Three reasons the coronavirus outbreak may hit financial markets harder than Sars did in 2003
- China today accounts for a much greater share of the global economy and is more reliant on domestic consumption, which has been affected by the trade war and Beijing’s deleveraging campaign
- Meanwhile, valuations in both stock and bond markets are already stretched
On January 27, global stocks suffered their worst day in almost four months, data from Bloomberg shows, while a surge in demand for so-called “haven” assets caused the value of bonds trading with negative yields to rise by US$860 billion, the largest daily increase since Bloomberg began tracking the data regularly three years ago. Commodities have also come under strain, with traders selling oil and industrial metals because of concerns about a slump in demand.
Although fears over the spread of the virus triggered the sell-off, the disease has hit a pressure point in markets, one that has been apparent for some time but has been offset to some extent by central banks’ pivot towards looser monetary policy, led by the US Federal Reserve.
The outbreak of the virus has revived concerns about the lack of growth in the world economy, the Achilles' heel of the current rally.
What impact will coronavirus outbreak have on currency markets?
Ever since global equity markets roared back following a brutal sell-off in the final quarter of 2018 – the MSCI All Country World Index, a gauge of stocks in advanced and developing economies, surged 23 per cent last year – there has been a worrying disconnect between share prices and economic fundamentals.
In a sign of the extent to which equity investors got ahead of themselves, last year’s fierce rally coincided with a further deceleration in the rate of global output, with the JPMorgan Global Composite Purchasing Managers’ Index, a gauge of manufacturing and service sector activity, finishing 2019 at a lower level than at the start of the year.
While output has strengthened over the past few months, even the more resilient service sector is expanding at a weaker pace than a year ago, while manufacturing activity is almost in contraction territory.
What is more, persistent pessimism in bond markets suggests stock markets have been too sanguine about the green shoots of recovery. German and Japanese bond yields remain deep in negative territory, while the benchmark 10-year US Treasury yield currently stands close to its all-time low set in July 2016.
Just as importantly, back then, the global economy was in the early stages of a strong recovery following the bursting of the dot-com bubble in 2000. The coronavirus outbreak, by contrast, is occurring at the end of a lengthy expansion. In short, China poses a much bigger systemic threat at a time when the global economy is far more vulnerable.
What to expect from China’s economy in 2020
Second, valuations in equity and bond markets have become dangerously stretched, increasing the scope for a disorderly sell-off if worries about the virus morph into a full-blown growth scare.
In a report published on January 24, JPMorgan noted that not only is China “far more consequential” for the world economy and markets, the threat from the epidemic is “focused on Asia and services, the two sectors which have led the global recovery”.
It is too soon to say whether the coronavirus is the trigger for the much-talked-about correction in markets. What is clear, however, is that without stronger growth, the bullishness in stock markets makes little sense.
Nicholas Spiro is a partner at Lauressa Advisory