Global Economic Growth Disrupted

At year-end, equity investors based some of their optimism for 2020 on expectations for improved global growth. The International Monetary Fund’s (IMF) World Economic Outlook projected global economic growth (as measured by real gross domestic, or GDP) would increase to 3.3% in 2020 compared to 2.9% last year. Emerging markets and developing economies generated all the forecasted growth masking projected declines for advanced economies as a whole (see Figure 1). The recent outbreak of the 2019 Novel Coronavirus or Wuhan Virus in China brings into question these forecasts.

In making the following comments, we acknowledge the unknowns as to the extent the virus will affect various geographic regions and their economies

Figure 1

Source: World Economic Outlook/International Monetary Fund

Vulnerable Region to Virus Spread

The World Health Organization (WHO) recently declared an international emergency because of the potential that the Coronavirus will move beyond China. In doing so, the WHO released the following statement: “Our greatest concern is the potential for the virus to spread to countries with weaker health systems.” Their concern particularly reflects roughly 1 million Chinese nationals working in Sub-Sahara Africa. Currently, without an effective vaccine, China fights this virus with, in effect, one hand tied behind its back.

SARS Compared to Coronavirus – Wuhan Virus

Many compare the current Coronavirus epidemic to the outbreak of SARS (Severe Acute Respiratory Syndrome) in 2002-03. Figures 1 and 2 show the Wuhan Virus is more infectious than SARS but less lethal.

Figure 1

Coronavirus—Wuhan Virus More Infectious Than SARS

# of Total Cases (Dotted Lines Estimated)

Source: World Health Organzation, BofA Research, WSJ/Daily Shot

Figure 3

Wuhan Virus Less Lethal Than SARS

Mortality Rate of Corona—Wuhan Virus vs. SARS to Date

Source: World Health Organzation, BofA Research, WSJ/Daily Shot

Economic Impact—SARS Compared to Corona-Wuhan-Virus

When SARS broke out, China played a much smaller role in the global economy than it does today (see Figure 4). In addition, China’s contribution to global GDP growth nearly doubled since then (see Figure 5). Adding to the potential current risk, high levels of financial leverage burden today’s Chinese economy. With that perspective, the Coronavirus will likely provide greater global economic headwinds today than did SARS.

Figure 4

China a Much Larger Portion of Global Economy

Nominal GDP As a % of Global GDP

Source: Source: MBS, Fitch Solutions, WSJ/Daily Shot

Figure 5

U.S. and Chinese GDP (PPP Basis) As a Share of Global Total (1980-2018)

Source: IMF; World Economic Outlook 2019, Congressional Research Service

Growth of Global Supply Chains

In 2001, China joined the World Trade Organization (WTO) giving it entry into the global economy. Shortly thereafter, 2002-03, the SARS outbreak occurred. At that point, complex global supply chains did not play the role in global trade that they do today. Global supply chains typically move goods and supplies across multiple borders. Figure 6 pictures the sharp step up in global supply chains — global value trade — that occurred since the time China joined the WTO.

Figure 6

Traditional and Global Value Trade (GVC)

(Percent of Nominal World GDP)

Source: IMF Working Paper — Global Value Chains: What Are the Benefits and Why Do Countries Participate? Traditional Trade Comprises Exports of Goods and Services Produced In One Country and Absorbed In the Desination

Economic Effect—China

With the growth in complex global supply chains over the last two decades, the current Coronavirus outbreak will likely cause much greater disruption to global world trade than did SARS. Recognizing current forecast uncertainties, our limited reading of revised forecasts from economists suggests growth for China’s real GDP growth in the first quarter will decline from previous forecasts of about 6% to a revised outlook of 5%. Most economists than look for a recovery to begin sometime in the second quarter depending on how soon the epidemic comes under control. Investors will look to see what responses China’s government and monetary authorities will use to stimulate a recovery from the economic impact of the virus.

Economic Effect — Globally

The economic impact outside of China will ultimately prove broad and in many cases not clear beforehand. At the same time, commodities as a group clearly feel the negative effect. China represents over half of global copper consumption and imports over 70% of iron ore production. The prices of both commodities currently show sharp declines.

With the major role China plays in petroleum consumption, reduced internal travel, and shipments, combined with a pullback in ocean shipping and flights to and from China will prove a depressant to oil demand and prices (see Figure 7). If that proves the case, the Organization of the Petroleum Exporting Countries (OPEC) may temporarily cut back oil production to stabilize prices.

Figure 7

NYMEX Crude Oil (1^st Nearby)

Source: WSJ/Daily Shot

Economic Effect U.S.—Phase 1 Trade Agreement

For the United States, exports to China as well as travel and tourism to and from that country will initially prove a very modest drag on first quarter GDP growth. Combined, on an annual basis, both add less than 1% to US GDP. In our view, shutting down Boeing’s 737 Max production will likely produce more of a depressant to first quarter growth. At the same time, unknown surprises will show up the longer the virus plays a damaging role. Finally, China will likely use this virus outbreak to delay implementation of the phase 1 bilateral trade agreement.

Investment Conclusions

Unexpected events, such as the Coronavirus confirm to us the value of a diversified investment approach to a portfolio’s asset mix. We can only use past experience with SARS to provide some basis for looking forward. On that basis, a rapid recovery could follow in a relatively short period. Again, this virus could take on an entirely different path than did SARS resulting in a different recovery path.

The current period could also create investment opportunities. Those opportunities may arise when quality companies sell for more attractive valuations. In our view, such quality companies demonstrate their worth with steady profit growth that reward investors with regular dividend increases. The current environment also points out the value of diversified portfolios that use alternatives as well as fixed income investments. In the case of fixed income, we prefer employing shorter duration credits in their role to preserve capital.