The rapid spread of the Wuhan virus has forced economists and market participants to confront a series of questions that are almost impossible to answer. The outbreak has the potential to cause severe economic and market dislocation. But the scale of the impact will ultimately be determined by how the virus spreads and evolves, which is almost impossible to predict, as well as how governments respond. If the epidemiologists are unsure how events will play out, then you should be sceptical of any economist that claims to know better.
At this stage, I think there are three useful things we can say about the potential economic and market fallout.
The first is that, while past epidemics offer some clues about the possible economic impact, the parallels are inexact. At the risk of stating the obvious, no two viruses are the same. The economic backdrop to the current Wuhan virus is also different from previous epidemics. While it’s tempting to draw comparisons to the SARS epidemic in 2003, China’s economy is now much larger and more closely integrated into global supply chains. An economic shock in China is now more likely to spread to the rest of the world.
The market backdrop is also very different. The SARS virus hit at a time when global stock markets were starting to bottom out following the bursting of the dot-com bubble. In contrast, the Wuhan virus has hit ten years into a bull market for equities. With valuations no longer cheap, and in some cases a little stretched, investors are more likely to be looking for an excuse to sell rather than buy. The potential for the virus to trigger a significant market correction is much greater now than it was back then.
The second point to make is that the steps to contain the virus - rather than the virus itself – are causing most of the economic damage. It is therefore significant that the response by China’s government has been both faster and more extensive than was the case with SARS. The Lunar New Year holiday has been extended for most of the country, keeping factories and other workplaces shut. Widespread travel restrictions have been imposed, transport services curtailed and tourist groups banned. The scale of the response is perhaps one reason to expect the initial hit to activity to be larger than it was with SARS.
The third point to stress is that economic dislocation caused by the virus will spread across sectors over time, and this will have implications for the scale of the impact on the rest of the world. The initial disruption was concentrated in the travel and tourism sectors. Passenger numbers have fallen by 55% compared to the Lunar New Year period in 2019. And given that Chinese tourists spend a lot in Asian countries, the costs of travel bans will be felt throughout the region (particularly Cambodia, Thailand and Hong Kong).
But the disruption is now spreading to domestic industry, as factories that should have opened on Friday following the New Year holiday remain shut. Given that China is now at the heart of many global supply chains, this will have knock-on effects around the world. Economies in Asia (particularly Vietnam and Taiwan) look most vulnerable but, the bigger the disruption, the higher the chances that it affects economies further afield including commodity producers such as Chile and Australia and manufacturers such as Korea, Japan and Germany.
So what can we draw from all of this? The best we can infer from past epidemics is that we should expect a significant hit to activity in China in the first quarter of this year followed by a rebound in output once the virus is brought under control. As long as factory closures don’t lead to job losses, by this time next year the level of GDP is unlikely to be very different from what it would have been without the virus. We’ve just cut our forecast for Q1 growth (as measured by our China Activity Proxy) from 5.5% y/y to around 3.0% y/y but, for now, think the lost output will be made up over the rest of this year
There are three implications for the rest of the world. First, given the size and importance of China’s economy, the impact on the global economy is likely to be more significant than in previous epidemics (including SARS). Second, the greater the disruption in China, the more likely it is to spread overseas. And third, given that we’re ten years into a global equity bull market, the potential for the virus to trigger a significant market correction is much greater now than it has been during previous epidemics. This much we know. As things stand, everything else is just speculation. We’ll continue to monitor the spread of the virus and its effect on China’s economy and global markets in a dedicated page in our China chart book.
In case you missed it:
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- Our Senior Economist, Stephen Brown, explains why monetary policy is losing its power over households.