China, Coronavirus and Global Growth

Jack Ablin Market Commentary

The current virulent coronavirus outbreak, infecting nearly 20,000 people so far and killing more than 425, could not have come at a worse time politically for China. The US and China have been bitter trade rivals for nearly two years and the two nations only recently signed phase one of detente. Meanwhile, US manufacturers, facing the prospect of protectionism, scrambled to find alternate supply chains. The coronavirus is increasingly isolating China. One step forward, two steps back.

Barriers have been hastily erected, this time not to stymie trade, but to stunt the spread of the virus. China has implemented full-scale lockdowns of Wuhan and several other cities and imposed travel restrictions on several others. Apple announced it has closed all offices and stores in China through February 9, and McDonald’s has suspended business in five Chinese cities that are at the center of the outbreak. Starbucks has announced store closures. Delta, American and United airlines have suspended all flights to China through the end of March.

News of the shutdown has sent oil prices cascading, since China is the world’s largest oil importer. West Texas Intermediate crude, which began the year at $63/bbl on January 6, has plunged into bear market territory and is at $50.02/bbl as we write. This reaction sent shockwaves through oil-producing countries and prompted Saudi Arabia to call for an emergency meeting of OPEC members.

It’s possible, with enough supply-chain disruptions, that China won’t be able to meet its US trade deal purchase obligations. Beijing has already reached out to Washington for forbearance. Recession fears, which were off the table at the beginning of the year, are beginning to take shape. Bond investors are anticipating a 16 basis point reduction in overnight rates sometime over the next 18 months as a result of the coronavirus.

China’s health crisis will test the global economy, which was enjoying a tepid recovery going into 2020.  Thanks to its relatively high growth rate, China’s economy accounts for more than 30 per cent of global economic activity. The US economy, much slower by comparison, drives less than 10 per cent of the world’s expansion. Global manufacturing, which was improving going into year-end 2019, will be tested.  As November, five of the top seven industrialized countries suffered manufacturing contraction, including the United States.

Economists expect China’s Q1/20 growth to fall by one percentage point as a result of constrained business conditions. The pullback is forecast to shave about 50 percentage points from US Q1 growth – turning what would have been a two-per-cent-plus expansion into one-per-cent-plus growth at best. Asian economies, like South Korea, Hong Kong, Thailand and Japan, would be most affected by a Chinese slowdown, according to the International Monetary Fund.

Equity investors are particularly sensitive to economic vagaries this year since, unlike last year, equity market growth will likely be closely tied to earnings growth. The S&P 500 delivered a 30 per cent return in 2019 even though earnings grew by a meager one per cent, owing virtually all the difference to valuation expansion. Investors understand that further valuation expansion is unlikely in 2020 without substantial central bank accommodation. The best-case scenario is S&P 500 price growth will match S&P 500 earnings growth. Of course, earnings – anticipated to expand by 13 per cent this year – will be tied closely to economic growth. We suspect S&P 500 earnings growth will have difficulty achieving that level in 2020 as a result of the ripple effects of the coronavirus outbreak in China.