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February 7, 2020

Markets Jitter after Coronavirus Outbreak

The coronavirus outbreak that started in China has sent jitters across global financial markets amid fears of a hit to the global economy. We think it is too early to assess the eventual impact on the economy yet see potential downside risks posed by the outbreak – with its unknown magnitude and duration. This underpins our view that U.S. Treasuries provide a source of portfolio resilience.

The outbreak has sparked a classic risk-off response, albeit one of relatively modest magnitude to date. Emerging market equities, airlines and oil prices have declined since Jan. 20, when the Chinese government confirmed the virus can spread from person to person. Perceived safe-haven assets such as U.S. Treasuries, as well as their inflation-protected peers, have gained. See the chart above. The VIX index, a gauge of U.S. stock market volatility, shot up to the highest level since October. Yet the risk-off sentiment has so far been relatively limited, with modest pullbacks in high yield credit and U.S. stocks, even after Friday’s sell-off. The impact from worries about the outbreak may have been partially offset by positive results in the current quarterly earnings season that so far are in line with our expectation for global growth to edge higher this year.

What can we learn from past global disease outbreaks? Economic growth and markets have historically responded with a V-shaped pattern. The temporary hit to economic activity results in pent-up demand, which eventually helps fuel the rebound in economic activity. This recovery is typically led by retail and manufacturing sectors, since lost revenues are harder to recoup in the services sector (think of tourism).

It is too soon to gauge the impact of the current outbreak, given the many unknowns related to the coronavirus. These include the duration and severity of the outbreak in China – and whether it remains largely contained geographically. The reduced flow of people and goods due to travel restrictions and quarantine measures are likely to hit demand in the short term, pressuring economic activity in the most affected areas. The extent of the policy response by Chinese authorities to any growth slowdown is another key uncertainty. We are likely to see a meaningful policy response from Chinese authorities to shore up growth, as we have after prior epidemics, though an ongoing desire to rein in financial excesses leaves open the question of how sizable China’s stimulus will be. Another potential difference from past episodes is China’s increased role in the global economy: the country makes up 15% of global GDP today in purchasing parity terms. This is three times its size in 2003, when the world was hit by the SARS virus.

We also see potential supply side disruptions. China is now a key component of global supply chains. Any sustained outbreak could disrupt the supply chains of certain industries, with potential for bottlenecks. Investors should be on the lookout for potential shifts in the economic regime, such as a world in which growth slows as inflation creeps higher.

Bottom line

We still see global growth edging higher this year, given easier financial conditions, a lull in global trade tensions, and generally positive economic data. An encouraging start to the latest quarterly earnings season also underpins our moderate pro-risk stance. Yet the coronavirus outbreak creates downside risks to the growth outlook and underscores our preference for U.S. Treasuries as a source of portfolio ballast against any growth scares.

Mike Pyle, CFA, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy function. He is a regular contributor to The BlackRock Blog.

Investing involves risks, including possible loss of principal. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. ©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. BIIM0220U-1075290.
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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