A major economic and earnings dampener

  • Analyst Reports
  • Saturday, 15 Feb 2020

WE are used to say the axiom: “When the Wall Street sneezes, the rest of the world catch a cold”. This time around, Wall Street is still at near record high and it has not “sneezed” but half way around the globe, we have a new bug, and the world is catching a cold. Yes, it’s the coronavirus or what is now known as Covid-19.

By now most readers would have been tired of reading yet another article on Covid-19. However, with the death toll now nearing the 1,500 mark and some indicators seem to suggest that this is not just another flu virus, perhaps a more detailed impact on the economy and markets is warranted. It is worrying that there is an increase in both number of cases and deaths as the Chinese authorities has now included numbers that are related to what is defined as “clinically diagnosed”. The numbers added 13,332 new infection cases to the total cases tally for Feb 12 and 135 new deaths that were previously unaccounted for. The new numbers indeed caused investors to be concerned on two counts.

First, whether the reported figures can be deemed to be accurate and second whether there will be more surprises, which could potentially disrupt markets and economy even more.

The epicentre of the Covid-19 is in Wuhan, China – a city of 11 million inhabitants and capital of the Hubei province. It is China’s 11th largest city by population.

Economically, Wuhan is where China’s main steel industry is located and a major manufacturing centre for not only consumer products but also textiles, trucks and machinery.

Geographically, Wuhan plays a significant role as a transport hub for central China as it is well connected by road, railway and the mighty Yangtze River. Wuhan has established itself as an international city with more than 300 multinationals that have made their presence felt in the central Chinese city.

It is also reported that Wuhan has a gross domestic product (GDP) of about 1.48 trillion yuan in 2018, making it one of the most economically important city in China.

Covid-19 is a new variant to the flu virus that we have seen in the past and it all started on Dec 31.

China first alerted the World Health Organisation (WHO) of several cases of pneumonia in Wuhan and the numbers that were affected rose rapidly, even before health authorities could identify the virus’ variant. It was only on Jan 7 that the novel virus was named and identified as belonging to the coronavirus family, which includes SARS and the common cold.

Coronaviruses are common and spread by being in proximity to an infected person and inhaling droplets generated when they cough or sneeze, or by touching a surface where the droplets land and then touching one’s face or nose. Sadly, the virus could not have come at the worse of time – during the Chinese Lunar New Year holiday season. Reports suggest that nearly half or about five million of Wuhan’s population had travelled, not only within China but to at least 24 other countries, prior to the city’s lockdown.

Now let’s look at the economic and market impact.

On the economic front, there have been numerous reports that suggest the economic fallout to be significantly impacted not only for China but for the rest of the world. With the lockdown of Wuhan and other cities in China, the economic fallout in the affected cities will be severe, depending on the duration of the virus being a threat to society. In a recent report published by ICBC International Research (ICBC), Covid-19 is expected to peak in late February and end by late May this year.

Obviously, by this measure, the overall GDP implication to China for 2020 will be significant, especially in the first quarter of 2020. ICBC, in its report, suggests that first quarter GDP will be lower by 1.7 percentage points (pps) to 4.3% (from 6%) while the second quarter will be less impactful, at just 0.3 pps to 5.6% from 5.9%, which is without the impact of the Covid-19.

There has been numerous market prediction as to how much Chinese GDP would be impacted with some suggesting even a zero GDP (source: Evercore ISI chairman Ed Hyman) for the world’s second largest economy.

Others that have lowered their first quarter forecast included ANZ by 0.9 pps and Macquarie by 1.5 pps. The Chinese GDP will slow down, in particular during the first quarter period, but the impact beyond that period will depend on the nature of extent of the Covid-19 on China and the rest of the world.

How will we know if we are moving on the right track?

While a host of countries have imposed travel bans or even a self-imposed 14-day quarantine, one of the most important charts to gauge is the daily occurrence of cases and deaths.

While most are fixated by the cumulative figure, what is more important is the daily change in number of cases and deaths.

Chart 1 shows the current COVID-19 status and while we have seen the daily cases dipping about a week ago, the number of deaths continue to surge in a “controlled” manner as we can track the number of daily deaths, which is rising. Inclusive of what is now defined as “clinically diagnosed” cases and deaths, the numbers spiked considerably on Feb 12 but fell the next day as seen in chart 1.

