SARS vs COVID-19: Why It's Different This Time and The Effects On The World Economy

I see many comparisons of the coronavirus outbreak to SARS everywhere. From the media to analysts, everyone loves to compare this COVID-19 outbreak to SARS and assume that the economy recovered quickly last time, so it will do the same this time. A lot has been discussed about the supply chain disruptions, so I do not think it is necessary to dive into this article. The differences between the diseases themselves as well as a potential pandemic breaking out has been discussed at length too, so I do not find it necessary to go into that either.

What I will do is show how the Chinese economy is much weaker and much different now than when SARS hit in 2003 and focus primarily on the demand side and the banking industry. Even if factories reopen tomorrow at 100% efficiency (they have been struggling to reopen amidst labor shortages), coronavirus is completely eradicated, and everyone starts consuming at the same levels that they would have otherwise, the Chinese economy (and the world economy with it) is still in significant trouble.

China today is much different than China during the SARS outbreak in 2003, here are some graphs that show just how different. Notice how China was a much smaller share of the world economy back then (just above 4% according to this graph) compared to 16% now. Services and consumption make up a much larger part of the Chinese economy now, going from a little over 40% back then to around 52% now. According to this source, that service industry was hit with a $144b loss in a week from coronavirus. SARS was estimated to do $33 billion in damage to the world economy, coronavirus did an estimated 330% more damage (not adjusted for inflation) just to the Chinese service industry (and I think that is an underestimate) in one week. China also accounts for over 12% of global exports now as opposed to a little over 6% back in 2003. China also accounts for one-third of global GDP growth.

Additionally, chinese tourism has boomed since 2003. Tourism to Hong Kong has dropped off sharply thanks to the protests as well as coronavirus, going from 200,000 visitors per day in February 2019 to less than 3,000 now. Most flights to and from America (and other countries) are cancelled through the end of March or April. SARS hit a manufacturing based economy growing at a 12% rate and that was only 4% of the world economy. This is a service based economy growing at 6% (if you believe the real numbers) that is 16% of the world economy. You cannot make up the tourism or services revenue like you can with manufacturing. 750 million people according to the NYT are currently under some form of lockdown. Even if these quarantines lift soon (that’s a major question), the massive tourism industry both to and from China has taken a huge hit for the near future that cannot be recovered.

In December 2019, a Moody’s analyst called Chinese corporate debt the biggest threat to the global economy. 4.9% of China’s private issuers defaulted on loans in 2019. This number is up from 0.6% in 2014. Banks have been encouraged to give loans to tiny, risky businesses while also trying to get bad debt off their books. Due to problems with their banking system, China nationalized its first bank in 20 years last year. Then they proceeded to take over two more. This over-leveraged banking system had been showing its cracks before coronavirus made China grind to a halt for a month. Questions have been raised as to whether or not the industry can be leaned on for an economic recovery as hard as the Chinese government is leaning on it now.

This was an economy in trouble before the coronavirus hit. The shadow banking system appears to have gotten out of control. Shadow banking accounted for 39% and 45% of total lending in Q1 and Q2 2019. According to Bloomberg, wealth managers have been offering “high yield products” to investors and have been using their own capital to make these returns whole due to that high default rate mentioned in the last paragraph. The Bloomberg article states that, “because the products are opaque and regulation is minimal, nobody knows exactly how much money is at risk.” This article is from October 2019, before coronavirus became a concern.

This is not an economy poised to bounce back like it did with SARS in 2003, despite what the market thinks. It might take a while for the market to realize it, but all it takes is a look at the data to see why that assertion is false. The market is focused on the fact that the virus will not kill us all and not on the fact that the lost revenue from Chinese consumption cannot be made up, despite the CCP propaganda that is being put out from Chinese government officials and Chinese economists. An article from Barron’s has this to say:

One area, in particular, is back at the forefront—local debt. Policy makers have directed regional lenders to tolerate a higher threshold for bad loans, hoping to keep thousands of small- and medium-size enterprises (SMEs) from collapsing amid the economic standstill. A survey conducted recently by Peking and Tsinghua universities—China’s top two schools—found that two-thirds of such firms said they could stay afloat no more than one to two months with their current savings. An additional 18% said they could last at most three months.

