When to Fade the Coronavirus Fear Factor

Around the Curve

When to Fade the Coronavirus Fear Factor

The COVID-19 outbreak highlights the vulnerabilities created by two decades of unbridled globalization and the rapid flow of goods and people.


Stepping into 2020 -- blessed by the Phase 1 trade deal and monetary easing from more than 20 central banks -- investors eagerly looked forward to a global economic recovery. After moving beyond the pessimism of 2019, few investors expected a black swan event that could jeopardize what was expected to be a spectacular year.

Enter the coronavirus outbreak, which has already dealt epic-level disruption to the global economy and financial markets. Clearly no one can predict the future, but our job as investors is to calibrate the probabilistic outcome distributions, find asymmetries priced into asset valuations, and exploit them. Since the coronavirus is a relative unknown, we explain how we are assessing its information risk, and monitoring economic indicators and market signals

The Information Risk of the Coronavirus

Headline risk suggests the virus may be on the verge of being declared a pandemic, though our base case is that the COVID-19 should ultimately play out like a bad flu season. The range of probabilistic outcomes will depend on available data, which is particularly challenging since stakeholders do not have complete information regarding the extensive impact of the virus, particularly in China. For example, even though new cases outside of Hubei have slowed down, it is still too early to declare victory in China. Data were probably underreported as a result of cover-ups, the lack of reliable testing measures, and an initially delayed response in Wuhan. With a renewed focus on resuming production to meet growth targets, there is a risk that the outbreak will be reintroduced as people return to work. How fast the virus will globally spread may depend on the density of local populations, the vigilance of the public, government containment measures, and the availability of testing measures and medical resources. It's not hard to imagine that some countries are deficient in some of those aspects; treating infected patients could be a significant strain on medical resources.

Implications for China's Economic Activity

With over 400 million people under lockdown and 80% of China's economy shut down for several weeks, there will be a long, drawn-out process to resume economic activity. Reopening businesses will be challenged by ongoing containment measures, transportation difficulties, migrant worker shortages, potential relapses of the outbreak, supply chain disruptions, and generally weaker demand.

The rate at which local governments resume business will vary by geographic location, firm size, industry, and the operational dependence on the migrant labor force. The type of business also matters, as state-owned enterprises (SOEs) are resuming work faster than small-to-medium enterprises (SMEs). For example, SMEs are mostly focused on downstream industries and rely more on supply chains, while SOEs are generally focused on upstream activities.

The central government has designated various levels of emergencies for cities/provinces based on the severity of the outbreak, implementing differentiated policies. Coastal areas have a higher resumption rate than inland areas as export demands are stronger than domestic demand. The financial, IT, and real estate sectors have initially reopened faster than the construction and industrial sectors, as the latter two rely more on migrant labor. Currently, it is estimated only one-third of migrant workers have returned to work, with the rest still facing difficulties due to quarantines, the lack of transportation, or a scarcity of job openings.

As the virus spreads to more countries, their government officials may try to emulate China's measures by implementing lock/shutdowns, social distancing and control, restricting or banning travel, or canceling events and conferences. If many countries adopt those decisions, there may be a negative impact on the global economy, but it's hard to quantify at this point.

The Potential Impact to the Real Global Economy

China accounts for roughly 30% of global growth. Therefore, the outbreak has been costly for China (and the rest of the world) by triggering both demand and supply-side shocks to the domestic and global economies. China's efforts to contain the virus through forceful lock/shutdown measures should sharply contract 1Q and, potentially, 2Q growth. It should also spillover into the global economy through overseas tourism, visible goods trades, services imports, and supply chain disruption.

The outbreak has interrupted the global supply chain, tourism, and trade, which should further dampen corporate earnings and heighten the default risk for levered companies with weak balance sheets. Capital spending is expected to be delayed or reduced. Therefore, the risk of a global recession could rise from the current 40% probability. As an earlier indicator, China's PMI data in February are already lower than the 2007-2008 recessionary levels. For now, inventory levels could sustain the supply chain for a couple weeks. However, if the shutdown is extended to several weeks, the risk of greater supply chain disruption will increase. This shutdown will result in unpaid workers, which could be an additional drag on income and consumption and increase the demand shock. The hit to consumer sentiment amid the fear factor could last through April.

The degree of the negative impact will depend upon the scale of contagion, the severity and duration of the economic damage, and the efficacy of containment measures taken. While the virus alone may not trigger a recession, its effects along with the consequences of increased tariffs, growth slowdown in China, and rising election and geopolitical risks could precipitate a global economic contraction if there is broad-based policy misstep.

Policy Reactions

The policy slack China has for stimulus is more limited than the SARS outbreak in 2003 given the significantly higher debt levels, the massive infrastructure buildup, and concerns of a property bubble. Nevertheless, the magnitude of the recovery will depend on the scope and effect of China's policy response. The market has been looking forward to massive stimulus from China ever since the trade dispute escalated in 2019; the demand for that policy impulse has only increased since the coronavirus materialized. Investors could be disappointed if China only focuses stimulus on business continuity and rescue efforts rather than flooding liquidity and boosting demand. The Chinese government has already reiterated that the property market will not be used as a tool for stimulus. Flexible monetary policies and proactive fiscal policies will certainly help, but they are still a band-aid rather than a panacea, because China's domestic demand was sluggish even before this outbreak.

