With the virus still spreading, the question of effective containment is likely to linger -- especially if emerging market countries, where public health standards are not as strong, are affected.
At the time of this writing, we still see the growth impact as primarily falling on China and its largest trading partners, and expect activity to recover by the second half of the year. On the other hand, an accelerated, broad-based and prolonged outbreak will materially shift the global growth trajectory over the course of 2020.
- Chia-Liang Lian and Kevin X. Zhang
Investor attention to the ongoing outbreak of a respiratory disease, first referred to as coronavirus and now as COVID-19, has intensified this week. Market analysts are assessing the magnitude of short-term economic shock beyond China, and we believe the heightened concern globally is not without basis. From what was thought of as a predominantly domestic public health crisis in China that first emerged in 4Q19 in Wuhan, the country’s sixth-largest city by population, the epidemic has now spread to 37 countries across five continents, according to data from the Center for Disease Control and Prevention (CDC).
Undoubtedly, the short-term pain is immediate and acute for the Chinese economy. The upcoming release of February data in mid-March should provide the first glimpse into the extent of damage. Anecdotal reports point to an activity falloff in 1Q20 that would be unparalleled in recent history. The regions in China under official lockdown (around 50 cities in four provinces) are likely to be hardest hit. Restricting the movement of people, while necessary, has a punitive effect on household consumption, especially in the services sector. Indeed, the timing could not have been worse, given the peak travel season due to the Lunar New Year holidays.
It should be noted that there has been significant progress in containing the outbreak within China, as evidenced from declining new cases and rising recovery rates. That said, full economic normalisation in China will take time. While the majority of state-owned enterprises have reportedly resumed operations after an extended period of closure, small and medium-sized firms continue to face operational challenges. The situation regarding air travel provides some guidance as to the extent and duration of the cyclical downdraft in China. Over 70 airlines have suspended flights to China, with cancellations as far out as the end of April.
Impact to China's GDP
So it comes as little surprise that last week the IMF revised down China’s GDP growth to 5.6% in 2020, the slowest since 1990. Ironically, the downgrade came just one month after an upgrade of the IMF’s forecast to 6.0% (previously 5.8%) following the passage of the US-China phase one trade agreement in mid-January. Further downside risks to growth exist given the evolving developments surrounding the COVID-19 outbreak. In our view, the central government in China is amply equipped to spur activity via expansionary fiscal and/or monetary policies as necessary.
V-Shaped Rebound in Question
Despite containment progress in the epicenter of the outbreak, we would stop short of proclaiming it is “business as usual” for China. Given the recent rise in infections outside China, this is also true for the global economy. We believe the growth risks still skew toward the downside for the first half of 2020. What’s more, we think the pundit-driven scenario of a V-shaped rebound, drawing from the Severe Acute Respiratory Syndrome (SARS) episode of 2003, falls short on at least two counts.
First, the economic influence of China on the rest of the world is far greater today than it was before China’s WTO accession in late-2001. Over the last two decades, China’s share of global GDP has increased significantly, to 16% from 5% (Exhibit 1). It is possible that the extent of supply chain disruptions, underscored by Apple’s recent sales warning, has yet to be fully appreciated. Equally significant is the impact on global tourism, given travel restrictions imposed on China. The number of outbound Chinese travelers has risen dramatically to close to 150 million annually, from below 20 million in the early 2000s (Exhibit 2). Tourist destinations that are some of the most reliant on Chinese visitors—Europe, Japan and South-East Asia—will feel the bite.
Exhibit 1: China and Emerging Asia Have Become Important Drivers of the World Economy
Source: IMF World Economic Outlook Database. As of 31 Oct 19.
Second, we would note that, in a world now dominated by social media, “herd instincts” of communities could accentuate the psychological toll over and beyond what is reasonable. Excessive communication, particularly from non-expert sources, can be immensely counterproductive. As an illustration, empty supermarket shelves recently seen in Hong Kong, Italy and Singapore reflect the panic buying that was allegedly induced by misinformation regarding supply shortages. As our Singapore-based colleagues aptly put it, a fear-induced reaction function could infect the economy harder than COVID-19 itself.
Exhibit 2: China International Tourism Departures
Source: The World Bank. As of 20 Dec 19.
Economic Impact Hinges on Containment
Given the broadening scope of infections globally, the question of effective containment is likely to linger. This is especially crucial if emerging market (EM) countries, where public health standards are not as strong, are affected. While the mortality rate of COVID-19 appears low relative to SARS, uncertainty persists, especially if the outbreak should last longer than is widely assumed. We acknowledge that there continue to be a lot of unanswered questions about COVID-19. At the time of this writing, we still see the growth impact as primarily falling on China and its largest trading partners, and expect activity to recover by the second half of the year. On the other hand, an accelerated, broad-based and prolonged outbreak will materially shift the global growth trajectory over the course of 2020.
CDC is the Center for Disease Control, a section of the US Department of Health and Human Services that researches and monitors the spread of diseases as part of its mission to protect US health security.
COVID-19 is the World Health Organization's official designation of the current coronavirus.
Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
The International Monetary Fund (IMF) is an international organization of various member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements.
Severe acute respiratory syndrome (SARS) is a viral respiratory illness caused by a coronavirus called SARS-associated coronavirus (SARS-CoV). SARS was first reported in Asia in February 2003. The illness spread to more than two dozen countries in North America, South America, Europe, and Asia before the SARS global outbreak of 2003 was contained.
The World Trade Organization (WTO) is an intergovernmental organization which regulates international trade.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).
This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.
This material is only for distribution in those countries and to those recipients listed.
All investors and eligible counterparties in EU and EEA countries:
In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.
In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH.
Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.
All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.
This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.
All Investors in the People’s Republic of China (“PRC”):
This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.
This material has not been reviewed by any regulatory authority in the PRC.
Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.
This material has not been reviewed by any regulatory authority in Korea or Taiwan.
All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
All Investors in Australia and New Zealand:
This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827). The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.
The aforementioned Legg Mason entities are wholly owned subsidiaries of Franklin Resources, Inc.