After a strong start to 2020, global share prices plunged early this week after new disclosures about the spread of the COVID-19 coronavirus in Italy, Iran, Japan and South Korea. While the rate of increase in cases appears to have slowed in China – in itself a positive sign – the spread of the virus has instead accelerated in other countries. Monday's 3-4% stock market decline in Sweden and the United States, followed by Tuesday's continued slide, left Stockholm's OMXS30 equity index just below zero so far this year and the broad S&P 500 index in the US down by 2.6%, both calculated in local currencies.
How will the coronavirus affect economic growth and stock markets?
In last week's Market Outlook we said that most analysts appeared to foresee a V scenario (quick decline, quick recovery) for the economy or a U scenario (quick fall but delayed recovery), but not an L scenario (slower long-term growth). We still believe that developments over the next few weeks will be crucial in determining the impact of the epidemic on growth, not only in the first quarter of 2020 but in a full-year perspective.
Three things to keep an eye on as developments unfold:
• The spread of the virus
• What supportive measures central banks and political leaders enact
• What companies say – will there be long-lasting disruptions in production?
As the virus continues to spread, we believe that the U scenario is the most likely. It will probably take time before we can sound the all-clear signal and before the economy and financial markets recover. This implies a period of uncertainty, but central banks and governments can provide support to their economies via expansionary policies. We foresee various stimulus measures in China, and the Trump administration has requested USD 2.5 billion in extra appropriations from Congress to combat the spread of the virus.
The latest International Monetary Fund (IMF) forecasts show that virus effects may push global gross domestic product (GDP) growth about 0.1 percentage points lower during the first quarter of 2020. This would be consistent with the impact of SARS (another coronavirus epidemic originating in China) 17 years ago. That virus had a higher mortality rate but a lower total number of cases. Given the larger number of COVID-19 patients and the more vigorous official response this time around, we believe that the IMF's economic impact estimate is too low and that global growth will instead fall by several tenths of a point. Meanwhile we foresee recovery effects this coming autumn or in 2021, which would mean that the total impact in a multi-year perspective will be neutral.
Economic performance will be highly dependent on how the epidemic affects demand and production. If demand falls − in the form of lower consumption − this will mainly be a matter of postponed purchases, trips and so on, implying that demand will return: initially perhaps even at a higher level. In case of production problems, companies − especially manufacturers − will instead need to tap their inventories or relocate production. If their problems continue for so long that companies need to cut output and people lose their jobs, this is of course a different situation, since both incomes and investments would disappear. The impact would then be bigger and more long-lasting, in the form of an L scenario with growth at a persistently lower level. In our assessment, however, the situation would have to become far worse before we see such effects. Our conclusion is that the steps being taken to prevent the spread of the virus, along with expansionary economic policies, still suggest that the economic impact of the virus will be manageable.
The stock market, the dollar and bond yields increase pressure on the Fed
Since the virus outbreak, the market has been pricing in a rising probability of key interest rate cuts by the US Federal Reserve (Fed). The market expects the key rate to be lowered by 0.5 points this year, with an initial cut likely this summer. Former Fed policymakers are talking up a potential immediate rate cut, without waiting for the next policy meeting scheduled for March 17-18, as a sort of insurance against a global slowdown.
Our forecast that the Fed will cut its key rate − though not until September − is primarily based on continued muted inflation, but falling stock markets and bond yields along with a flow of money into dollar-denominated investments may increase pressure on the Fed to act earlier. Economic data have been mixed in recent weeks. If current trends continue this spring, it may be difficult for the Fed not to act, although so far it has communicated that both lasting and significant virus effects would be necessary before it does so.
Our market view
Growth overshadowing worries as stock market driver
At this writing, stock markets have been reacting almost exclusively to news headlines about the spread of COVID-19 and the measures being taken to combat it. As indicated above, we expect continued uncertainty for a while, but we believe that economies and financial markets will eventually revert to their earlier trend. On the macroeconomic front, there has also been plenty of encouraging news, especially from the US, where the labour market has demonstrated continued strength and purchasing managers' indices – often a good indicator of future growth – have bounced back after a period of weakness. There have also been signs of recovery in Europe. We believe that world economic growth is stabilising and that recession risks have diminished, assuming that virus effects are not long-lasting.
Also on the plus side are recent Q4 2019 corporate reports, or perhaps more importantly the market's reaction to them. Overall, quarterly reports were a bit better than expected, but it is interesting that even some of the slightly weaker reports were well-received by the market. This is in contrast to earlier quarters, when weak reports were initially punished by sharp declines in share prices.
To summarise, better macro signals and reasonably good quarterly reports should provide support to high stock market valuations, but worries about the negative effects of the virus outbreak will probably mean continued market turbulence, with a risk of new downturns in response to negative news. We see long-term potential, but because of short-term uncertainty we recommend a risk level of around neutral. If we should see further stock market downturns, this might represent buying opportunities, but we are not there yet.
This week's agenda
- February 27 – Swedish retail sales. Last autumn's upward trend has the potential to continue, but the warm snow-free winter has adversely affected sales of clothing and sports equipment.
- February 28 – Swedish GDP. Growth indicators are more ambiguous than usual, but consumption and export data indicate that GDP continued to grow during the fourth quarter of 2019.
Please contact your private banker if you have any questions or concerns