Coronavirus may delay the global economic recovery, but not derail it.
Trade tensions have been replaced with investors’ concerns about the potential economic implications from the coronavirus outbreak that originated in China. Global consumption is likely to be affected somewhat by travel restrictions to and from China. Given the expected downturn in Chinese economic activity from a government enforced lockdown on parts of the country, mainland import demand is also likely to be a drag on global growth. Macro data downside for the first few months of the year can be expected and especially so in Asia. Market uncertainty will not be helped by coronavirus cases being detected outside China in places like Korea, Japan, Iran and Italy. However, we expect the global economic recovery that began last autumn to continue for three reasons.
First, the underlying drivers of output growth remain intact. Personal consumption, which accounts for the bulk of GDP for advanced economies is supported by job creation. The unemployment rates in the US, UK, Eurozone and Japan are close to historic lows*, providing the confidence for consumers to spend take-home pay.
Second, although the global manufacturing survey data was depressed in February*, due to the sharp slowdown in China from the coronavirus outbreak, there is room for factory activity to improve from here, supported by past interest rate cuts and a step-up in China credit stimulus from last year.
Third, benign inflation enables central bankers to run incrementally easier monetary policy from here. In an unusual inter-meeting move, the Fed cut interest rates by 0.5% in response to “evolving risks” related to the coronavirus. Other major central banks should sound dovish in their guidance on interest rates too. Since central banks have warned that they are coming up against limits of what monetary policy can do, fiscal policy is also likely to provide another lever to stimulate global growth.
On balance, most commentators expect that detected cases of coronavirus, which seems to be an extreme form of viral flu, should peak when the weather warms up. So while there is plenty of uncertainty over the recovery trajectory following the coronavirus outbreak, whether it could be contained and its impact on supply chains, with additional central bank stimulus we continue to believe that the global economy and company earnings are sufficiently resilient to mitigate against these headwinds. Current consensus forecasts show forward Earnings Per Share (EPS) growth, as represented in the MSCI All Country World Index, to rise by 9.3% over the next 12 months*, down only slightly from the start of the year. Provided company earnings hold up, this should put a floor on how far the overall equity market can decline.
Notwithstanding the (as yet) unknown impact of the coronavirus crisis on the economy, we see the UK as a standout opportunity, and particularly for domestically focused stocks. Our optimism is predicated on stronger UK economic growth that gives uplift to company earnings at home. We see three channels driving the economy from here.
The first channel is through increased business and consumer confidence following an election that delivered a large majority for the Tory party, removing the political risk of a left-wing Labour government for the next 5 years. Consumers now feel sufficiently confident to release pent-up demand through greater expenditure. Increased confidence is manifesting itself in the residential market. According to the Royal Institution of Chartered Surveyors, estate agents reported another strong consecutive monthly reading in January over the outlook for house prices. Given the fairly tight relationship between house prices and retail sales, this is a constructive omen for private consumption.
The second channel is through deregulation, as part of the UK’s economic policy in a post-EU world. In the past, PM Johnson has talked about a divergence in UK rules from the EU, a point that was made clear in his Greenwich speech in early February. Essentially, the government wants the flexibility to adjust regulation in order exploit new technologies to raise productivity and growth.
The third channel is through an end to austerity via public spending. In the September spending review for the next fiscal year, then Chancellor Javid announced the biggest day-to-day government current expenditure increase for 15 years. The rise in public spending was broad-based with no government department seeing a cut, the first time that has happened since 2002.
Rishi Sunak’s replacement of Sajid Javid as the new Chancellor paves the way for a fiscally loose budget that is more aligned with the political demands of Number 10. Essentially, the Boris Johnson administration is embracing a close relationship between Downing Street and the Treasury, akin to how the David Cameron and George Osborne regime operated.
Looking forward, research house Capital Economics believes that the government can raise spending (focused largely on public investment) by another 0.5% of GDP from here at the upcoming Budget without exceeding existing fiscal rules. Capital Economics expects total fiscal spending amounting to a sizeable 1% of GDP boost to the economy in the fiscal year 2020/21, which should provide a favourable demand-driven environment.
In short, we expect UK personal consumption growth to accelerate from here and see an opportunity in domestically focused stocks.
*Source: Refinitiv Datastream, Bloomberg
(data correct as of 3rd March 2020)
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.
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