The Broad View
Though much remains unknown about COVID-19 and its potential impact on the global economy, here are answers to some widely asked questions.
The global economy may weaken notably in the first half of this year, particularly China and Europe. China represents almost 20% of global GDP, and business activity there has slowed because many people remained at home over the past month rather than return to factories or offices. As a result, our China economist predicts that the nation’s economy will contract in the first quarter before experiencing a mild recovery in the second half of the year.
As for Europe, our economist there believes the widening epidemic could push the eurozone into a recession. The Continent has significant exposure to China. Falling demand from China, coupled with a breakdown in supply chains, would hit the European economy — with Germany and the U.K. exposed to weaker demand for goods, and France vulnerable to softening tourism. Not surprisingly, luxury goods, electronics and autos would be among the most negatively impacted industries.
The U.S. is in a better position to withstand the economic jolt, in part because it was in relatively strong shape before the coronavirus outbreak. In addition to a robust labor market and solid consumer spending, the industrial sector had appeared to be bottoming out, the trade clash with China had receded, and housing was benefiting from low interest rates.
However, the U.S. is not immune to economic fallout, and the risk of recession has been heightened considerably. When the virus was first detected, it caused a supply shock as multinational companies had trouble securing products and parts. It was initially hoped that the disruption would be temporary, with companies filling orders through in-house stock until supply chains were reactivated. Unfortunately, supply problems have been more disruptive than expected.
More concerning, the spread of the virus to developed markets is now eating into demand, with signs that businesses and consumers are reining in spending. No data is available yet, but there are increasing reports of companies canceling corporate events and business travel, and consumers delaying vacations and questioning whether to enter large public spaces.
It helps on the margins, but the effect may be limited. Unfortunately, lower rates by themselves may not prompt consumers worried about possible infection to engage in everyday activities such as boarding airplanes or driving to the mall. Quite frankly, there is a growing risk that caution by businesses and consumers could trigger a more pronounced economic impact.
There are several options. To start, additional action by the Federal Reserve is expected, and the government can boost fiscal spending. This week, Congress passed an $8.3 billion spending bill to combat the virus, and further outlays are possible. The government also could resume so-called quantitative easing. Beyond that, authorities could turn to unconventional or less commonly used strategies. For example, the U.S. and China could temporarily lower or eliminate tariffs. Global central banks could implement some form of loan relief for businesses. And the government could make funding available to small and medium-size companies.
Capital Group Private Client Services’ philosophy is to manage portfolios with the goal of protecting and prudently growing capital. To that end, our portfolio managers take a long-term view, paying attention to downside risk and prioritizing companies with steady cash flow, strong balance sheets and the wherewithal to get through inevitable market shocks and recessions. As the equity market rose in 2019, portfolio managers sought to reduce exposure to cyclical stocks, as well as to certain stocks that had surged in price and become extended in valuation, where appropriate. Our fixed income managers have positioned portfolios to favor high-quality bonds that have the potential to hold value in an economic rough patch.
Since the coronavirus crisis began, our entire global investment team has actively monitored the potential economic and market impact. Market declines can create opportunities for investors with a long-term orientation, and our analysts have worked to identify companies with strong prospects that have become attractive on a valuation basis.
Avoid the urge to react abruptly. Market turbulence is understandably unnerving, but sudden investment moves in volatile environments can hurt long-term returns. As mentioned above, our long-term orientation helps our portfolio managers prepare for bouts of periodic volatility. While our consensus view is that the odds of a recession have increased, it is also possible that the news will be better than expected, in which case the market could recover quickly. Regardless of short-term fluctuations, it’s important to remain focused on long-term investment goals.
Originally posted March 6, 2020.