It’s hard to think of a worst time in recent memory for the world’s oil superpowers to have a spat.
With markets struggling to hold off capitulation amid the COVID-19 outbreak, the failure of OPEC and Russia to agree a deal regarding supply cuts proved too much, the oil price promptly tumbling 30 per cent and stock markets suffering their biggest one-day falls since the global financial crisis.
So, at a time dominated by known unknowns, including the impact of a local recession as forecast by Westpac chief economist Bill Evans and Standard & Poor's, what other curveballs could emerge? Despite Italy’s escalating COVID-19 troubles, some strategists say keep watching the two biggest economies: China and the US.
“This weekend’s launch of an oil price war amongst Russia, Saudi Arabia and US shale is one of the three worst possible shocks for markets engulfed by the COVID-19 crisis,” said John Normand, the head of cross-asset fundamental strategy at JPMorgan. “(The other two would be a hypothetical lockdown of parts of the US economy and a second wave of infections in China.)”
Thankfully, China, the epicentre of the outbreak, has seen new COVID-19 cases slow materially. But in the US, cases remain on the rise, hitting more than 970 confirmed cases and 28 deaths, according to the Johns Hopkins University’s real-time tracker. In Italy, now entirely in lockdown, cases moved beyond 10,000, while in Australia they’ve topped 100 with three deaths.
What began as an unusual health problem far away has quickly become a global economic one, particularly for Australia given the massive lift in trade with China since the SARS outbreak in 2003. The Westpac-Melbourne Institute Index of Consumer Sentiment released today fell 3.8 per cent in March to the second lowest level since the GFC. It follows yesterday’s NAB business survey for February which showed a dive in conditions and confidence, the latter sliding to minus four, the weakest reading since mid-2013.
For context, business confidence plunged to minus 30 at the height of the GFC while consumer sentiment of 91.9 compares to a GFC bottom of 79. So, clearly things can be worse.
Still, Evans on Monday said that unlike the GFC, the coronavirus, or COVID-19, would cause the first technical recession – two consecutive quarters of negative GDP growth – in almost 30 years. He pencilled in a 0.3 per cent contraction in the first two quarters of the year, mainly due to the hit to export industries and supply chains, plus the fact that the economy will have to confront the crisis in a “relatively fragile state” amid “insipid” consumer spending.
But positively, Evans sees a rebound in the second half of the year as the virus and policies to contain it ease and financial markets calm down, resulting in annual GDP growth of 1.6 per cent.
“That growth profile constitutes a technical recession but given the expected recovery in the second half of the year it is much more realistic to characterise the situation as a ‘major disruption’ to growth rather than the style of recession that Australia has experienced in the past,” he explained.
“Indeed, recall that in Australia’s last two recessions the unemployment rate lifted from 6 per cent to around 11 per cent. We expect the unemployment rate to hold below 6 per cent through this period.”
However, Evans’s numbers are based on a “no fiscal stimulus package” basis and will be reassessed once the government’s measures land this week.
What the package brings, the effect will be unclear for a time. Evans says policies that support “incomes, spending and jobs” are needed, arguing trying to lift business investment through temporary subsidies was “unlikely to have any short-term impact as businesses will be concerned about the state of demand”. He also backs bringing forward the legislated personal tax cuts set to begin in 2022 in the May Budget.
With COVID-19 being an unusual shock to supply and demand, supporting the latter looks needed despite the obvious concern that sick, quarantined or worried people won’t be out and about spending as much.
Already, NAB’s monthly business survey showed a slump in profitability and decline in forward orders. It added that while around 50 per cent of respondents were yet see an impact on their business from COVID-19, the other half were already feeling minor or “moderate to major” impacts.
Time will tell how minor or major the situation becomes as everyone – governments, central banks, businesses and consumers – try to navigate something entirely new.
But uncertainty is kryptonite to markets.
And looking back at the GFC, the biggest share market fall in Australia wasn’t in September 2008 when US investment bank Lehman Brothers collapsed. It was a few weeks later on October 10 when the S&P/ASX 200 slumped a record 8.3 per cent, according to Morgan Stanley. It also collapsed almost 6 per cent a month or so later on November 13, 2008. On Monday, the index dived 7.3 per cent – the second biggest on record and taking it down almost 20 per cent in a few weeks.
But history – and trading in the past few days – suggests this week’s oil-driven rout might not be the last wild swing.
In fact, Goldman Sachs says it’s looking like global equities are facing an “event-driven bear market”, which average declines of 29 per cent and reach a trough after around six months before recovering within a year. “The rebound is likely to be strong when it comes, albeit from lower levels,” Goldman’s strategists say.
Right or wrong, more volatility might be the safest bet.
The views expressed are those of the author and do not necessarily reflect those of the Westpac Group.
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