Put another way, 85% of China’s SMEs would crumble within three months without financial injections of some sort.

Here is a report from McKinsey from July 2019 that has a lot of good data in it regarding China’s exposure to the world economy. Below are some direct quotes and charts from the report and let you decide what they mean:

In 11 of the 16 quarters since 2015, consumption contributed more than 60 percent of [China’s] total GDP growth.

In the United States, among the firms listed in the MSCI USA index, revenue exposure to China amounted to 15 percent of the IT sector, 7 percent of materials, and 6 percent of industrials. In 2017, US companies were estimated to have generated around $450 billion to $500 billion revenue in China through a mix of exports and revenue from Chinese subsidiaries.

Here is a chart from the report showing how exposed the world is to China. Luckily for us, as shown in the above report, US exposure to China is not as massive as you might think. The exposure comes mostly from the rest of Asia, Australia, and Africa instead of developed markets. However, the amount of exposure from developed countries is not negligible. The technology sector, which has driven the majority of our stock market growth, has a disproportionate exposure to revenue coming from China, especially semiconductors like Intel, Micron, Nvidia, and AMD. That chart uses data from 2017 so I would almost guarantee it is less now, but still concerning.

While 4 of the 5 mega caps that make up almost 20% of the S&P 500’s value and have generated 1/5 of S&P 500 returns since 2009 do not have much, if any, China exposure on a surface level. However, Apple derived 16.7% of their revenue from China, Taiwan, and Hong Kong in 2019. Not to mention that Foxconn factories are still mostly closed down over there and not producing anything. Additionally, 20% of Amazon’s COGS for private label brands is attributable to China. Due to how prevalent indexing is, I believe that a technology selloff lead by semiconductors and Apple (just like the old trade war selloffs) would drag down all mega cap tech stocks and present a good entry point for an eventual recovery.

All of this comes on top of Boeing’s struggles with the 737 Max, which are expected to cut US GDP growth by 20% in 2020. In 2017 and 2018, China accounted for 22% of Boeing plane deliveries. In 2019, that number dropped to 12%. These struggles with China’s economy and the self-inflicted 737 Max struggles will put even more downward pressure on US GDP growth for this year. The phase one trade deal was expected to help Boeing out, but there are now questions as to whether or not China will hold up to their end of it.

In addition to these Chinese economic struggles, other Asian countries are showing economic woes as well. Singapore just cut their 2020 GDP forecast from 0.5%-2.5% to -0.5%-1.5%. Japan released their Q4 2019 GDP numbers, showing its largest GDP decline since 2014, an annualized rate of -6.3%, coming in way lower than analyst expectations of -2.6%. This was before the coronavirus started sweeping Asia, the Q1 GDP numbers could be worse. While China is responsible for 12.6% of our trade, Japan accounts for 5.4%. A Japanese recession will hurt the US too.

To summarize and give some of my personal assessments to go along with this data, the Chinese economy is in a lot more trouble than most people realize. The shadow banking system is massive, and their banks are incredibly over leveraged. There are questions as to whether or not banks can perform the economic stimulus that China is demanding from them to keep small and medium sized firms open. The data shows China is in very dangerous economic territory that could lead to a recession or at least a major drop in growth for at least Q1 and Q2 2020 that cannot be made up in the second half of the year. It appears to me that these China economic troubles will take a lot of Asia and other developing economies down with them. It remains to be seen if it will take the American economy down too, but I believe that semiconductors and Apple should be trading lower than their current valuations to reflect potential lost growth and revenue streams. I also see Boeing’s struggles continuing to weigh on our GDP growth. I believe the market is fundamentally mispricing risk in the technology sector right now and it will overcorrect downwards in the near future.

tl;dr: China’s economy is potentially going down led by an over-leveraged banking system and it may cause US tech stocks, which derive supply and demand from China, to lead a market correction. Comparing this coronavirus situation to SARS is extremely disingenuous due to the state of the Chinese economy in 2003 compared to the state of the Chinese economy now. The downward pressures from China on world GDP growth as well as Boeing’s pressures on US GDP growth create a significant risk in all world equity markets that is not being priced in. While this does not mean that the US is definitely heading towards a recession or even a global recession, but that the risk should not be ignored by world markets, no matter how much liquidity central banks pump in.

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