An Eye on the Market: Explaining the inexplicable
Head of Macro Analysis
Summary: It is obviously too early to know exactly the impact of the coronavirus on the global economy and the supply chain. We have some ideas, but we don't have accurate figures yet to corroborate our hypothesis. I remain deeply skeptical about forecasts i see here and there saying that the coronavirus will reduce global economic growth for this year by 0.2% or 0.3%. In this macro update, I want to share with you my humble understanding of the situation and some key risks I have identified related to the coronavirus crisis.
Based on the official number out of China, the coronavirus is worse than the SRAS. The number of people affected is five times higher and the number of deaths is 41% higher. On the upside, a major difference with the SRAS is that the authorities are now fully able to implement in a very short period of time efficient methods to contain contagion.
We are unable to assess the exact economic impact of the coronavirus in China, but we can guess the amplitude of the slowdown. China has decided to delay the release of a bunch of economic data, including January trade, retail sales and many other indicators. There is basically nothing to analyze and plenty of room for conjecture. However, we already have some clues pointing out the slowdown in Q1 is likely to be more important than expected at first. We use Taiwan January trade data as a proxy to estimate the amplitude of the economic effect of the coronavirus…and it’s ugly. Taiwan’s export to China decreased by 7.8% YoY in January and imports to China fall by 18.2% YoY. This very sharp decline is partially explained by some Lunar New Year effect, but not totally. There is also a clear impact due to the coronavirus breakout. Obviously, we don’t expect any improvement in February. It also means that; contrary to market expectations, there is no chance that global trade rebounds in Q1.
China cannot afford the closure of factories and property sales showrooms much longer. During the Lunar New Year, it is quite common that factories close down, but if the shutdown is prolonged until March, it may put at risk of bankruptcy many companies. Earnings would fall, which would increase repayment pressure on the most vulnerable and indebted companies, notably in the real estate sector. As of today, more than 100 Chinese cities have temporarily close property sales showrooms and investors we have talked to are already wondering how some companies, such as Evergrande, one of the top Chinese real estate firms, will cope with the situation.
My base case scenario assumes a sharp drop in GDP growth in Q1 followed by an asymmetric recovery in Q2. We are still more optimistic than our Chinese colleagues, but we strongly believe that China’s whatever it takes, composed of high inflow of liquidity from the PBoC, via open market operations, and further fiscal stimulus (both tax cut and public spending), will be able to restart growth engine at some point in the next quarter. China will have no other choice than prioritizing growth over deleveraging this year.
Asian economies and Australia are the most exposed to China’s slowdown. In my view, the most vulnerable economies to the coronavirus and travel restrictions are Thailand, Vietnam and the Philippines followed by Australia and Chile (due to the dependence on commodity exports to China). We expect that the reversal in monetary policy which has started in 2019 will be amplified. Since the coronavirus breakout, the BSP cut rates by 25bps to 3.75%, the BOT followed the same path with a 25bps and the MAS adopted a more dovish tone to weaken the SGD. Indonesia is likely the next to cut on Feb 20. Fiscal stimulus is also on the table with India slashing taxes and widening deficit to spur economy. I see more expansionary fiscal and monetary policy in Asia as unavoidable in coming months.
There is no sense of panic in the market due to the perception that liquidity will continue to push up the equity market. I think the basic rule we have learnt last year is that it is very costly to fight liquidity. Investors that did not manage to understand liquidity is the main driver of the stock market and focused too much on macro and political risk were trapped in 2019. This year, they cannot afford to miss any upside move again. The ongoing narrative is that China’s response, both on the fiscal side and on the monetary side, will be effective to mitigate risk and that the coronavirus will only delay and not reverse the 2020 global growth rebound that was announced last year. Bears tend to consider that this view is way too optimistic and that China and the rest of the world are walking on thin ice. The sad reality is that the recovery has been fueled over the past ten years mostly by monetary policy support and the 2019 Powell pivot confirms that central banks are not ready to let down the economy and the stock market. I share most of the bears’ concerns about the economy, but I am pragmatical enough to consider that this time is different. As long as liquidity inflow continues, the biggest risk in my view is to face a short-term healthy correction.
The market has not priced in yet the risk of inflationary shock resulting from China’s public intervention. At the end of 2019, we mentioned as one of our 2020 top risks a potential countershock of inflation at the global level due to a sharp increase in food price. This risk is becoming reality as the FAO food price index is reaching at five-year high at 182.5 in January, up 11.3% YoY. Before the coronavirus breakout, we already had confirmation of a jump in food inflation in many Asian countries. We think the market is not ready to face an inflationary shock that could be fueled both by food price increase and China’s expansionary policy.
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