Virus reality dawning on financial markets

A medical worker wearing protective gear takes a rest as he waits for ambulances carrying patients infected with the COVID-19 coronavirus at an entrance of a hospital in Daegu in South Korea. Picture: AFP

The big fall in the Australian sharemarket is another clear signal that world markets now fear they have miscalculated and that the coronavirus is a major danger rather than merely a short term blip.

We are now looking at the possibility of a major and extended disruption in world trade which will slash growth numbers and reduce the values underpinning world share markets.

Remember that global and Australian shares are priced on the basis that nothing serious will go wrong in China and world economies.

Over the weekend the biggest warning sign came from none other than China’s President Xi Jinping, who grimly declared the situation in Hubei province was still serious, and that coronavirus epidemic had not reached its peak, despite a drop in the daily number of infections.

Xi said the epidemic was a major public health emergency with “the fastest spread, the widest range of infections, and the most difficult prevention and control in China” since the founding of the People’s Republic of China

Xi said that to minimise the impact China would maintain a “prudent” monetary policy, and would introduce new policy measures in “a timely way”.

My comment is that if the situation gets worse we may be looking at Chinese economic stimulation that will rank with the global financial crisis.

Bonds as barometer

The US sharemarket has always been behind the US bond market in forecasting the impact of the virus and so while Wall Street shares dipped over the weekend, there was an almost panicked rush for safety, and the 30-year US treasury yield fell below 1.9 per cent: a record low. The 10 year bond fell below 1.5 per cent, while another advance warning indicator, the Australian dollar, again dipped below US67c, reversing its recovery of earlier in the week.

Bad news rising

Last week I looked at what might happen if the market was right that the virus was a blip and what might happen if it was wrong. Later in this commentary I will look at what it means if President Xi is right and there is much worse to come.

But first I will detail some of the seemingly endless stream of bad news that hit the wires over the weekend because that conveys the extent of the danger but also the remarkable efforts being taken to contain the virus.

(dot) In China there is much community outrage and the government is cracking down on the frustrated citizens who are disrupting epidemic control measures. Some individuals are airing their grievances and disappointment by spitting at members of the public, in lifts, on supermarket merchandise and even at medical staff.

Others have refused to wear any protective gear in public places, and have abused and beaten workers carrying out control measures.

• There cases in China where recovered patients continued to show traces of the virus through nucleic acid tests. There were similar results in Canada, where nose and throat swabs taken from a couple who had recovered from coronavirus revealed they still had traces of the virus. This is a dangerous situation.

• A third person infected with the coronavirus has died in Italy as the government struggles to contain an outbreak in the north.

• The last two days of the Venice Carnival, which draws tourists from around the world, have been cancelled

• Asian airlines set to lose$US28billion as demand for flights shrivels amid the outbreak. Some 13,000 flights gave been cancelled in key regions. .

• Turkey will close its border with Iran as a precautionary measure after Iran reported 43 cases of the disease.

• South Korea’s reported 169 over the weekend, bringing the its total infected to 602. In Japan the situation is also serious.

Leaving aside the obvious declines looming for global and China growth figures, how does this affect world business? The first area is the service industries like airlines, cruise ships and international tourism. Already in a large number of countries, including the US, we are seeing a major fall in service activity. And it’s not confined to retail, with tertiary education also hit hard. Once confidence is pricked people become more cautious. One of the few markets in the world which showed no signs of fear was last weekend’s Australian residential property market.

The second area immediately affected is mineral prices, led by iron ore and oil and gas. That hits Australia, particularly Queensland’s gas exporters.

If the virus is contained and the impact confined to the service and commodity sectors, the recovery can be quick. But once the global supply chain is hit for an extended period, the consequences become very serious. We are not at that stage yet.

Higher prices threat

We have moved to a globalised world where China, as the world’s second largest economy, is a key component. Then add South Korea and perhaps Japan and we have a supply chain in serious trouble.

In China and the rest of the world, shortages will multiply in food and many goods led by computers and phones.

That means higher prices, and in time, higher inflation rates. And once higher prices get into the system they multiply.

Australia will be among the worst sufferers because our dollar will fall along with the prices of minerals, thus increasing inflationary pressures.

It will take a while, but interest rates will follow if the crisis extends for, say, six months. And that will take the steam out of the property market and given our high level of consumer borrowing it will hit the economy. But we will not be alone.

The good news is that the world is taking extraordinary efforts to contain the virus. We have to hope it is enough.