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Sunday, March 1, 2020


New York Stock Exchange, New York City

GUEST BLOG / By Craig Fehr. Analyst, Edward Jones--The spreading virus raises the temperature on the market.

The U.S. equity market has declined sharply this week as new reports show confirmed cases of the coronavirus have picked up outside China, including outbreaks in South Korea and Italy. Somewhat encouraging, the pace of new reported cases within China has moderated slightly, but the economic impact in the world's second-largest economy is increasingly significant given ongoing factory closures, supply chain disruptions and city lockdowns that are wiping out a large portion of consumer spending

The economic impact is meaningful but temporary.

U.S. economic growth is likely to take a modest hit this quarter as efforts to contain the virus have curbed air travel, international business activity and domestic companies’ foreign production and sales in China. As a result, U.S. GDP growth is likely to drop below 2% this quarter for the first time since late 2018.

That said, we don’t think this will knock the economy off its expansionary path, as U.S. household spending (70% of the economy) is less affected at this point. GDP growth contracted by 1.1% in Q1 2014 due to severe weather (remember the “polar vortex”?), dropped to 0.1% in Q4 2015 as oil prices and production plunged and fell to 1.1% in Q4 2018 amid Federal Reserve rate hikes and the manufacturing slump. None of these marked a recessionary turn with GDP rising in the following quarters, as shown in the table below.

Economic growth in China will see a much more negative impact, however. Virus containment efforts have curbed consumer activity and tourism, while many businesses and manufacturing plants have closed temporarily. Looking at the SARS epidemic in 2003 as the closest comparison, China’s GDP growth was cut in half for a quarter, but then rebounded twofold in the following period as the virus was contained.
It’s too soon to tell if the coronavirus will see a similar timeline, but we think the economic impact will be temporary. We’d note, however, that the global implications are much larger this time. China was 4% of world GDP in 2003 versus 16% today. China is the destination of less than 3% of global exports, but the world’s second-largest economy currently accounts for more than 13% of global oil demand, over 50% of commodity consumption (steel, copper, aluminum, iron ore) and greater than a third of total global smartphone and auto sales.

A prescription for higher volatility.
Stocks don't take well to uncertainty, and given the ongoing uncertainty around the effectiveness and timelines of containment efforts, it's unlikely market anxiety will subside quickly. This is not insignificant for near-term market performance, as we believe global GDP and corporate earnings estimates will need to be revised lower for the first half of 2020.

That said, we don't view this as a turning point in the economic expansion, nor do we see this as a catalyst for more restrictive monetary policy. Some economic output will be lost, but most will be delayed. As such, we'd expect a rebound in Chinese and global growth in future quarters. The foundation of this bull market has been (and will continue to be) an expanding economy, rising corporate profits and accommodative Fed policy – all of which are poised to remain intact for the year ahead.

Last Monday’s drop (2/24/2020) was the largest daily percentage drop in the stock market in two years. A drop of 1,000 points in the Dow is certainly an attention grabber, but a wider view provides a much more useful perspective. Even with the declines this week, the stock market has gained 12% over the past 12 months.

Moreover, stock market volatility has been notably subdued for the past several months, so a return of volatility should be viewed as more the norm than the exception. Over the past three years, the S&P 500 has had 19 days in which it fell more than 2% – none of which kicked off a longer-term downturn.

We doubt the growing risks related to the coronavirus outbreak will blow over immediately, so further volatility should be anticipated. But we also doubt this will permanently impair the broader fundamental backdrop of economic expansion and low interest rates, supporting the case for the bull market to persist as we advance through 2020.

Craig Fehr, CFA is a market analyst with Edward Jones, the broker of record with the ownership Reposted with permission.

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