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| 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 PillartoPost.org. Reposted with permission.
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