The coronavirus presents a sudden exogenous shock to the global growth cycle at a time when the world economy was on the cusp of a synchronized cyclical upswing. This negative shock led to a noticeable decline in our market sentiment indicator, with a drastic drawdown in future growth expectations, particularly in China and the rest of emerging Asia (Figures 1 and 2). In our last update, our leading economic indicators suggested that this region was likely to lead the potential global recovery. However, the regional concentration of the coronavirus directly challenges this thesis, at least for now. In light of this new information, our framework places the global economy in a contraction regime for the near term (i.e., growth below-trend and expected to decelerate). The duration of this regime will likely depend on two things: 1) the duration of the virus outbreak and 2) its impact on the economy.
1. Duration of the virus outbreak: likely over by the spring
The virus alone is unlikely to derail the global growth outlook for 2020, as it is reasonable to assume the outbreak will follow the typical path of any seasonal flu, which hits most of the northern hemisphere this time of year and largely runs its course within 2-3 months (i.e., by the spring). In fact, this is also what we experienced with SARS in 2003, when markets took a hit in the winter months before running its course by mid-April. Therefore, by itself, the outbreak can be considered a temporary economic event.
2. Impact on the economy: temporary and longer-lasting shocks
China and the rest of Asia are likely to see the most pronounced decline in growth for Q1 2020, as economic activity is disrupted from quarantines, factories shutdowns and canceled transportation services. Revenues from consumer spending, travel and tourism services are likely to suffer the most given most celebrations were canceled for the Lunar New Year holidays. However, this should only be a one-off, temporary drag on growth. That said, the industrial sector is likely to experience both a near-term and elongated shock to growth. The loss of Chinese output in Q1 may lead to a sharp drawdown in inventories, followed by a similarly sharp rebound in production in Q2 and Q3, depending on the degree of disruption to global supply chains and global demand outside the region. Given the large share of global GDP coming from China today (~18% compared to 5% in 2003), the impact on global growth is likely to be larger than the SARS epidemic. On the bright side, the meaningful decline in industrial commodity and energy prices (10% year-to-date) may provide some support to industrial and consumer demand going forward.
In summary, over the next few months, we expect our leading economic indicators to deteriorate—especially in China and emerging markets and play “catch-up” with the information already baked into the market. The impact on our developed markets leading indicators will likely be more modest, but negative nonetheless. More importantly, we will continue to monitor trends in global risk appetite to gauge whether economic data will surprise positively or negatively versus financial markets expectations.
Exhibit 1: Coronavirus shock to market sentiment challenges the nascent growth recovery, increasing near-term downside risks in a below-trend growth environment.
Exhibit 2: Leading Indicators likely to dip back into contraction, especially for China and emerging markets.
Following these developments, we have rotated a portion of our equity exposure in the Invesco Oppenheimer Global Allocation Fund from emerging to developed markets, resulting in a net underweight EM position relative to the benchmark1 (Figure 3). The recent deterioration in the macro environment has also led to a meaningful outperformance in defensive equity factors such as quality and low volatility, which we expect to continue in an environment of increasing risk aversion and downward revisions to growth. Finally, barring renewed easing rhetoric by global central banks, the decline in bond yields over the past month and recurrence of flattening yield curves seem to appropriately reflect the increased risk aversion in the markets.
Exhibit 3: Global Allocation Strategy positioning
Allocations as of February 1, 2020
1. 60% MSCI ACWI & 40% The Bloomberg Barclays Global Aggregate Bond Index (USD Hedged)
All data sources from Bloomberg L.P. as of 1/31/2020, unless otherwise stated.
Duration measures interest rate sensitivity. The longer the duration, the greater the expected volatility as rates change.
The MSCI ACWI Index is an unmanaged index considered representative of large- and mid-cap stocks across developed and emerging markets. The index is computed using the net return, which withholds applicable taxes for non-resident investors.
The Bloomberg Barclays Global Aggregate Bond Index is an unmanaged index considered representative of global investment-grade, fixed-income markets.
The opinions expressed are those of Alessio de Longis as of January 14, 2020, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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