Could the coronavirus outbreak trigger a recession?

On the latest edition of Market Week in Review, Quantitative Investment Strategist Dr. Kara Ng and Head of AIS Business Solutions Sophie Antal Gilbert discussed the latest on the coronavirus outbreak and its potential impact on global markets and economies.

Markets plunge as coronavirus fears grip investors

Global equity markets were battered the week of 24 February as the coronavirus spread beyond China, Ng said, with the S&P 500® Index down approximately 15% from its all-time high on 19 February, as of midday Pacific time on 28 February. The U.S. 10-year Treasury yield also sank to a new record low of roughly 1.2%, she added.

In recent days, the coronavirus has spread rapidly through South Korea, Italy and Iran, Ng said. “The outbreak in Iran is of particular significance, because much of the Middle East lacks the infrastructure to properly contain the virus,” she explained. Meanwhile, the outbreak in Italy has spread to many countries in the European Union, threatening to severely disrupt supply chains in the region, Ng noted.

In addition, she said that the recent news that a coronavirus case in the U.S. was unable to be traced back to China is sparking additional worries in America, as it suggests that the virus may become more prevalent in the U.S. than statistics currently show.

The ultimate impact of the virus’ spread is not clear, Ng said. “U.S. and global economic activity and earnings growth will take a hit,” she stated. However, the duration of the setback may vary among markets and economies, Ng added. “Markets are generally forward-looking, and may bounce back fairly quickly once the coronavirus is contained, while a rebound in economic activity and corporate earnings will likely take longer,” she noted.

The coronavirus market rout: Is there a buying opportunity?

If markets overreact to the spread of the virus, there could be a buying opportunity - but Ng and the team of Russell Investments strategists don’t see evidence of one just yet. “In our opinion, we’re almost to that point, but not quite there,” she said, explaining that the magnitude of the selloff has been intensified by the record market performance seen earlier in February.

“Remember, markets are generally efficient, except during episodes of fear or greed,” she remarked, adding that while many indicators suggest widespread pessimism across most markets, levels of indiscriminate panic - such as what was observed in December 2018 - have yet to be reached.

If coronavirus continues to spread, will businesses actually close?

Potential measures to contain the virus, such as the closure of businesses and schools, will depend on each country’s appetite for containment, Ng said, adding that there is a possibility that many businesses will be temporarily shut down. “China shuttered its factories, Japan is closing schools for a month and Italy has banned live soccer games and fashion shows,” she noted, explaining that travel restrictions, closures and quarantines are all part of a government’s toolkit to help reduce contagion.

Because the U.S. economy is largely services-based, Ng said that some businesses may opt to allow employees to work from home, rather than closing shop altogether. “This option isn’t really available in countries where manufacturing makes up a larger part of the economy,” she noted.

Market and economic impacts: Short-term or long-lasting?

It’s very difficult to assess whether markets and economies will rebound from the coronavirus in relatively quick fashion or not, Ng said. “It all depends on when the virus can be contained. As of right now, it’s clear the global economy will experience detrimental impacts this quarter. If the virus persists for two or three quarters, a recovery may prove problematic unless central banks and governments provide fiscal and monetary stimulus,” she said.

The wild card in all of this is economic contagion, Ng added. If companies start going out of business, the ripple effect could harm the financial sector and the U.S. consumer. “Quite simply, the longer the virus shock, the disproportionately harder the recovery will be,” Ng explained.

Could coronavirus spark a recession?

There is a possibility that the coronavirus outbreak could tip the globe - and the U.S. - into a recession, Ng said. This could happen if the slowdown in global growth causes credit defaults and a downward spiral in business and consumer confidence. However, she stressed that this is not the team of strategists’ central scenario.

“If a recession does unfold, there are a few bright spots in some countries,” Ng noted. In the U.S., for example, economic imbalances are few, banks are well-capitalised and household leverage is relatively low, Ng said. “So, in the event that coronavirus does ultimately lead to a recession, there’s a good possibility that growth rates would bounce back fairly quickly once the virus is contained,” she concluded.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.