Ten questions about the economy in a time of coronavirus, answered.
More than a decade since the global financial crisis, the coronavirus outbreak is threatening to being the world’a economy to its knees.
Amidst the flurry of thought pieces and news articles, I’d thought I’d be helpful to write a primer on the potential economic impacts of the viral outbreak in today’s financial markets.
How is the coronavirus shock different than other natural disasters?
A viral outbreak represents a demand and supply shock to the economic system. Let’s take the US economy, for example. On the demand side, households and consumers may buy fewer things in uncertain times or delay big-ticket purchases.
On the supply side, production is lowered as some firms make fewer things as a result of stay-at-home policies or general uncertainty. Those delays or closures may also have ripple effects throughout the global supply chain.
In an event like an earthquake, the initial shock can be damaging to sentiment and the demand side of the economy, leaving much of the supply-side of the economy intact. With coordinated fiscal and monetary policy support, the fallout can be quite contained, and a strong economy can absorb the shock in the long-term.
In addition, the coronavirus outbreak presents an especially serious challenge since it affects the service sector of the economy, which constitutes the grand majority of economic activity in developed countries like the US, Eurozone, and the UK. In other words, all rate cuts in the world can’t reopen schools closed down by virus-related fears.
Are we in a recession?
A recession is very broadly defined as two consecutive quarters of negative GDP growth. For places like Hong Kong and Japan, real GDP growth already shrank in Q4 2019 and will very much likely contract again in Q1, which would mean a recession. In places like the US, it is too early to call it a recession but growth will most likely be on a much weaker footing.
Recession or not, economic activity around the world is most likely going to be slower this year as a result of the coronavirus outbreak. In fact, the IMF has cut its global growth expectations back in February and may even revise down those expectations.
What is fiscal policy and why should I care?
Policymakers around the world generally have two kinds of toolkits to bolster the economy. The first set is monetary policy whereby central banks can adjust interest rate policy to improve access to credit in stressed circumstances. When interest rates are near 0%, central banks can also buy a large amount of assets, usually government bonds, to further increase liquidity in the financial system and make sure things are working.
Fiscal policy is the toolset federal and local governments have to support the economy. Expansionary fiscal policy can come in the form of tax cuts or emergency spending to help juice up aggregate demand.
In the face of a crisis, economists usually advocate for a combination of both monetary and fiscal policy, to boost aggregate demand and stabilize financial markets.
The Federal Reserve cut interest rates to the lowest point since 2008, isn’t that good thing? Why are stocks going immediately lower?
The Federal Reserve held emergency meetings twice in March and essentially reduced its interest rates to 0%, alongside a host of other policy moves, in an effort to support the economy through the coronavirus. These moves could well indeed improve liquidity conditions in the US and around the world in the coming weeks to months.
However, markets tend to hate uncertainty and may have been rattled by these surprise moves. Economic indicators have not yet covered the time period of the initial coronavirus outbreak in the US, so some investors may be worried that the Federal Reserve is acting based on much weaker than anticipated data. Investors around the world may also question how many more tools the central bank may have going forward if the impact of the virus gets worse since interest rates are already at 0%.
Is the financial situation as bad as the 2008 financial crisis?
In some respects, it’s worse. The current sell-off is the fastest in history. In the US, the S&P 500, fell as much as 26% in the time span of a month and essentially erased the gains it made since the start of 2019. Stock market volatility has soared to the highest point since the 2008 financial crisis. Other stock markets around the world also have seen significant sell-offs.
In comparison, during the financial crisis, the S&P500 lost more than 50% from October 2008 to February 2009.
Should I buy into the stock market?
It depends on your financial situation.
Wall Street analysts have mixed recommendations: Goldman Sachs expects another >30% decline in US equities. Morgan Stanely, on the other hand, recommends that now is a good time to get into the stock market.
For the individual investor, these are very volatile times. I would take the advice of personal finance advisors:
- Don’t invest what you can’t afford to lose. Given the market’s extraordinary volatility, it’s best to invest discretionary income that you don’t absolutely need in case the economic situation worsens. As John C. Boyle, inventor of the index fund once said: “If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks”
- Be patient. Buying and selling short-term tends to always underperform more active strategies or market timing in the long run. The S&P 500 took six years to recover after the financial crisis and eight years to recover after the “dot-com era.” But it did recover.
- Do your homework. The current equity sell-off affects the share price of companies and levels of different stock market indices differently and may not be as “on-sale” as you may think.
Are there other things besides the coronavirus to watch out for?
The market sell-off was exacerbated by a plunge in oil prices resulting from a price and production war between Russia and OPEC. That could put stress on energy companies who are used to selling oil at higher prices.
The coronavirus outbreak also could threaten the “Phase One” trade deal struck between the US and China. The Trade War, whereby both countries increased tariffs on one another, was a huge headwind on markets throughout 2018 and parts of 2019. That could flare up again since China’s ability to promised agricultural purchase from the coronavirus outbreak may be impaired due to the coronavirus outbreak.
How are things in China?
By all accounts, better.
Back in February, the manufacturing and non-manufacturing PMI, proxies for economic activity, printed record-low levels (even lower than 2008/2009 levels!) in China as the count of coronavirus was increasing by the thousands on a daily basis. The Hubei province, the center of the outbreak, was virtually locked down, and parts of the economy in many areas of the country showed no signs of activity.
A month later, UBS reports that indicators like coal usage and traffic data suggest a tentative recovery in Chinese economic activity. Encouragingly, Foxconn, an important supplier to Apple, reported that production levels have already “beat expectations.”
In Hong Kong, the Financial Times reports that preventative measures mitigated the spread of the disease compared to the outbreaks occurring in Europe and the US.
How has bitcoin been doing?
Some safe-haven instruments have performed well in an uncertain environment. An index of US Treasuries, considered some the safest financial assets in the world, reported a 6% gain year-to-date. Gold prices too, have sharply risen to some of its highest levels ever.
Meanwhile, the prices of bitcoin have collapsed from then $10,000 level seen in February to less than half of that in mid-March.
Where can I get my news?