Photo of woman wearing mask over her mouth to protect from infection.
Feb. 7, 2020 Commentary

Pandemic Fears

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Global equity markets appear to be swooning over the fundamental and emotional risks triggered by the coronavirus. Fears about the impact of the virus are now running through the capital markets that, if not controlled, may actually have a possible economic impact.  

The economic impact of this type of disease tends to center on travel, trade and confidence. This impact is evident in market reactions of company’s stocks directly involved in various aspects of the travel business. Additionally, companies with sales that rely heavily on China’s consumer demand are being hurt. The chart from Thompson Reuters is a price chart of China Yum Brands’ stock. As can be seen, the downward movement of this company (Kentucky Fried Chicken outlets in China) declined by about 20% in value from highs reached in early January. 

Economic Impact – Negative Impact Skewed to Emerging Economies

From a macroeconomic perspective the Center for Disease Control and Prevention (CDC) has modeled that the economic impact of an influenza-based pandemic may lower U.S. gross domestic product (GDP) by $71.3 - $166 billion.1 Assumptions on this modeling process are broad so may not be accurate, given the unknown intensity of the outbreak.  

 
Seeing that the U.S. GDP output is approximately $20 trillion, a reduction of $119 billion likely wouldn’t throw the United States into recession, but it would reduce U.S. economic growth by about .60%. Globally, the impact would likely be around $570 billion, again, impacting other parts of the world – the emerging economies for example – seemingly much more than the United States. We project the impact on global GDP would be a decline of about .70%, with the negative impact being muted in Europe, the United States and Japan, as compared to the emerging economies, including China.

China a Problem – in Many Ways

I have written extensively on China’s economy over the last year. I have primarily focused on how they bend the rules and cheat in their trade practices, based on international standards set by the World Trade Organization (WTO). But that is another issue. Today I want to bring some light to the harm China has brought on the rest of the world’s physical health. 

When we think about the history of global pandemics, of virus strains costing lives and economic growth, we think of the following outbreaks: SARS, Avian flu, the Hong Kong flu and the Spanish Flu which have all started in China. The Spanish Flu of 1918-1919, which, despite its name, did originate in China, cost the lives of approximately 5% of the world’s population as almost one-third of the world caught this awful virus.2 Think of this. The world population clock now estimates that there are 7.8 billion people living on the earth. If the Spanish Flu occurred today and spread as it did in the early 1900s, nearly 390 million people would die. That figure outnumbers the total U.S. population.

As noted, all of these strains started in China. Why does this happen? We need to remember that, until fairly recently, China was a true third-world country. The country was very poor and lacked the resources needed to care for its own population. It wasn’t until the launch of market-based economic reforms in 1979 that China’s current economic rise took place. So, in a global sense, China has become an economic power relatively recently. China is a country where wild animal and domestic animal meats are sold in wet markets. These markets are unregulated and a place where diseases and viruses spread due to spoiled meat. These markets are a throwback to a time where refrigeration and cleanliness standards didn’t occur. Add to that the fact that China has more people than any other country, and the persistent cause of these viruses becomes clearer.

Finally, the transmission mechanism of these viruses goes hand in hand with global travel. According to worldbymap.org, China ranks as the world’s second most active country for air travel at approximately 463 million travelers per year, trailing only the United States at around 798 million travelers per year. With 463 million travelers, less-developed food regulations and a population base of more than 1 billion, it is no wonder that many of the world’s pandemics are born in China. 

Until these conditions change, we will probably see more pandemic outbreaks over the foreseeable future. 

I suspect that we won’t be focusing on the coronavirus by the end of the year. The virus will have some degree of impact on overall economic activity, more so in emerging markets than in the developed economic world, but these types of concerns tend to burn out somewhat quickly. We’ve been suggesting that U.S. GDP growth will slow this year, as compared to 2019, to about 1.5% on an annual basis. We stand by that outlook.

Three Risks to Monitor

While I’m not the sole decision maker when it comes to making capital market calls at Mariner Wealth Advisors, I wanted to share my fundamental thoughts as to what I believe investors should focus upon when making capital allocations. I think there are three risks that investors need to monitor, any of which have the capability of surprising the capital system and throwing it into a correction mode.

  • A rise in inflationary pressure. Most analysts believe inflation is globally low and will remain low in the future. Capital market risks may rise if inflation makes a sustained, upward push. 
  • Federal Reserve policy change. Most people believe the Fed will remain in an accommodative policy mode for the foreseeable future. If the Fed reverses course and starts to raise interest rates, the capital markets may not accept this easily.
  • U.S. GDP Growth. Most analysts think U.S. GDP growth will be 2.5% or so this year, and corporate profits will rise about 5%. If growth is meaningfully lower than most currently believe, the markets may swoon.

I bring this forward in the spirit of highlighting possible future economic risks. It seems to me there is a high degree of agreement between economists and market pundits. When unpredictable events such as a health pandemic occur in an environment where outlook variance is low (such as now), then the possible impact from that unpredictable event may be high.

Of the three risks I mentioned above, I believe the possible growth disappointment may have the highest probability of occurring.   

Thoughts on Tax Rates

The Iowa caucus has occurred; election year is now in full swing. Next stop: New Hampshire. From an economic perspective, assuming a Democrat wins the general election, the biggest change that is identifiable are tax rates. By and large, Democratic candidates are wishing to expand governmental spending reach. They are proposing to raise taxes to pay for this increased reach. These revised tax rates have a higher chance of reaching reality if the Democrats also take control of the Senate and retain control of the House.

Below are proposed changes the top marginal tax rate would experience, if the candidates running for office were elected3

At this time, there appears to be limited to no real pushback on these types of increased tax rates within the Democratic party. While these increases may moderate, these types of rates are common in Europe (with their 0 - 1.5% systemic growth rates and 10% unemployment rates).

While no one desires economic stagnation from a global perspective, such stagnation tends to go hand in hand with these types of tax rates. I’ve written on this issue in the past, outlining the fact that countries with high tax rates and large government systems tend to grow more slowly than countries where lower tax rates and smaller governments prevail.

If these types of tax rates are in our future, the need to focus on taxation ramifications of various investment alternatives will do nothing but intensify. 

1TrendMacro: Is Coronavirus a Chinese Bio-Weapon? (Feb. 3, 2020)

2CDC: History of 1918 Flu Pandemic

3The Wall Street Journal: The Tax Increase to Come (Jan. 27, 2020)

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