Commentary: Novel coronavirus reveals old vulnerabilities in the global economy

NEWPORT BEACH, California: Last weeks fretting over the coronavirus was a good illustration of a tug of war that has been playing out in financial markets for a while: Between favourable sentiment and mounting longer-term economic uncertainties.

Until now, at least, that contest has been resolved in favour of ever-higher stock prices.



But investors need to decide if they want to opt for more of the same, by continuing to implement an investment playbook that has served them well, or if they want to treat the viral outbreak for what it is — a big economic shock that could derail global growth and shake markets out of their “buy-the-dip” conditioning.

Entering 2020, investors faced the challenge of balancing favourable short-term market technicals with weaker fundamentals, and doing so with government bonds providing little protection given the very low — and, in some cases, negative — level of yields in advanced countries.


The coronavirus outbreak amplifies two vulnerabilities: Structurally weak global growth and less effective central banks.



It is becoming harder for markets to treat such fragilities as being beyond the immediate horizon, especially with a host of other uncertainties not far behind, including the recurrence of trade tensions, growing realisation of the impact of climate change, technological shocks, political polarisation and changing demographics.

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Retail, trade and travel are simple ways to illustrate what is going on in China.

Stores are facing dramatic disruptions involving a virtual halt in traffic, while suppliers are finding it harder and slower to move their merchandise, both within and in and out of the country.

And there is a huge drop in travel to China, dealing another blow to economic activities undermined by less internal mobility.

This virtual stoppage of economic activities is cascading throughout the second-largest economy in the world, and one with considerable regional and global ties. It is fundamentally weakening the countrys services sector, at a time of considerable challenges for manufacturing.


With both engines of growth now sputtering, internal and external, China will also find it harder to navigate its transition from a middle-income economy.

The countrys increasing “sudden stop” economic dynamics also involve adverse spill-over effects, first and foremost for emerging Asian economies with strong economic and financial linkages with China.

Apple has closed its stores in mainland China due to the new virus, which is fundamentally weakening the countrys services sector, at a time of considerable challenges for manufacturing. AFP/NICOLAS ASFOURI

A weakening China is also a problem for Europe, where the European Central Bank is effectively out of productive ammunition and politicians are yet to implement a comprehensive pro-growth policy package.

And with the virus affecting the movement of people and goods, there is an increased risk of a multi-year process of de-globalisation that neither the global economy nor markets are wired for.

The coronavirus also has the potential to constitute a structural break for markets: A big enough shock that fundamentally shifts sentiment.

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Previously, markets had been underpinned by the belief that central banks were always willing and able to repress volatility and boost asset prices. That fuelled investors fear of missing out on a seemingly never-ending rally.

Until last Friday (Jan 31) when US stocks dropped about 2 per cent, markets inclination was to respond to sell-offs by deploying a game plan that worked well in 2019 and early 2020, including in response to shocks such as the US missile attack that killed a top Iranian general and the disruption to half of Saudi Arabias oil production.

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