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Coronavirus: How Bad Will It Get?

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This is an excerpt from our most recent Economic Outlook report. To access the full PDF, please click here

 

With equity markets plunging and U.S. Treasury yields breaking one negative record after another once it became clear. Coronavirus shutdowns are very likely to hit the U.S. economy hard. Investors appear to be bracing for the worst.

With the number of infections and fatalities increasing around the globe there is no doubt. In our minds, the impact of this viral outbreak will be felt across the board, in many areas of life. As Nancy Messonnier, Director of the National Center for Immunization and Respiratory Diseases put it: “Disruptions to everyday life might be severe.”

An initial hope for containment within China was not realistic. More and more countries -- such as South Korea, Japan, Italy, and Iran -- witnessed firsthand how contagious the disease is. They reported an increasingly high number of infections. By now, very few countries have not reported infections. This much has become obvious. A coordinated global health policy effort will be necessary to try prevent a pandemic.

As policy measures to contain the disease -- to prevent further illnesses and fatalities -- spread and deepen, it also becomes necessary. Investors must grapple with the degree to which this will affect business activity, both in the U.S. and around the globe.

With this in mind, we provide an overview of important factors to watch, over the upcoming weeks and months:

1) Effects on global supply chains. Across carefully hidden and often complex inter and intra company trade linkages, these are hard to estimate given the large number of uncertainties. The biggest factor is possibly the extent to which factories in China -- which had to close temporarily -- might be able to reopen. At this point in time, their shutdown should extend further into the next few weeks. Only one fact remains clear. This fast-moving virus has disrupted almost every Chinese link in global supply chains, once more demonstrating how interdependent the global economy has become in recent years.

Comparisons to the outbreak of SARS in 2003 are not worth much. The share of the Chinese Economy in worldwide production has risen from 4% in 2003 to 15.5% today. China’s share in global trade has risen from 12% in 2003 to 34% today. These two numbers illustrate the fairly obvious facts. Not only will individuals become affected across borders. So too will an increasing number of U.S. and non-U.S. businesses.

Studying how China effects work their way to the U.S. economy is important.

Companies that rely heavily on production inputs from China, such as tech equipment companies, industrial equipment producers, and apparel and shoe makers will feel virus shutdown effects the strongest. Companies such Apple have indicated this already, in downwardly adjusted revenue estimates. Effects will be felt, in particular, among companies which focus on consumer goods. These tend to rely upon multiple steps in wage-sensitive backend production from industry clusters in southern China.

Yes. Industries such as car makers have become more internationally diversified over the years. Yet, they produce for local markets under heavy local content restrictions. Who would have guessed those would be a good thing for the global economy?

Due to ongoing trade uncertainty over the past years, many companies already started shifting production away from too much concentration in China. Established domestic production linkages came in handy, after all.

2) It might be argued. Companies that sit on large amounts of cash (such as Apple) can always make up for lost production down the road.

But smaller and more leveraged companies will eventually hit the wall when it comes to making timely debt payments.

Want to study the other end of the spectrum of global trade?

Think about oil companies which export into China. These will see lower demand. This has caused a massive drop in the price of crude oil, further increasing strain on the struggling U.S. Energy sector. U.S. rig counts are going to go down more. Think hard about Houston, Texas.

3) The U.S. economy has only been hit indirectly so far through the supply side, via disruptions to a variety of U.S. production supply chains. Yet, it remains only a matter of time. Until the U.S. demand side takes a solid hit and consumer spending declines.

The latest readings on U.S. consumer sentiment show little sign of concern. However, once we all begin fewer visits to coffee shops, restaurants, malls, work locations, etc. we surely begin to see a stronger impact on first (ending March 31st) and then second quarter GDP.

Even more concerning? Will we see disruptions strong enough to cause restrained hiring by companies? Even firing?

These might be catalysts for a vicious cycle of lower U.S. employment leading to lower U.S. consumer spending… it’s a key macro link to be vigilant about now. Pay attention to the internals of the monthly nonfarm jobs reports, by sector, and to the ISM/PMI Manufacturing comments section.

We remain cautious regarding projections about the overall development of the viral outbreak. We agree with experts. The impacts of the disease will be felt not only in personal health standards (or the lack thereof of our society) but also throughout our economic system.

This is our base case (50%) expectation. Ultimately, coronavirus shutdown effects will be limited to the first 2 quarters of 2020. For the remainder of the year, Zacks economists can imagine a rebound towards normal activity levels.

But this must be confirmed by data. We should be able to see the evidence of a turn consistently, only by perusing both personal health statistics and broader economic aggregates… at the same time.

Keep a 50% probability on this scenario getting worse.

 

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