Fri, 07 Aug 2020

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.

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