The outbreak in December 2019 of the coronavirus disease (COVID-19) is affecting now the global economy.
Concerns about this disease, which was first identified in the Chinese province of Hubei, and the measures taken to stop its spread are affecting travel agencies and tour operators, the transportation and warehousing sector, financial markets, the arts, entertainment and recreation sector, and public finance.
As a matter of fact, while some businesses and administrations are facing stock shortages as a result of the restrictions on exports from China, the world's factory, other businesses are coping with multiple cancellations of reservations and events.
Stock and oil prices are falling.
Governments are revising downward the forecasts of their economies' growth and the estimates of their budget revenue.
Some commentators are already talking about a recession or worse a depression.
How serious is the situation?
In this post, I take a look at the current situation in some major financial markets and compare it to historical data in order to find out if, actually, there are reasons to fear the worst.
Figure 1 plots 12 benchmark indices of the following markets:
(1) the New York Stock Exchange,
(2) the NASDAQ,
(3) the Tokyo Stock Exchange,
(4) the London Stock Exchange,
(5) the Hong Kong Stock Exchange,
(6) the Euronext,
(7) the Toronto Stock Exchange,
(8) the Bombay Stock Exchange,
(9) the Frankfurt Stock Exchange,
(10) the Australian Securities Exchange,
(11) the SIX Swiss exchange, and
(12) the Brazil Stock Exchange.
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| Figure 1: Natural Logarithm of Some Weekly Stock Market Benchmark Indices, Jan 1, 2000 - Mar 7, 2020 |
How serious is the situation?
It appears clearly in Figure 1 that stock prices have been declining over the past weeks, in all these 12 major exchanges. Particularly, on January 24 and on February 21 of this year, these benchmark indices went down simultaneously, when the markets were closing. To take a measure of the situation using a single summary statistic instead of looking at 12 time series individually, I have computed financial turbulence scores following Mark Kritzman and Li Yuanzhen (2010). This statistics is given by the following relation
where the vector lists the current growth rates of the benchmark indices (the capital gains or losses),
the vector their historical averages,
and designates their variance-covariance matrix.
Figure 2 plots the square root of the turbulence score (i.e., ) computed using the benchmark indices of the 12 major exchanges listed above.
The two horizontal lines on this figure are thresholds defining three regions:
(1) in the region below 2.5 (demarcated by the green line), the global financial market is in a quiet state,
(2) in the region above 4.1 (demarcated by the red line), the market is very turbulent,
(3) in-between, there is an unconditional probability of 82% that the market be in a quiet state.
For information, these estimates have been produced fitting a Markov-switching model to the turbulence statistics.
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| Figure 2: Financial Turbulence Score Based on 12 Major World Indices, Jan 7, 2000 - Mar 7, 2020 |
The two highest turbulence scores observed since the outbreak of the coronavirus are 6.2 (on February 21) and 9.7 (on March 6).
As one could see in Figure 1, this indicates that the global financial market is currently in turbulence.
But, contrary to what we were led to think, this only started on February 21.
Furthermore, the situation is not comparable to the episodes of turbulence experienced during the burst of the dot-com bubble in the early 2000s, the financial crisis of 2007-08, or the oil crisis of 2015.
What to expect in the coming weeks?
An accurate answer depends on how the COVID-19 will evolve. While encouraging signs are coming from the province of Hubei in China where the virus was first identified, warning signs are coming from Italy where this mortal virus is spreading. Using the historical data, I can predict that there is a very high probability that the current state of the global financial market remain the same in the next 12 weeks. However, this probability decreases progressively going from 88% for the week ending on March 13 to 32% for the week ending on May 29.| Date | Score |
|---|---|
| Feb 14, 2020 | 1.36 |
| Feb 21, 2020 | 6.23 |
| Feb 28, 2020 | 3.68 |
| Mar 6, 2020 | 9.74 |
