Isaah Mhlanga, chief economist at Alexander Forbes.
- Reports of new Covid-19 infections in Beijing and a bubonic plague outbreak in the Mongolia autonomous region may derail recovery and introduce a new risk for markets.
- For policymakers, we still have an incomplete response to Covid-19.
- Being the second-largest economy in the world, developments in China often drive sentiment in markets.
Recent
global economic data has been encouraging, so much that risk appetite has
improved to the benefit of global equity markets and many emerging markets’
borrowing costs.
The
quick rebound in China’s economic activity following the most stringent
lockdown due to Covid-19 helped to revive emerging-market assets. However,
there are reports of new Covid-19 infections in Beijing and a bubonic plague outbreak in the Mongolia autonomous
region, which may derail the recovery and introduce a new risk for markets.
We
know of the Covid-19 impact as we are still reeling in it with roughly 11
million people infected globally and over half a million dead globally. While
we do not know how the Covid-19 will end, historical estimates of the bubonic
plaque are sobering. It was responsible for 50 million deaths across Africa,
Asia and Europe in the 14th Century, in what is now known as the Black Death.
High alert
The
plague did not disappear completely, as it emerged again and killed 20% of
London’s population and more than 12 million people in China and India in 1 665
and the 19th century, respectively. Rightly so, the Chinese authorities
are on high alert and actively encouraging citizens to keep safe.
What
could this mean for the global economy, emerging markets and the investment
landscape? Several avenues of impact come to mind.
First,
a round out of market developments last months to provide context. Global short
and long term bond yields have declined over the past month and continued into
the first week of July, across the term structure.
However,
we notice that two-year bond yields declined more than ten-year yields,
resulting in steep bond yield curves, an indication of the market is still
concerned about long term impact on growth and fiscal issues while buoyed by a
flood of money from central banks over the short term.
Credit
default swaps (CDS) spreads across emerging markets declined, even for
countries like Turkey with volatile monetary policy anchors. Indeed the US
dollar index depreciated by 2.9% in the three months to the end of June and by
0.4% in June as risk appetite improved.
Second,
being the second-largest economy in the world, developments in China often drive
sentiment in markets. So far nothing has caught financial markets in the wake
of the news of a bubonic plague.
Third,
the fact that the Covid-19 resurgence is reported in Beijing is concerning, especially given how stringent China’s lockdown was in Wuhan. Two take-outs
here are that there are limited ways to prevent this deadly virus from
reaching any part of the world and there is more likely to be a second wave or
more after the first wave that shocked the global economy and markets.
Fourth,
given the rapid recovery in markets, since they bottomed out in March, combined
with a still fragile reopening of the economy and its subsequent recovery,
there is a significant risk that if conditions worsen in China, the global
economy and emerging markets, in particular, will be dealt a blow.
Important consequences
The
abovementioned factors have important consequences for how policymakers should
prepare and in turn how investors should think about markets.
For
policymakers, we still have an incomplete response to Covid-19. The instruments
we have sunset dates while Covid-19 is expected to be with us for much longer.
In the South African context, this implies that we need to prepare a response
mechanism for a second wave or a prolonged healthcare crisis in addition to the
current response.
The
question in this regard is aren’t we too ahead of ourselves to think about a
post-Covid-19 economy before we have a response mechanism to deal with a
prolonged stay of the virus? I am tempted to believe that the current response is
not yet adequate to ensure the resilience of livelihoods and the economy. We
need to learn to live and manage an economy in this pandemic.
One
big problem is that society seems to not have grasped the enormity of what we
are facing. I make one suggestion to shift society’s behaviour that will likely
reduce the need for active enforcement of social distancing as a society will
do this on its own.
Publish
statistics on all hospitals’ capacity for Covid-19 patients, including those
facilities that have been established specifically for this. These statistics
are then published through print, TV and radio daily for society to grasp the
burden on the healthcare system. Taking lessons from behavioural economics,
this could work to shift the behaviour of society.
For
investors, a possibility that we have to think about actively is that of “stop
and start” in the economy if the virus continues on its current trajectory. By
the end of this week, the health department might report two hundred positive
cases or more. The death rate will also be going up.
Some
of those that will succumb will be critical employees for businesses that will
have a noticeable impact on business operations if business operations are not
prepared to have contingency plans if critical employees where to be impacted. Ultimately,
this will show up in business disruptions and company earnings down the line.
For
now, the stock market has rallied on expectations of continued stimulus from
central banks and fiscal authorities. But the risk of downward earnings
revisions seems little taken into account. That is the risk that bubbles
beneath the recovery that we see on the Johannesburg Stock Exchange.
Developments
in China are crucial to track and any policymaker and investment
professional that does not have a good understanding on them run the risk of
missing the future trends on markets and the economic evolution, and as a result,
policy response and investment approach will be found wanting.
Isaah
Mhlanga is chief economist of Alexander Forbes. Views expressed are his own.
