As a result of COVID-19, we expect a protracted slowing of global growth that will extend through the second quarter. We expect first quarter growth in the US in the neighborhood of one percent. The hit to US growth will be larger, and longer in duration, if there are signs of the virus spreading more widely within the US. Vulnerabilities in the US economy, including falling profit margins and high corporate leverage, could serve as amplifiers of the economic impact of the virus.

In the weeks since cases of COVID-19 first began to rise sharply, the economic consequences are coming into greater focus. There is still much uncertainty about how events will unfold, especially around the breadth and depth of virus outbreaks outside of China. Still, at this point we expect a slowing in global economic activity that extends through the second quarter. Supply disruptions suggest that the recovery in activity once the virus is contained will be gradual and fitful, rather than the rapid rebound in activity that many had expected.

We believe that the Chinese economy will likely contract in the first quarter. Note that even during the financial crisis, China did not register a single quarter of negative growth. Why might this time be different? Quite simply, the Chinese economy has undergone what can best be described as a sudden stop in activity as a result of work and travel stoppages in many parts of the country. Even regions not directly affected by these measures have still been impacted via supply chain linkages to regions that experienced shutdowns.

Chinese authorities have responded to COVID-19 with a range of economic support measures. Many of these measures have focused on ensuring financing availability or relieving immediate cash flow pressures for the private sector. Still, it remains unclear whether the senior leadership will still seek to achieve its six percent growth objective for this year. There is yet to be a formal and definitive communication on this, but the hit to economic activity looks to be large enough that trying to achieve the growth objective no longer looks practical.

As for the US, the combined impact of the coronavirus and the Boeing production halt suggests first quarter growth of around one percent on an annualized basis. The channels for the impact of the virus’ spread within China and elsewhere are as follows, with many of these channels reinforcing one another:

- Sharp reduction in Chinese tourism and business travel to the US

- Reduced goods exports, due primarily to weaker demand

- Reduced corporate earnings on falling foreign demand can impact hiring and investment decisions

- Uncertainty/confidence channels that impact business investment and hiring, and through this channel the consumer. Falling stock prices play a role in increasing uncertainty/reducing confidence in the business sector

- Falling stock prices have a further impact on household spending by reducing wealth

Thus far, the first two channels have been most immediately impactful on the US economy, and are easier to dimension. The other three channels will have a greater influence on economic activity going forward. Of particular concern is the impact of these channels on the labor market. The consumer has been an extremely consistent and solid contributor to this expansion, powering the economy through the trade war last year as well as the manufacturing recession of 2015-16. Thus we remain attuned to the very real possibility that depressed earnings on foreign activities and increasing uncertainty regarding the spread of the virus domestically, will lead to a pullback in hiring and household spending.

It is worth highlighting that the first three channels above concern the spread of the virus outside the US. Should the number of cases in the US grow, the uncertainty and wealth effect channels will become larger. In addition, if there is continued evidence of the virus spreading directly within the US, an additional channel would become operative, namely, a shock to domestic demand and supply: on the supply side, reduced business activity as employees stay home and supply chains experience further disruptions; on the demand side, reduced spending as activity outside the home falls and hiring slows. In addition, hourly workers could see an immediate reduction in take-home pay and would adjust spending accordingly. With greater evidence of “community spread” of the virus, these aggregate supply and demand effects now look inevitable.

An additional consideration is that the US economy faces this new headwind at a time when it is particularly vulnerable to a shock. The economy had only recently begun to emerge from a manufacturing recession. In addition, aggregate corporate earnings growth has been anemic, and profit margins have been under pressure. Meanwhile, total corporate leverage remains near an all-time high. While low interest rates have reduced the burden of carrying high leverage, it is unclear how highly leveraged corporations will adjust hiring and investment in the face of an increasingly likely revenue shock stemming from the coronavirus. All told, these types of imbalances in the US economy could serve as amplifiers of the economic fallout of COVID-19.

Regarding portfolio implications, these imbalances have long informed our late-cycle view of the US economy. As such, our portfolios have been oriented towards shorter spread duration, over-weighting non-cyclicals over cyclicals, and a preference for higher quality credit. Thus we believe our portfolios have been well-positioned for the current environment. In addition, while credit spreads have widened notably in recent weeks, they still remain well within the average range of the current expansion. As such, given the significant uncertainty over how this risk event will play out in the months and quarters ahead, we still do not believe there is sufficient compensation for risk relative to the macro backdrop to consider materially adjusting positions at this time. We will continue to monitor for any dislocations in the market that could present opportunities, particularly as the macroeconomic consequences of the virus become clearer.