FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 10, 2020

IN THIS ISSUE:

1. The Coronavirus is Spreading Rapidly, As You Know

2. How the Coronavirus Could Spark a New Recession

3. American Consumers Will Cause the Next Recession

Overview

The question I am increasingly getting from friends, business associates and clients is: Do you believe the coronavirus will cause a recession in the US this year? Obviously, no one knows for sure, but I do believe the risks of a recession have increased significantly in the last few weeks as the virus continues to spread.

The other related question I am hearing more and more is: Do you think the latest plunge in the stock markets is a signal that a recession is coming soon? Here too, no one knows for sure, but I have no doubt the severe selloff in stocks is directly related to the coronavirus and the increased risk of a recession.

Forecasters around the world have been downgrading their outlooks for economic growth in the last several weeks, but thus far most have stopped short of predicting a recession. While it is impossible to know how bad this virus may get, I think it’s important to understand just how the virus could lead to a recession if, in fact, it does. So today, I’ll walk us through how the virus could spark a recession if it continues to worsen.

I don’t mean to sound alarmist in what follows, because I don’t believe anyone knows what will happen. But if the virus continues to worsen, some predictable things are likely to happen. And above all, we need to keep our eyes focused on American consumers whose spending makes up 70% of Gross Domestic Product. If consumers get truly scared and cut back spending significantly, look out below – hello recession.

The Coronavirus is Spreading Rapidly, As You Know

In my E-Letter last Tuesday, I gave you the latest figures on the total number of confirmed coronavirus cases and deaths worldwide and in the US. Unfortunately, the numbers grow significantly every day and are now considerably higher than what I reported last week.

Let’s begin by comparing the coronavirus to the seasonal influenza (flu) in the US. Normal seasonal flu kills ten to sixty thousand people a year in the US, or about 0.05%–0.1% of those infected.

The coronavirus death rate is estimated to be about 3-4% in most some countries, or 20 to 60 times greater than seasonal flu. As of this morning, over 116,000 people are reportedly infected worldwide and almost 4,100 have died from the coronavirus. The latest estimates are that nearly 65,000 people have recovered from the virus; the balance is yet to be determined.

Most infections and deaths have occurred in China, followed by Italy with over 9,000 cases and 463 deaths. South Korea is third with over 7,500 infections and more than 58 deaths. The US now has 804 confirmed cases and 28 deaths, but because testing has been inadequate, there is the risk that the virus may be spreading more rapidly than is now estimated in America.

Here’s the good news (hopefully): Health experts predict that the impact of coronavirus on the US is not going to be nearly as significant as it was in China. That’s because China’s population density is much greater than that of the US – some 1.5 billion Chinese people live mostly on the coasts, an important factor for virus transmission.

More importantly, the Chinese government copied the Soviet rulebook from the Chernobyl disaster; it lied to and misinformed its people, even punishing doctors who sounded the alarm about the virus. In other words, China tried to keep the epidemic under wraps as long as possible.

Yet today the US and the rest of the world are anything but underreacting to the virus. Governments are restricting travel from virus-impacted countries and quarantining people on the possibility of having been exposed. Many public gatherings have been cancelled and potentially many more will follow.

Increasingly in recent days, companies are curtailing business travel. People are postponing vacations. We are starting to see cancellations of large public events. Unlike China, we had a lead time to allow our government and healthcare system to try to prepare for the response.

While there will undoubtedly be many more deaths than we’ve seen so far, let’s hope and pray that our preparedness limits the numbers. The question is, what happens if it doesn’t? Now, let’s look at how a recession might unfold in the US.

How the Coronavirus Could Spark a New Recession

Let’s start with China, the epicenter of the crisis. China’s impact will be twofold, as a consumer of American-made goods and as the manufacturer to the world. Chinese consumption of foreign goods will definitely decline, impacting some companies more than others. For example, car sales to China declined 92% in February.

How important is this to the US economy? Opinions vary. Some say our exports to China of apprx. $100 billion a year are not a major threat to our $21 trillion US economy and may only shave a few basis-points off of our GDP growth. Maybe so, but the impact will be significant, and much more so to many other countries that trade with China.

A much bigger impact will likely be felt from the interruption of Chinese manufacturing. Quarantined cities, shut-down factories and strict travel restrictions have had a significant impact on Chinese production. China reported one of the worst manufacturing numbers for February in its history – it was even worse than in the depths of the Great Recession.

We import about $350 billion worth of goods from China each year; and that on its own is also not a crippling number. However, in addition to assembling iPhones and making many other products we buy, China produces components that go into a lot of US products. This is where things get very complicated: If you are missing a $100 component that goes into a $30,000 car, suddenly you cannot sell the car.

Furthermore, our global supply chain has been optimized for “just-in-time” efficiency, not for resiliency to shocks. If the coronavirus crisis continues for a prolonged period of time, it will definitely have more serious consequences for the US and global economy in the medium-term and for China in the long-term.

China is very aware of this, and the government is in a very tenuous position. It has to make a choice: It can maintain the lockdown and try to contain the virus, but undermine its status of manufacturer to the world, risking a long-term exodus of manufacturing. The longer the lockdown continues, the more permanent damage it does to China’s economy.

Or it can lift travel restrictions and send people back to work, risking a further spread of the virus, leading to more sick people, more shutdowns and more loss of human life. For better or worse, the latter path seems to be the one the Chinese government is taking now – it is telling its people to go back to work. It remains to be seen if they will on a large scale.

American Consumers Will Cause the Next Recession

As discussed above, most forecasters don’t believe that a sizable loss of US exports to China will be enough to send our economy into a recession. Likewise, most don’t believe that a reduction of our imports from China will be enough to cause a recession, although if supply chain disruptions are serious enough, they will slow our economy significantly.

While these developments require close monitoring, the most critical thing to watch is the level of US consumer spending. Consumer spending in this country amounts to 70% of GDP. If US consumers get really spooked by the coronavirus, it’s a no-brainer that people will significantly cut back on spending and increase their savings. This will have a direct negative effect on the economy.

With the huge crash in the stock market in recent days, it can be argued that consumers are getting “really spooked” by the coronavirus. We all see what is happening: talk of not shaking hands, avoiding large gatherings, avoiding or limiting travel, cancelations of public events, etc., etc. – and closures of schools in some places. Stocks have crashed 20% from the highs.

This is beginning to feel like a panic. Let me be clear: I am not predicting these things will happen. But I’m also not predicting they won’t. We just do not know how bad the coronavirus is going to get. But I think it’s safe to say it will get worse before it gets better. How much worse is the only question.

Again, I don’t want to sound like an alarmist, but it’s clear we do NOT know what will happen next, so we should all be extra vigilant in the days and weeks just ahead. I hope this discussion has been helpful.

Best regards,

Gary D. Halbert

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