In today’s Macro Briefing we focus solely on the current China health crisis and the outbreak/containment of novel Coronavirus. Much of the analysis looks to make comparisons between the Coronavirus and Sars to assess economic and market impact, but much has changed since 2003. Communications, offshore tourism and supply chains are all markedly different today. This has positive and negative implications for how this crisis is dealt with and what it means for asset prices globally. The research we highlight today seeks to add some clarity to this backdrop.
Substantive's Top Themes - Best of the Broker Notes
1. Xi’s big test of authority and the risk of overspill
In this note Eurasia Group, the geopolitical experts, assess the ability of China’s political system to meet the key challenges of the crisis: controlling the spread of infections, maintaining stability and order, and withstanding the economic fallout. Eurasia say that President Xi Jinping Xi’s heavily top-down leadership style likely contributed to delay in responding to the crisis because of its culture of making local officials fearful to act without proper authorization from Beijing. The political dynamics have shifted substantially over the last week, as Xi has clearly recognized that this is not only a public health crisis but the most serious test of China’s governance capacity since he took office in 2012, the note says. Eurasia adds that there are also risks that Xi’s top-down efforts will lead to “overshooting” in aspects of the response. Officials will be more likely to impose quarantines and take other emergency measures even when not warranted. This could lead to a misdirection of efforts and resources and deepen the economic impact of the crisis. Eurasia also highlight the risks for China’s international standing, especially if Beijing pushes back on efforts by other governments to evacuate citizens. A global health crisis, especially if there are new doubts about transparency, will dent China’s image at a time when—unlike with SARS—Beijing is making a bid to be viewed as a global leader, the note argues.
2. Viral outbreak scenario analysis
The team at Cornerstone Macro have put out an interesting note which showcases their quantitative tool that enables investors to look at the event studies of the previous 4 global viral outbreaks (Avian Flu, SARS, H1N1, and Ebola) and see how various segments of the global financial markets (e.g., stocks, gold, bond yields, etc.) performed before, during and after these events. In addition, they highlight higher-quality Value stocks and their YTD performance (if investors are looking for names that have pulled back recently). Cornerstone say that the largest pushback to their 2020 thesis to own higher-quality value/cyclicals was that “they’ve already gone up a lot” or “they were already too expensive.” Many investors had commented that they were waiting for a better entry point, or a pullback in markets. Could this be it? asks Cornerstone. History does show that after a viral fear recedes, markets do see a v-shaped recovery, they add.
3. The coronavirus and Europe
The US-China trade tensions have been a significant drag on business confidence in Europe over the past couple of years, writes Chris Hare from HSBC. So the obvious question is how will the coronavirus impact European growth, which Hare examines in this report. He looks at the impact through two channels, firstly, the obvious one being trade, looking at Europe’s exposure to China (8% of extra-eurozone exports), where HSBC’s models models suggest that a 1ppt GDP growth slowdown in China would only knock around 0.1ppt off eurozone GDP growth (HSBC forecasts 0.7% growth in 2020). The risk would be that the virus spreads across Asia, which could intensify the headwind to Europe, writes Hare. Exports to Asia as a whole account for 24% of extra-eurozone exports. The second channel would feed more broadly into European market and business sentiment, says HSBC. They show how European equity markets – specifically, the Euro Stoxx 50 index – have become more strongly correlated with Chinese equities in recent years. China might also be becoming a bigger driver of business sentiment – during the intensification of US-China trade tensions, Hare thinks there was a clear second round effect via business confidence which went beyond Europe's direct exposure to China.
4. The economic impact of the novel Coronavirus through "Big Data"
DeepMacro’s analysis is based on a combination of big data and macro analysis. Their DeepChina research uses big data to track industry, real estate, and capital flows pressure — the key drivers of China’s business cycle and its impact on global asset prices, on a daily basis. As result their analysis can be useful in tracking the economic impact of the novel coronavirus in China. In their latest report, they concede it is still very early to draw concrete conclusions, but the data shows that the impact on industry is so far muted. The impact on real estate appears somewhat negative, while the impact on jobs is difficult to differentiate from very large seasonal patterns around Lunar New Year. DeepMacro’s data is very granular and broken down by region, so it will have a lot of interesting information in the coming weeks. They expect to begin seeing signs of real impact by the first week of February, and look to see whether the economy will depart from its usual pickup following LNY. Stay tuned.
5. It’s not the disease it’s the treatment
The economic costs of the Wuhan coronavirus virus are not simply a function of its fatality rate, write Gavekal Research in their latest note covering the outbreak. They instead think the measures China’s government takes to contain its spread—which have rapidly escalated to an unprecedented severity will be more significant. For instance, a national holiday has been extended to keep businesses and financial markets closed, major cities have stopped running public transportation, and even tiny rural villages are discouraging family gatherings. Clearly, the most severe impact is going to be on travel, with passenger traffic during the holiday period certain to decline in 2020, and given that the volume of economic activity in China is always low in the first quarter because of the holiday, even small changes could have a big impact on growth rates. Ditto for tourism, following the closure of public facilities and the cancellation of activities. Gavekal say revenues in the tourism sector during the seven-day holiday period in 2019, were equivalent to 2% of first quarter GDP. The impact on consumer spending more generally is harder to judge, they say, but there is no doubt that an extended drought of purchases of consumer durables would be more damaging. In a separate note, published yesterday, Gavekal’s Louis Gave wrote that beyond the inevitable short term hit to consumption, the question is whether the lock down will cause supply chain disruptions. Wuhan is both an important logistics center, and an automobile and auto parts production hub. The auto sector was a major drag on growth in 2019, and has shown signs of stabilisation recently. But, with Wuhan quarantined there is a chance autos will again weigh on growth this year, says Gave. Will the People’s Bank of China shift from its current cautious policy of “selective easing” to a broader monetary stimulus?