EXTRAORDINARY COMPLACENCY: THE CORONAVIRUS AND EMERGING MARKETS / THE FINANCIAL TIMES OP EDITORIAL

Extraordinary complacency: the coronavirus and emerging markets

Outlook for EM equities ‘bleak’ amid risk of global recession

Geoff Dennis


Medical staff in protective suits in Wuhan, the epicentre of the novel coronavirus outbreak. The virus could trigger a global recession © REUTERS


Global financial markets are finally catching up to the threat of the spreading coronavirus and are now starting to reflect the real risk that the virus may tip the global economy into recession, typically defined as global GDP growth of less than 2.5 per cent.

The conventional wisdom is that the hit to global growth and risk markets from this virus will be severe but brief, and they will both come surging back after a few months. The “models” for this are the Sars epidemic in 2003 and, to a lesser extent, H1N1 swine flu, in 2009.

In my view, today’s situation is very different and much more threatening — from a macroeconomic (not clinical) standpoint — than those earlier episodes.

There is the obvious, and well-quoted, point that China is much more important to the global economy than in 2003. Today, China accounts for 17 per cent of global GDP (versus 4 per cent in 2003), 11 per cent of global trade (vs 5 per cent) and, most importantly for emerging market investors, 34 per cent of the MSCI EM equity index (vs 8 per cent).

However, I do not think the above data remotely reflect the full threat to the global economy and financial markets from the coronavirus. First, both of those two earlier epidemics, oddly, hit when the global economy was emerging from recession and equities from major bear markets with both ready to surge into recovery mode.

Today, the US economic recovery is very “long in the tooth”, having lasted for more than 10½ years — already the longest (if not the strongest) since 1945.

US GDP growth, even before the virus hit and despite President Donald Trump’s tax cuts and a huge budget deficit, was only about 2 per cent and slowing. Meanwhile, many other advanced economies are in recession or close to it, such as Japan, Germany, Italy (where the virus is most widespread in Europe) and post-Brexit UK.

In EM, growth is very weak in South Korea, Thailand, Brazil, Russia, South Africa and Turkey to name a few countries, while Mexico, Argentina and Saudi Arabia are already effectively in recession. Once-stellar growth in India is slowing sharply too.

In China itself, investment banks are falling over themselves to publish the lowest growth forecast for Q1; 2 per cent year on year seems about right to me at this stage, which represents a sharp contraction on a quarter-over-quarter basis.

Given the above, the risk of global recession from the effects, direct and indirect, of the virus is clear. Secondly, and related to this, global equity markets, more the US than emerging markets, have been in a bull market for 11 years.

Despite recent losses, the S&P Composite is still up more than 350 per cent from its early 2009 low and the MSCI EM index by a more modest 132 per cent from its late-2008 low. This has left valuations very stretched, at least, in the US with widespread earnings downgrades/warnings inevitable from the effects of the virus, building on those already seen from Apple, Mastercard, Microsoft and United Airlines.

Thirdly, however, with valuations, at worst, “fair value”, the threat to EM is different. The MSCI EM index is dominated now by China (with a weighting of 34 per cent, as noted above), but also has Korea as a large market with a weight of just under 12 per cent.

The direct effects of the virus on GDP and earnings-per-share growth in these two big EMs will be severe, without even considering how the virus — and its effects — may spread to other EMs.

Overall, if the world economy is about to slide into recession, which seems a better than 50 per cent chance at this point, the outlook for EM equities is bleak. The recession “playbook” looks awfully like the actual behaviour of financial markets in recent “down” days: stocks down (with EM stocks down more), oil down, bonds up, gold up and the dollar fairly flat.

In EM, the classic investment strategy for such market conditions is to raise cash; favour “closed economy” markets such as India and Brazil; overweight defensive, mainly domestic and high-dividend, sectors, including consumer, healthcare, telecoms/communications services, utilities and infrastructure; and to avoid cyclicals, such as energy and materials, as well as tourism and airline stocks.

There are two other points. Unlike in other downturns, the macro policy weapons available to fight the debilitating economic effects of the coronavirus are thin on the ground especially in developed markets. The bond market is telling us that the US Federal Reserve will cut rates soon, maybe in March, but will that be much help in this situation?

The European Central Bank has limited tools while fiscal policy is also largely tapped out across DMs, with the obvious exception of Germany.

Finally, I am shocked at the complacency of certain governments to the threat from the coronavirus. Let us face it, even if the virus does not turn into a global pandemic, it may trigger the next global recession. As the markets have started to tell us, this is serious and not a time for any complacency.


Geoff Dennis is an independent emerging market commentator.