The Coronavirus: Distinguishing Short-Term Tumult form Long-Term Impact
Markets have sent a clear message in recent days: investors are afraid of the coronavirus. The disease’s global progression and containment measures are seen as impediments to global economic recovery.
The toll on human lives has indeed been unnerving and regrettable. However, fear can lead investors to make irrational choices. We acknowledge that the virus is a global growth risk, and the situation will probably get worse before it gets better. But we suggest focusing on fundamentals and distinguishing between short-term tumult and long-term impact.
Read on for our assessment of developments, likely implications and what we are analyzing to test our outlook.
The economic and financial panic comes mainly from the unknown. A new virus like the coronavirus can only be contained and eradicated at the very beginning of an outbreak. That’s why the WHO and other health authorities have taken great emergency measures to contain the virus, such as restrictive quarantines, which can do severe, short-term, economic damage.
We had been witnessing early signs of exiting the global manufacturing recession of 2019. But emergency efforts to contain the coronavirus are smothering these green shoots. These measures also increase the palpable anxiety about the virus. At some point, if containment efforts are ineffective, we will have to go on with our daily routines, taking necessary precautions. Economic activity would likely return toward pre-coronavirus baseline assumptions.
The economic impact of pandemics is typically a sharp V-shape, where activity drops hard and fast for a quarter and then bounces back to recover most, but not all, of the lost output. Looking at China, by our initial estimates, the loss to the Chinese economy will be approximately 0.5% to 1% of GDP from 2020 baseline growth. That may not sound like much, but that is a full-year 2020 estimate. The quarterly impact could see GDP growth fall from 6% in the fourth quarter of 2019 to close to zero in the first quarter of 2020 before a sharp rebound. As we see it now, annual growth in 2020 will likely be in the low 5% range instead of closer to 6%.
As new clusters of infection occur outside China, the V-shaped recovery might look more like a U-shaped recovery. We have no idea how far quarantine efforts will go to contain the virus in the US and Europe, hence the uncertainty around the potential downside to growth.
But the economy does recover from pandemics. Using China’s recent experience, infections typically rise for two to three weeks before peaking, while the quarantine and economic loss continue for another three to five weeks. Hence, the economic impact of a pandemic usually lasts one quarter. But every time new clusters of infection occur, recovery is delayed. At this point, without knowing the spread of the virus in North America or Europe, we are initially assuming a net loss of around 0.2% to European and US GDP. That would place US and European GDP growth around 1.7% and 0.8%, respectively, for 2020. That is our current virus-related baseline loss estimate for all of 2020, and it is certainly subject to change.
The markets appear to be discounting a worse outcome. Our US recession probability model, which incorporates financial data, has risen from 16% at the end of January to 46% currently. So markets may be a coin flip away from a virus-led recession. Also, asset prices have been hitting downside targets that we modeled using our scenario-analysis framework at the beginning of February. Of course, things can get worse, but these moves indicate a lot of bad news is currently discounted.