Does coronavirus pose a long-term risk to the global economy?
On the latest edition of Market Week in Review, Senior Investment Strategist Paul Eitelman and Head of AIS Business Solutions Sophie Antal Gilbert discussed the latest coronavirus headlines, flash PMI (purchasing managers’ index) data for February and watchpoints for markets as the U.S. Democratic primary season heats up.
Potential impacts from the coronavirus outbreak on GDP
Markets slumped the week of Feb. 17 as the coronavirus outbreak spread beyond China, with global equities dropping roughly 1.5%, per the MSCI All Country World Index, as of midday Pacific time on Feb. 21. U.S. 10-year Treasury yields also fell approximately 10 basis points, hovering around 1.45% at noon Pacific on Feb. 21.
“The movement we’ve seen in equity and bond markets this week reflects growing concern over the potential economic impacts of the virus,” Eitelman said, explaining that while the number of cases appears to be plateauing, the virus’ spread beyond the Wuhan region of China has triggered additional worries.
First-quarter GDP (gross domestic product) in China is likely to be significantly impacted, he stated, noting that the country normally charts a GDP quarterly growth rate of roughly 6.5%. “China may see something like a 7% dent to GDP growth in the first quarter—which would spell a negative growth rate,” Eitelman remarked. The main reason why, he said, is simple: Many Chinese factories have been closed due to the ongoing outbreak.
“When factories are shut down, they’re not producing anything in the way of economic activity, which is precisely what GDP is trying to measure,” he explained. Eitelman added that in addition to China, the economies of Hong Kong, Taiwan and Singapore may also take a big hit—with lesser impacts expected in Europe. The U.S., he said, will probably only experience very minor economic impacts from the virus.
The bigger issue for markets going forward is the length of the duration of the outbreak, Eitelman said. “Historically, in past outbreaks where the virus was ultimately contained—such as SARS—there’s usually been one big quarterly hit to GDP, and then the economy has snapped back to normal fairly quickly,” he stated. Assuming this proves to be the case with coronavirus, financial markets should ultimately be able to look past this, Eitelman concluded.
Flash manufacturing data reveals impacts of coronavirus
Preliminary manufacturing PMI data for February, released the week of Feb. 17, painted a muddled picture of the economic impacts of coronavirus to date, Eitelman said. “The numbers were really all over the place, with softness in Japan, strengthening in Europe and a mixed bag of results in the U.S.,” he stated.
In Eitelman’s opinion, the clearest message came from Japan, where the flash manufacturing PMI for February fell to a reading of 47.6. A reading above 50 indicates expansionary conditions, and a reading below 50 indicates contraction. “The data in Japan shows that supplier deliveries and supply chains are struggling, while tourism is slowing—all indicative of the effects of coronavirus,” he said.
By contrast, the preliminary manufacturing PMI for the eurozone was fairly encouraging, rising to a six-month high of 49.1, Eitelman noted. “Europe is an area where we’ve seen some evidence of economic stabilization and improvement, starting in the fourth quarter of last year, and the latest numbers suggest this is continuing,” he said.
Turning to the U.S., Eitelman noted that IHS Markit’s flash manufacturing PMI for February dropped fairly significantly, falling to a level of 51.7. Yet, regional manufacturing surveys released by the U.S. Federal Reserve (the Fed) earlier in the week were outstanding, he said, showing a very strong improvement in economic activity.
“All in all, this makes for a very noisy picture—and with the effects of coronavirus just starting to show up in the data, it’s going to be quite hard to have a clean read on what’s happening in the economy over the next several weeks,” Eitelman said. “My overall sense, though, is that the U.S. economy is still performing fairly well, backed by a strong consumer and stabilizing business confidence.”
U.S. Democratic primary season: Watchpoints for markets
Eitelman and Gilbert concluded the segment with a look at the U.S. Democratic primary season, which kicks into high gear on March 3, when over one-third of the party’s delegates for president will be awarded.
Currently, markets are considering the proposed policies of the Democratic presidential candidates, some of which are fairly aggressive, Eitelman said. “In particular, markets are tuning in to the possibility that the corporate tax cuts enacted by Congress in early 2018 may be repealed, should some of these candidates win the White House in November,” he noted. The tax cuts boosted U.S. earnings growth by nearly 10% in 2018, Eitelman said.
“If these tax cuts are rolled back, there could be a similarly negative countereffect on corporate earnings, which could cause some volatility in markets,” he stated. Additional proposals among the candidates around a ban on fracking could be disruptive to the energy sector, Eitelman said, while proposed antitrust actions against mega-cap tech companies could cause additional financial-market disruption.
He cautioned, however, against taking the candidates’ proposals too literally at this stage, also noting that Congress controls the power of spending, not the president. “What happens in the Senate in November may ultimately matter even more than who wins the presidency—and if the Democrats don’t win the Senate, they may not be able to enact these proposals into law,” Eitelman concluded.