Economists who get one big market call right and others wrong are remembered for their right call. So it is with Nouriel Roubini, the New York University professor and economist who commands a loyal following among investors, especially those who think tomorrow will not always be a better day. He called the house-price collapse in the run-up to the 2008 financial crisis, achieving superstar status.
“Dr. Doom,” the sobriquet he earned among the media, was back at it this week. In a Financial Times column published Wednesday, he said investors were “deluding themselves” if they thought the damage triggered by the coronavirus outbreak will be short-lived and relatively painless, concluding that “the worst is yet to come.”
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The scene on Bay Street amid this week’s market turmoil
So far, he has been dead right. By Friday, the stock markets were on course for their worst week since the height of the financial crisis a dozen years ago. Indexes were firmly in “correction” territory – a drop of 10 per cent or more from recent peaks. On Friday alone, the pan-European Stoxx 600 index fell more than 4 per cent, putting it 14 per cent below the all-time high it achieved only last week.
The rout slaughtered oil prices, too, along with tech, airline, bank and manufacturers’ shares; virtually nothing emerged unscathed from the near-panic selling. Tesla has lost more than a quarter of its value in a week. Ditto airline companies such as IAG, owner of British Airways. Deutsche Bank lost 15 per cent. Fiat Chrysler Automobiles was down 8 per cent.
The market is being driven by fear that the coronavirus outbreak is just getting started, even if it appears to be contained in China; there are now more new cases outside China than inside it. While the World Health Organization still won’t call the virus’s near-global embrace a pandemic – COVID-19 cases had been confirmed in almost 50 countries by Friday – investors are sure treating it that way.
The virus’s rapid spread and potential to shut down factories and entire cities has exposed the vulnerabilities of our modern economic system.
Tourists wearing protective masks walk along an arcade at St. Mark's Square in Venice on Feb. 28, 2020.Francisco Seco/The Associated Press
The first vulnerability is corporate debt – lots of it. Since the financial crisis, companies have splurged on debt as borrowing costs plunged (interest rates went negative in some countries). Recent tallies suggest U.S. corporations are sitting on almost US$10-trillion of debt, equivalent to 47 per cent of GDP. “Cash” has become a dirty word among finance and treasury bosses. Loading up on debt to finance share buybacks and dividend payments is all the rage.
With little or no cash cushion, and heavy debt leverage, companies are especially vulnerable to shocks such as a sudden recession, which is certainly a possibility as the virus jolts businesses (on Friday, the Swiss government banned large gatherings in an attempt to prevent a major outbreak there, forcing the cancellation of the Geneva International Motor Show, which normally attracts 600,000 visitors). A recession could plunge huge amounts of BBB-rated corporate bonds, the lowest investment grade, into junk territory, pushing down their prices and triggering a funding crisis.
The second vulnerability is the just-in-time delivery system that supplies factories everywhere. Today, manufacturers are like concert maestros, orchestrating the arrival of parts from suppliers around the world. Those parts must arrive the moment they are needed to, say, slot into a transmission or a smartphone and keep the assembly process humming. Just-in-time deliveries are marvels of efficiency that erase the cost of carrying large inventories.
But if one supplier shuts down because employees are in quarantine, disruption hits the assembly process. A missing $10 part can halt the production of a $10,000 product. Earlier this month, Samsung shut its Gumi mobile-phone factory in South Korea because just one of its employees tested positive for the coronavirus.
You get the idea. One supplier’s shortage creates a shortage at the company it’s supplying. The shares of both companies fall, then those of the banks that are exposed to the supply chain. Everyone loses. If COVID-19 emerges as a full-blown pandemic, there is going to be a whole lot of corporate pain.
The latest purchasing managers’ index (PMI) data noted “a marked lengthening of supplier delivery time” because of COVID-19. The data are a few days old. Now that the disease has expanded at alarming speed, the next report could be a shocker.
Central banks to the rescue? There is little doubt that rate cuts are coming as a recession becomes a clear and present danger. But banks are almost out of ammunition, and a rate cut will do nothing to open a factory or a city that has been quarantined. Central banks can address demand shocks, not supply shocks.
The coronavirus is no longer a domestic Chinese problem. The big outbreaks in South Korea, Iran and Italy made the disease a global crisis, markets are in near meltdown, and central banks are powerless to fix the mess. The numbers of coronavirus cases and fatalities rise every day. By the end of the week, Mr. Roubini’s warning of recession no longer stood out. Everyone was talking about the hell to come.