To avoid default waves related to this halt in economic activity, China injected liquidity in the market and issued more special government bonds. The government also announced a mini-quantitative easing program of 850 million renminbi yuan for SME lending, which includes reducing their cost burden and lowering rates; cutting taxes/fees; forbearing social security contributions, electricity bills, and rents; extending bank loans; and increasing tolerance of non-performing loans.

Other countries have also begun to introduce easing policies. The governments in Hong Kong, Germany, and Italy have all launched their respective stimulus packages. In March, both the Federal Reserve (Fed) and European Central Bank are expected to announce rate decisions-with the Fed cutting its benchmark rate by 50 basis points on March 3 as a direct response to the epidemic. We expect concerted and coordinated easing from the world's major central banks. While central bank easing may not completely remedy the effects of the COVID-19 outbreak, monetary policy can have a powerful impact on risk sentiment and boost risk asset valuations-at least in the short term. When combined with fiscal stimulus, both policies may help support the financial market, which could decouple from the real economy for some time.

Drawing Comparisons

The coronavirus outbreak has already been billed as a black swan event, disrupting the global economy and financial markets. While many comparisons have been made to SARS and H1N1, the circumstances are a bit different. At the time of the SARS outbreak, China was still relatively new to the World Trade Organization. Supply chains were not as inextricably linked to China as they are now. When H1N1 was declared a pandemic in 2009, the global economy was reeling from the great financial crisis. We think the best proxy for understanding the financial impact of the virus could be last year's trade war. Both the trade war and COVID-19 are black swan events that were not significantly discounted by markets during their initial stages and had the potential to be exacerbated by policy mistakes. These events also highlighted the vulnerabilities created by two decades of unbridled globalization and the rapid flow of goods and people.

Evaluating Alternative Frequent Data

We have been using alternative frequent data to check the pulse of Chinese economy. Currently, our findings show that activities are resuming at a slow and gradual pace. The resumption rate, on average, is low at about 40%-capacity utilization is even lower. We are following three categories of data:

Activity data: daily coal consumption, passenger travel, traffic delay/congestion, air pollution, property transaction data, box office revenue, Macau casino gaming, Baidu migration index, etc.

Sentiment data: Baidu search for job openings and unemployment to gauge employment.

Macro policy data: local and central governments' announced measures to control the outbreak and support growth.

By following these datapoints, we can start to assess what the economic impact could be, particularly since the critical variable is how long it takes China to resume its output to a normal, average level.


We believe the Chinese government, along with other policymakers around the world, will introduce coordinated stimulus measures to address any economic slowdown and concerted efforts to contain the coronavirus. It may take a quarter or two for these effects to register within the global economy, but the possibility of a gradual recovery in China and around the world remain in play. While this will be our base scenario, we will continue monitoring developments of the outbreak and the efficacy of policy measures to assess the asymmetries and adjust our portfolios accordingly.


The Baidu Migration Index (BMI) tracks the rate of workers travelling back into China’s main cities. It was formulated by Japan's Nomura Global Markets & Research to track the rate of businesses re-opening in China.

Phase 1 refers to a trade agreement signed on January 15, 2020 between the U.S. and China billed by the parties as the first phase of a broader trade pact. 

COVID-19 is the World Health Organization's official designation of the current coronavirus.

The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.

Headline risk is the possibility that a news story will adversely affect a stock's price. Headline risk can also impact the performance of a specific sector or the stock market as a whole.

Information risk refers to the possibility that investment risk might be increased in the presence of inaccurate or insufficient information.

State owned enterprises (SOEs) and small-to-medium enterprises (SMEs) refer to companies owned primarily by government entities, or companies below the size of major corporate entities.

Purchasing Managers Indexes (PMI) measure the manufacturing and services sectors in an economy, based on survey data collected from a representative panel of manufacturing and services firms. PMI greater than 50 indicated economic expansion; below 50, contraction.

Severe acute respiratory syndrome (SARS) is a contagious and sometimes fatal respiratory illness. SARS first appeared in China in November 2002. Within a few months, SARS spread worldwide, carried by unsuspecting travelers.

H1N1 is a particular strain of flu virus, a combination of viruses from pigs, birds and humans. During the 2009-10 flu season, H1N1 caused the respiratory infection in humans that was commonly referred to as swine flu. Because so many people around the world got sick that year, the World Health Organization declared the flu caused by H1N1 to be a global pandemic.

The renminbi (or yuan) is the name of China's currency.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

One basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

The World Trade Organization (WTO) is an intergovernmental organization which regulates international trade.

The Baidu Migration Index (BMI) tracks the rate of workers travelling back into China’s main cities. It was formulated by Japan's Nomura Global Markets & Research to track the rate of businesses re-opening in China.

Baidu, Inc. is a Chinese multinational technology company specializing in Internet-related services and products and artificial intelligence (AI).


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