The guest commentary below was written by Daniel Lacalle.
The John Hopkins University Coronavirus Global Cases Monitor shows that the mortality rate of the epidemic is very low. At the close of this article, 83,774 cases, 2,867 deaths and 36,654 recovered.
It is normal for the media to focus on the first two figures, but I think it is important to remember the last one. The recovered figure is more than ten times the deceased one. This should not make the reader ignore the epidemic, but it is also worth reading the scientific study that shows that the death rate in citizens under 60 is less than 1.3%, 0.2% in young population, and on average it is a maximum of 4% (“The Epidemiological Characteristics of an Outbreak of 2019 Novel Coronavirus Diseases”, February 2020).
I have attended several debates in international media where scientists repeat these important factors to prevent panic reactions from the population. History shows us that these epidemics have diminishing mortality rates and are contained relatively quickly.
We must remember the victims and their families and pray for a quick response from the scientific community, a solution that will surely arrive… Although not in the time that market participants and media would desire.
The economic impact is completely different.
There is more logic in the negative reaction of markets because the coronavirus impact adds to an already weak and bloated global economy that was showing poor growth, high debt and an evidently disappointing earnings season before any epidemic was included in estimates.
The ramifications are not small. China has closed 21 provinces that account for about 90% of exports and 80% of GDP. At the close of this article, 13 provinces, which account for around 51% of China’s GDP, have begun to recover economic activity, but at a very slow pace.
China PMIs came at the lowest level in decades, even below 2008 figures. Manufacturing PMI fell to 35.7 in February, compared to the previous 50 and estimates of 46. More importantly, non-manufacturing PMI collapsed to an all-time low of 29.6 compared to the previous 54.1.
Few analysts expected to see China posting recession figures, even in their most negative estimates. China may print a zero GDP in the first quarter, which shows the extent of the economic shutdown.
The previously mentioned PMIs are important for two reasons: Manufacturing, which was already poor and in contraction in most leading economies, is likely to slump in the first quarter. However, the second conclusion is even more worrying. The non-manufacturing and services sectors have kept the global economy afloat in an earnings and manufacturing contraction and, this time, services will be hit harder and for longer.
Why? Because the only action that authorities can take to prevent a collapse in the health systems of their countries is to shut down borders, limit travel, cancel large gatherings and events as well as reduce international trading activity to reduce the virus spreading speed. Not because the mortality rate is high, but to avoid a massive flow of citizens into hospitals and hoarding of medicines.
The reaction of the authorities in many countries and the fear of the unknown generate a domino of cancelations of investment decisions as well as a slump in international trade. As such, we cannot fall into the unjustified panic of a global health disaster or the complacency of thinking, as we read in some economic research papers in February, that all this will be solved in a month and in two months world growth will be relaunched.
We must be cautious because the coronavirus card will be used, as the Brexit and Trade War cards before, to slash already optimistic global growth estimates.
Before the epidemic news broke, economies such as Spain, France, Italy, Germany, Japan or China already showed weakness in the fourth quarter of 2019. energy and industrial commodities, which have now entered into a correction phase, had already started the year with weak price action. We cannot forget important signals such as the Baltic Dry Index, which reflects the enormous global overcapacity and the collapse in the pricing of maritime freights, or the poor volumes posted by exporters in copper, oil, coal and iron ore.
In its analysis of economic risks, PricewaterhouseCoopers showed an estimate of the global economic impact that the coronavirus may generate. It stated that it could shave up to about 0.7% of global GDP, using the methodology of John Hopkins and McKibbins & Lee. However, that impact may well be seen as conservative once we have taken into account the global loss of market value in stocks and the China PMIs. Bloomberg raised the impact to a trillion US dollars considering that the effect on commodities, industries, and services will likely be greater than feared in the short term and the recovery may not to be the V-shaped one most analysts would want, but slower.
It is essential to remember the previous weakness of many economies, especially the eurozone, due to excess debt, low growth and high interventionism.
We cannot forget the impact on emerging markets either, as they face a massive wall of maturities of more than 1.4 trillion US dollars of dollar-denominated debt just as the price of commodities collapses and exported volumes slump to new lows.
Deutsche Bank analyzed the most exposed economies to the epidemic and concluded that South Korea, Japan, and Mexico will likely be the most affected, while the United States, which exports very little (11% of GDP more or less) is less impacted.
The biggest mistake, and one that is almost guaranteed to be made, is to try to disguise the economic impact of the epidemic by cutting interest rates (consensus already discounts a 68% probability of Fed rate cuts) and injecting more liquidity. No company will invest more with lower-than-zero rates if they are facing a sales decline from an epidemic, and there is an excess of complacency in governments that see their bond yields reach even lower levels. Falling sovereign bond yields make governments believe they are doing the right thing and there is no risk, two big mistakes, and a very negative combination. Low bond yields are a signal of high-risk aversion, not of excellent government policies.
China and Hong Kong have promised massive spending programs to “offset the economic impact”. Huge white elephants, unnecessary public spending projects to disguise the economic impact of an event, can generate a much worse effect and accelerate the path to stagflation. Core prices rise due to the supply chain impact and economic growth stalls.
Let us not forget the lessons from Japan. the country spent more than 6 trillion US dollars in massive infrastructure plans after the burst of its real estate bubble and the economy became less dynamic and more debt-ridden.
I am convinced that we will have a medical solution to this epidemic, but the real economy and science do not move as fast as market participants would desire.
The excess of pessimism reflected these days can only be explained by the previous and imprudent excess of optimism that all of us, financial market agents, had at the end of 2019 and the beginning of 2020 when stock markets reached new all-time high levels despite the coronavirus headlines in China, poor earnings and weak macro news.
In the coming weeks, we have to start thinking about important side-effects such as increased default rates, risks in emerging countries exposed to large monetary and commercial imbalances and analyze them calmly.
Central banks and governments are not going to disguise the real economic impact of the epidemic, rather the opposite. Aggressive shutdown measures will worsen an already weak economic trend.
Many call it “uncertainty”, but we have a lot of certainties:
- This epidemic’s impact will be longer than most would like
- Central banks and governments will try to disguise the risks with more financial and monetary repression and drown the issue in a sea of spending.
As in all episodes of panic, one of the greatest risks is governments that feel the need to do something quick and massive, probably contributing to that same panic that they call to mitigate. Taking unnecessary interventionist measures, closing the economy and disguising the risk with bricks and mortar may be even worse as a solution than the problem itself.
I trust the scientific community and global collaboration networks but don’t forget this: The coronavirus card will be used as an excuse to cut growth and employment estimates, blame an outside enemy, and present the government as the solution by throwing billions into more debt-fueled spending.
This is a Hedgeye Guest Contributor note by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap.