25 Feb 2020 08:46

How is the coronavirus impacting growth and stock markets?

The stock markets are jittery as the coronavirus is spreading. But what is it that is making investors act? How great is the economic impact, what will be the long-term impact on the stock market, and how should I act as a personal investor? SEB’s head of Economic Forecasting Håkan Frisén and Investment Strategist Johan Hagbarth answer nine questions on the coronavirus’s impact.

1. How serious is the situation?

Of course, it is still very uncertain how the contagion will unfold in the coming months. There appears to be both positive and negative signs right now. In China there are signs of stabilisation, but at the same time it is worrying that the virus now seems to be spreading rapidly in places in Italy, South Korea and Iran. Governments around the world are cooperating with strong measures to get the spread under control.

2. Will the economic impact be so large that it has macroeconomic consequences?

Yes, it's most likely unavoidable. In contrast to most other types of risks and crises that have popped up in recent years, the coronaviris is having direct economic consequences in various ways. This applies above all for China, where significant elements of economic activity have been shut down and where very large groups of people are being kept from going to work. It is therefore clear that GDP growth will be tangibly impaired during the first quarter. Thereafter, much of the course of recovery will be shaped like a V, U or L. A V-shape entails a fast recovery, i.e., the same as in previous virus outbreaks. In a U-shaped scenario, uncertainty would remain for a longer period, but the recovery would be supported by a normalisation of the situation, and more expansive finance policies would bear effect. The least likely scenario – an "L" – would entail a very prolonged loss of production.

3. How great will the impacts be, then?

It is still too early to say. The International Monetary Fund (IMF) has just issued its preliminary forecast in which China's GDP growth has been adjusted downward by 0.4 percentage points for the full year 2020, and is expected to be 5.6%. At the same time the IMF estimates that global growth will be dampened by 0.1%. This is likely too optimistic, since the IMF forecasts that GDP will reach a normal level already during the second quarter. Most likely we will see a slightly greater impact than this with a U-shaped scenario. We can expect to see estimates shortly from international organisations in which global growth is curbed by roughly a quarter of a percentage points. Disruptions in global production chains and a drop in travel are factors that will bear direct impact on supply and demand, resulting in ripple effects across the entire global economy.

4. What can governments and central banks do to soften the impacts?

To begin with, it can be said that the authorities in many countries have reacted quickly to minimise the risk of the virus spreading in the actual contagion process. Added to this, political-economic measures have already been instituted, such as an interest-rate cut in China and financial policy measures in several countries. An important area will be ensuring that the sectors and companies that are most exposed to the crisis receive help with credit support. The market is now also increasingly factoring in interest-rate cuts by the US Federal Reserve Bank. Such cuts would increase the risk appetite in the entire global economy, but the situation would have to worsen considerably before the Fed would act in a situation where the US economy in other respects has been showing signs of strength across a broad front. Nor should one underestimate other countering forces that may mitigate the impact over some time. On the demand side, households will gain economic scope for increased consumption in other areas by cutting back on travel, for example. At the same time, many production plants can ramp up growth during the rest of the year to work off overfull orderbooks. Financial markets will soon also begin focusing on growth figures for 2021, and if we do not wind up in a prolonged L-shaped scenario, it is reasonable to believe that production levels in 2021 will only marginally be affected by the coronavirus. This means that the downward adjustments being made for the full year 2020 will mainly be offset by corresponding upward adjustments for 2021.

5. How is the Swedish economy being impacted by the coronavirus?

First, the impacts depend on whether we succeed at avoiding a considerable outbreak of the disease here. And after developments in northern Italy in recent days, the risk scenario for Western Europe looks a little darker. Five per cent of our exports go to China, so the direct trade impact will probably not be that great. It is mostly disruptions in production chains that affect companies that are dependent on Chinese input goods that will be the greatest risk factor in the near term. In a U-shaped scenario it is likely that Swedish GDP growth will be dampened by a few tenths in 2020, which would then likely be recovered in 2021. Thus far the Swedish krona has withstood the recent uncertainties quite well. This is likely due to its already weak level and to the fact that Riksbanken, despite all, is quite far from making a cut into negative territory. Thus it is more likely that finance policy will make up the first line of defence if the situation were to worsen significantly.

6. How are the stock markets and corporate earnings being impacted?

As noted above, the virus will impact global growth in the current year, even if it is unclear how much and how fast the recovery will be. This entails greater uncertainty about corporate profits, which is never good news for the sentiment in the stock market. Most analysts expect that many companies will need to adjust their first quarter earnings forecasts downward, and certain companies have already flagged that this will be the case. China is today the largest market in the world for a large number of commodities and products. At the same time, the country is often referred to as the world's factory – products that are sold globally are produced in China, and many companies are dependent on Chinese subcontractors for their production in other locations. When large parts of the Chinese economy come to a standstill, as in recent weeks, this has a hard impact on production and consumption, i.e., supply and demand. Apple is among the companies that have already warned that production as well as sales are being negatively impacted during the first quarter.

7. Why haven't the stock markets started falling until now?

Until recent days, the stock markets have generally been rising, despite the worries. This is partly because most had expected that the virus's impacts would be relatively short-term and that growth and earnings would return to the previously quite positive trend soon, so that the impact would be limited to the first quarter. Both macro statistics and company earnings reports for the fourth quarter also painted a rather bright picture of the stock market. However, it is important to remember that these were based on data prior to the virus's outbreak. Finally, investors are expecting authorities and central banks to provide the support needed for growth to mitigate and avoid enduring effects.

8. What will be the long-term impacts on the stock market?

Naturally, this depends on how long it takes before the economic recovery gets started. Given our main scenario that the recovery will be V- or U-shaped (we revert to the previous growth trend), we expect that the stock markets will eventually regain lost ground. Don't forget that the ultra-low interest rates are resulting in a clear shortage of alternatives to equities. It may seem cynical, but in such a scenario, downturns caused by worries can represent buy opportunities. However, at present – before we know how the virus's spread to other countries than Italy will unfold and owing to the risk for new declines in the near term – we are cautious on investing in stocks.

9. How should I act as a personal investor?

It is always a good idea to review your investments and make sure you have good risk diversification and an optimum level of risk investments like equities. The low interest rates and relatively favourable growth prospects that prevailed prior to the coronavirus outbreak suggest that a long-term investor continue to hold a normal share of equity investments.