Although the numbers were still high for Feb 13 with 4,921 new cases, 3,095 were defined under the “clinically diagnosed” category, while the 124 deaths on the same day included eight cases that fall under the clinically diagnosed category. In chart 2, if we are to exclude this “clinically diagnosed” cases, the situation looks well under control as the number of daily cases is on a downtrend since peaking on Jan 30 but the number of daily deaths remained on a rising trend as it hit 118 on Feb 12 before decreasing marginally to 116 the next day.

With economic activities at a stand-still in most of Hubei province, the economic fallout is not only felt in China but globally.

Any slowdown or contraction will have severe implication to global growth. Malaysia is feeling it too. From the cancellation of not only Chinese holiday makers but other tourists, the cascading impact from Covid-19 cannot be discounted as it will have significant impact on tourism-related activities, retail spending, net exports, oil prices (Chinese demand is already down by about three million barrels per day), commodity prices, mainly due to slackened demand from China.

The slower fourth quarter 2019 GDP for Malaysia of 3.6%, which was announced just three days ago, has not even taken into consideration the impact of Covid-19 and from the impact on the retail sector, our first quarter 2020 GDP data could be another dampener.

The market is now pricing in expectations of another rate cut of 25bps, which could potentially kick-in as early as the next Monetary Policy Committee meeting scheduled for Match 2-3.

Depending on the severity of Covid-19, one cannot rule out the potential of another rate cut, which could take the Overnight Policy Rate (OPR) to 2.25% by early May, which will be the lowest OPR level in 10 years.

If this is to materialise, the first sector to be hit will be the banking sector as net interest margin will compress for the next one to two quarters before recouping some of the loss via re-pricing of deposits.

Will lower rates help the economy?

In theory, obviously yes. However, lower borrowing cost doesn’t mean the consumer or businesses are going start spending or buying big ticket items.

It boils down to confidence of both the consumers and businesses, and surely with the Covid-19, that is nearly absent.

With potentially much slower economic data in the first quarter, Malaysia is likely to see a GDP growth of between 3% and 4% in 2020 as some pent-up demand may return in the second half of the year if the outbreak is contained.

The lower GDP will play-out in listed companies earnings potential as the 5%-6% earnings growth expectations that have been pencilled in by consensus estimate is unlikely to materialise. This will lead to another round of downgrades among brokers, which could take the FBM KLCI to below 1,500 – a trigger point that basically suggests we will be in a bear market.

Although contained in China and the Hubei province, the implication of the virus on the global economy and Malaysia cannot be discounted as most countries will be taking a hit from the reduce aggregate demand and this would impact earning growth for the year.

Judging by previous episodes of disappointing earnings season due to an epidemic, companies will likely be quick to blame Covid-19 as a reason for missing estimates, whether rightly or wrongly. Government’s stimulus measures can be more impactful

While the government is expected to table an economic stimulus package to address the economic fallout from Covid-19, it is hoped that the size of this package will be meaningful with at least RM15bil in total value.

With the GDP expected to slow to 3%-4%, a RM15bil package will help to sustain economic momentum at least by one pps (without taking into consideration the multiplier-effect) based on the current size of the Malaysian economy which stands at RM1.51 trillion as at end of 2019.

The RM15bil, will cause the budget deficit for Malaysia to be higher but given the global phenomena and its impact, the increase in that budget deficit is understandable. After all, with 10-year MGS trading at 2.9%, it’s an opportune time to tap the market for a sovereign offer.

The RM15bil package should help the industries most affected by Covid-19, which among others include the hospitality and tourism sector, the retail and transport segment affected by the drastic drop in tourism arrivals. The external sector, especially those that are dependent on the Chinese export market while SMEs, which are main drivers of the economy, should be given safety nets to ensure their business is able to withstand the impact of Covid-19, especially in terms of maintaining the level of employment.

While we can hope that Covid-19 will be just a temporary disruption to global and local economic momentum this year, the reality may soon set in that Covid-19 is more than just a flu bug.

While businesses and individuals take necessary measures to protect or contain themselves from being infected, it is the government’s duty to ensure the economic momentum is not lost as this can have serious repercussion to the economy. It is time to take out the bazooka with both monetary and fiscal policies to re-ignite growth in the economy. After all, just like any flu bug, without the right medicine or antibiotics, a growing economy could either stall or worse, turn into a recessioN.

The views expressed are the writer's own

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