Will China’s coronavirus outbreak send the world economy into recession?
As cases spread across Asia and in Europe, only some of the multiple indicators investors use to monitor recession signals are flashing red, implying the frail global economy may not necessarily be heading towards a contraction.
It is too early to be sure, however. The outbreak is still continuing to spread and key data points for February are still unavailable.
What’s more, forecasting global recessions is tricky because most countries can’t match U.S. data for its breadth. It’s also rare for the world economy to actually shrink - prior to 2008-2009, that happened only in 1990-1991.
But taking into account population growth and poor countries’ need for faster expansion rates, the broad rule of thumb is that world growth below 2% can be classed as recession.
The International Monetary Fund still expects 3.3% global growth in 2020. But it cut China forecasts to 5.6% and voiced fears the coronavirus impact could be longer-lasting than previously expected.
Chinese President Xi Jinping has vowed the country’s 6% growth target will be met.
But Justin Onuekwusi, a portfolio manager at Legal & General Investment Management (LGIM), said there was a 90% probability Chinese growth would fall below 5% if the virus continued to disrupt economic activity.
“That would be the tipping point. The question then will be if world growth will fall under 2%,” he added.
Here’s a look at 10 factors frequently seen as recession indicators.
U.S. LEADS THE WORLD
If the world’s biggest economy tips into recession, it’s likely others will follow. But a closely watched Leading Economic Index in the United States, compiled by the Conference Board think-tank, hit a record high in January.
The index suggests “the current economic expansion – at about 2% – will continue through early 2020,” the Conference Board said.
But the index also leans heavily on indicators tied to manufacturing, which now accounts for less than a fifth of U.S. economic activity. The surge also reflected the run-up in stock prices last month.
An inverted yield curve, when short-dated borrowing costs rise above longer yields, has been a reliable gauge of U.S. downturns, having predicted almost every recession in the past half-century.
Now, the coronavirus has sent three-month borrowing costs above 10-year rates while the two-year/10-year curve is less than 20 basis points from inversion.
“The Treasury market is pricing that the world economy is going to be flirting with sub-2% growth,” LGIM’s Onuekwusi said.
CHINA MOMENTUM INDICATOR
Chinese Premier Li Keqiang reportedly favours three indicators to monitor growth - freight volumes, power consumption and bank loans - unified in Fathom Consulting’s China Momentum Index.
The index tumbled in 2008 before the global crisis and fell below 2 in 2015-16 amid Chinese “hard landing” fears.
The index stood at 5.1 in December, off three-years lows touched in mid-2019 during the Sino-U.S. trade spat. But recovery has probably fizzled this year as the virus dampened activity.
If growth hinges on booming trade, the Baltic Dry Index (BDI) shipping benchmark is sounding alarm bells. It hit three-year lows this month and has dipped during every previous recession. Since September the BDI has plunged 80% to around 506 points. It troughed during the 2016 growth scare at around 300 points.
WHAT DO PURCHASING MANAGERS THINK?
Purchasing Managers’ Indexes have been reliable in predicting manufacturing and services trends so February’s drop in the U.S. services PMI to the lowest since October 2013 was a shock.
Signalling that a sector accounting for two-thirds of the world’s biggest economy was in contraction, the “flash” PMI “brought home how close we might be to recession because of the coronavirus,” London and Capital Group told clients.
Global composite global PMIs from JPMorgan showed output and new orders still expanding last month. But February’s composite is likely to be very different.
INFLATION AND BONDS
Bond yields and inflation usually rise when growth is strong and vice-versa. So the recent tumble in market-based inflation gauges - five-year forward swaps - in the euro zone and the United States is cause for concern.
And 7-10 year yields on the Bloomberg/Barclays Multiverse, a global debt benchmark, are at six-month lows and approaching the lows hit during the 2016 growth scare.
ASK DR COPPER
Copper’s record as a boom-bust indicator has earned it the “Dr. Copper” moniker. And because gold is considered a store of value during recession, the gold/copper ratio can point where growth is heading. So if the economy’s tanking, dump copper and buy gold.
The current ratio - approaching 2009 peaks - is worrying. But in the modern economy copper’s predictive power has weakened. Also during market panic, “sentiment tends to boost gold and weigh on copper. That can open the spread and lead to a false signal,” said Julius Baer analyst Carsten Menke.
DEMAND FOR DEFENSIVES
There are shares that do well when the economy is robust and others which perform in tough times. The former category comprises ‘cyclicals’ - carmakers and retailers for instance - while ‘defensives’ include utilities and consumer staples.
But these days the cyclicals vs defensives ratio is skewed by tech - nominally classed as cyclicals, companies such as Apple and Amazon have behaved increasingly like safe defensives.
Financial conditions indices (FCI), comprising elements such as long-term borrowing costs, exchange rates and equity moves, show how supportive the backdrop is for growth. Tighter conditions are generally a negative.
A Goldman Sachs index shows conditions have eased since early January, possibly as China loosens policy. But the index does not yet reflect this week’s massive equity selloff.
South Korean trade figures are the first to emerge each month from any major economy and therefore receive close scrutiny. The picture isn’t pretty - exports contracted in January for the 14th straight month.
February data is now awaited, especially on semiconductors - used in electronics and comprising a fifth of South Korean exports, overseas sales have fallen for five months straight.