If you’re a bear, the escalating coronavirus outbreak lends itself to the argument that the U.S. economy might finally tip into recession and the stock market might finally correct.
After all, the economy is coming off a lackluster fourth quarter. Data from the Commerce Department on Thursday showed that U.S. gross domestic product grew at a 2.1% rate—primarily because of a temporary collapse in imports, due to the U.S.-China trade war, that hid weakness in consumer spending and business investment. Without that trade boost, fourth-quarter GDP would have risen just 0.6%, a level not seen since the beginning of 2015.
Some prognosticators have been saying that it would take a shock to meaningfully push the U.S. economy down and the market lower this year. But it’s too soon—and probably not right—to say that this fast-moving epidemic, declared a global emergency on Thursday by the World Health Organization, will be what derails the still-growing economy or end the nearly 11-year bull run.
Sure, the yield curve inverted on Thursday for the first time since October, as long-term yields fell below short-term yields—historically a recession indicator. The move wasn’t coincidental: It came as investors reacted to coronavirus headlines and rushed to safe assets, says Torsten Sløk, chief economist at Deutsche Bank Securities.
And China’s economy will certainly take a hit from the virus. “Based on the continuing rise in the number of coronavirus cases and deaths, it’s increasingly apparent the disease is becoming an economic as well as a public health concern,” says Ben May, an economist at Oxford Economics. The near-term impact on Chinese GDP growth is apt to be large, he says, revising down his 2020 forecast to 5.6% from 6%.
Because of spillover effects, May says the impact on China’s economy could, in turn, lower global growth this year by 0.2%.
Investors can’t underestimate China’s importance in the global economy. The U.S. is more dependent than ever on China, given the global supply chain and how big China is as a U.S. customer.
U.S. companies operating in China have reacted to the outbreak. Apple (AAPL) has cut store operating hours there. American Airlines (AAL) said it would halt flights to and from the Chinese mainland until the end of March. Starbucks (SBUX) has closed more than half of its roughly 4,300 stores in China—its second-largest market—while McDonald’s (MCD) and Yum China Holdings (YUMC) have similarly closed stores.
“This is an economy with tentacles in every other economy,” says Diane Swonk, chief economist at Grant Thornton, and “there is a storm out there.” But while quick actions to contain the virus may hurt some companies’ first-quarter profits, they could stem damages later.
To go from having an impact on companies to hurting the broader U.S. economy, though, will take a lot more. To put it in perspective, it would take a loss of $22 billion in economic activity to move U.S. GDP by just 0.1%. For the sake of illustration, analysts at William Blair say that Starbucks’ closures would hurt revenue by about $25 million each week they’re closed—meaning that it would take 880 weeks of Starbucks China store closures to shave 0.1% off of U.S. GDP.
Deutsche Bank’s Sløk says that a hit from coronavirus on the U.S. economy would probably come from the stock market. “It’s really about the fear effect,” he says. If equities were to sell off much more sharply, “then the wealth effect would have a significant impact” if it translated to pullbacks in consumer spending.
We’re not there yet. Market losses have been restrained, with the S&P 500 (.SPX) losing 1.7% and the Dow Jones Industrial Average (.DJI) falling 1.5% on the week and roughly flat for the month. One silver lining, some analysts say, is that higher sales at e-commerce and health-care companies could offset weakness in transportation and traditional retail sectors.
“For those calling for a stock market correction, you would think the market would be more sensitive to the coronavirus news,” Sløk says. The market has been resilient, he adds, making it difficult at this point to see how it results in a real economic dent. Sløk reiterates his view that the U.S. economy will grow about 2% for the next 18 months.
All of this isn’t to say that the epidemic couldn’t escalate as both a health and economic problem. Federal Reserve Chairman Jerome Powell, in his post-policy-meeting news conference, said on Wednesday that uncertainties about the outlook remain, including those posed by the new coronavirus. But while he said there is likely to be some disruption to activity in China and possibly globally, Powell reminded investors that 85% of the U.S. economy is domestic.
There’s one factor that could turn the coronavirus from a short-term, contained hit to a broader economic concern. China now has an enormous amount of debt, Grant Thornton’s Swonk says, as opposed to much lower levels when the 2003 SARS outbreak rattled Asian economies and markets. “What you worry about,” she says, “is what does this set in motion in China that is already fragile?”
For now, though, Swonk—who has been warning of a 2020 recession long before the virus struck—thinks the outbreak will amount to a short-term disruption in the first quarter, with some activity hopefully recouped subsequently. It’s too soon to say that this event could derail the current expansion, she says, adding that one upshot is a possible Fed interest-rate cut.
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