China – The coronavirus is hitting China during Lunar New Year, a period when households tend to spend more on travel, entertainment, and gifts – Even if the virus is contained fairly quickly, the initial stages of high uncertainty are likely to affect spending. While centered in Wuhan, other large population centers including major tier-one cities have begun reporting cases – been spreading to the rest of the world –
      1. To give a sense of how big the effects could be on China’s demand – consider that consumption contributed about 3.5% to China’s overall real GDP growth rate of 6.1% in 2019
      2. The supply-side impact, stemming from fewer people going to work, may be limited to the Wuhan area so long as the recorded cases remain concentrated in the city’s immediate vicinity. Recent estimates indicate that Wuhan is China’s sixth-largest city, with a population of about 11 million – so accounts for about 1.6% of national GDP
      3. While this suggests any macro-level impact would be small, there are complicating factors if it is taken out of proportion –
        1. Wuhan is an important national transport hub, given its central location and that the city is a stop on the two major north-south and east-west high speed rail lines
        2. Also, a key player in China’s auto industry – Wuhan hosts production facilities for seven major domestic and foreign manufacturers, and for hundreds of auto parts suppliers – is some potential for spillover effects –
  1. As we stand today – impact on financial markets has been mostly limited to equities – seeing it bouncing around between losses to gains – Economically – the short-term funding rates in China, including the repo rate, remain well within recent ranges and one-year swap rates have been edging lower
    1. The renminbi exchange rate has depreciated somewhat since the news broke, but this also be due to some retracing of the strengthening seen after the U.S.-China trade deal was signed – which is the more likely culprit = Implied renminbi volatility remains steady based around the market expectations
    2. Overall – too early to start thinking about revising GDP growth estimate for 2020 due to the coronavirus

 

What about the potential spillover Effect On the rest of the world?

  1. Of course, much will depend on the extent to which the virus spreads outside China – again between the media and the high uncertainty – better to concentrate on the economic spillovers from China – The most important short-term impact will be felt on travel and tourism
    1. In Australia – Tourism receipts in the region could fall as people curtail their travel plans in response to heightened health risks – other countries in the region that have large tourism sectors and would, therefore, have a relatively larger impact include Thailand and Vietnam – Thailand- tourism exports are about 11% of GDP. Tourists from China also represent a large proportion of arrivals for these economies, particularly for Thailand and Vietnam, where more than 25% of arrivals are from China – But these tourism numbers effects the local economy – if anyone has been to these countries – how many listed companies benefit from this in Thailand or Vietnam – think the local street vendors are listed on a market? Airlines may be impacted and large hotel chains – but that is it when it comes to the share market directly
    2. Largest spillover will probably come from uncertainty – resulting in equity market volatility across the region
      1. At least currency and bond markets have been calm
      2. While prolonged volatility in equity markets could lead to broader risk aversion, there are few signs yet that financial conditions have tightened

 

This is a bit of a side note – but where is the real money going to be made from this? – in the WHO and the media

  1. Media – fear creates more clicks – which drives more traffic for advertisers
  2. WHO – The medical marshal law – pharmaceutical companies that sit on the pandemic council of the WHO – get to declare pandemics – such as swine flu – when they get billions of dollars out of vaccines for a virus –
    1. Even the European council – year after swine flu in 2010 said it was a scare tactic that was a false pandemic to get billions out of the population

 

If you are worried about the economic effects – Where to avoid

  1. Exposure to Chinese demand
  2. Reliant on Chinese and global tourism
  3. More importantly – longer term –
    1. Companies with too much debt
    2. Countries with consumers carrying with too much debt
    3. Countries with too much debt not denominated in their local currency
    4. Cyclical companies, like resources or capital equipment which tend to rise more quickly in booms but fall more rapidly in busts
    5. Exposure to Chinese students – Banks exposed to the above
    6. Australia ticks almost every box above. Europe ticks a lot. Canada has a decent spread.
  4. But like most pandemics of the past – think it will blow over and be more market noise
    1. This does depend on government responses
    2. If markets do crash in response to this – will be yet another convenient scape goat to the underlying structural problems that markets face

 

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