Jobs and GDP growth

The view is often promoted that low GDP growth over the past decade is caused by low interest rates and balance sheet expansion (QE) by central banks. That is putting the cart before the horse. Central banks have tried to stimulate their economies, with massive QE and low interest rates, because of low GDP growth. Not the other way around.

The real cause of low GDP growth is low job growth, as the chart below illustrates.

Real GDP and Nonfarm Payroll Growth

[click here for full screen image]

Offshoring jobs means offshoring growth.

The last time that the US had employment growth above 5.0% is 1984 which also the last time that we saw real GDP growth at 7.5%. Since then, job growth has progressively weakened — and GDP with it.

In the last decade, employment growth peaked at 2.27% and GDP at 3.98% in Q1 of 2015.

Real GDP and Nonfarm Payroll Growth

We now expect job growth to fall to -20% in April, four times the -5% trough in 2009, and a sharp GDP contraction.

How long the recession/depression will continue is uncertain. But, in the long-term, it is unlikely that the US can achieve +5% real GDP growth unless employment growth recovers close to +3.0%.

No V-shaped Recovery

Initial jobless claims in the US for the 6 weeks to April 25th exceed 30 million.

Initial Jobless Claims

That will take unemployment above 20%, with total jobs falling to levels last seen in 1997, and more job losses still to come.

Total Employment (Nonfarm Payroll)

Employment is the key to economic recovery. While unemployment is high, consumer spending will stay low and the economy will struggle. Companies may receive bailouts and the Fed will keep financial markets awash with liquidity but that does not help falling sales.

Be prepared. April employment numbers are going to be ugly. Expect some turbulence.

Crude oil: Opportunities and value traps

On the weekend we wrote that the bottom had fallen out of the oil market after Nymex crude broke support at $20 per barrel.

Now, the previously unimaginable has occurred, with Nymex Light Crude falling below zero for the first time in history, closing at -$13.10 per barrel with reports of intra-day lows at -$37.63.

WTI Crude

From The Age:

“Traders are still paying $US20.43 for a barrel of US oil to be delivered in June, which analysts consider to be closer to the “true” price of oil. Crude to be delivered next month, meanwhile, is running up against a stark problem: traders are running out of places to keep it, with storage tanks close to full amid a collapse in demand as factories, automobiles and airplanes sit idled around the world.

Tanks at a key energy hub in Oklahoma could hit their limits within three weeks, according to Chris Midgley, head of analytics at S&P Global Platts. Because of that, traders are willing to pay others to take that oil for delivery in May off their hands, so long as they also take the burden of figuring out where to keep it.”

Cushing Storage

Brent Crude is trading at $25.57 per barrel but a Trend Index peak deep below zero warns of similar strong selling pressure.

Brent Crude

Outlook

Crude oil production is still in a long-term up-trend. Low prices may present opportunities to buy cyclical stocks at historically low prices.

IEA Oil Production

The Oil & Gas sector has plunged as expected.

DJ US Oil & Gas

Oil infrastructure is also suffering from low activity levels.

DJ US Pipelines

Energy-consuming industries, however, may benefit from lower oil prices.

EIA: Industrial Sectors

Transport

Transport is the biggest consumer of crude oil products.

IEA Oil Sectors

If we break usage down by fuel types, the largest is diesel/gas, followed closely by motor gasoline, with jet kerosene significantly smaller.

Products from Crude

Airlines which have suffered from a massive drop in air travel.

DJ US Airlines

While delivery services (formerly air freight) are suffering from the collapse of global trade.

DJ US Delivery Services

So is marine transport.

DJ US Marine Transport
But trucking is holding up well.

DJ US Trucking

Construction Materials

Crude oil runs a distant second to coal as the chief energy source for cement production.

IEA Cement - Energy Usage

But the industry is a heavy transport user and should benefit from lower oil prices.

DJ US Construction Materials

Mining

Mining is also likely to benefit from lower extraction and transport costs.

DJ US Basic Materials

Forestry & Paper

Forestry is another heavy fuel user.

DJ US Forestry & Paper

Chemicals & Plastics

Basic chemicals (including fertilizers) are the largest industrial consumer of crude oil.

DJ US Chemicals

Specialty chemicals are also largely oil-based.

DJ US Specialty Chemicals

Aerospace & Automobiles

Aerospace, laid low by problems at Boeing (BA), has been floored by a massive downturn in the airline industry and will take a long time to recover.

DJ US Aerospace

Automobiles have so far stood up well because of stellar performance from the likes of Tesla (TSLA).

DJ US Automobiles

But the sting is in the tail. Light vehicle sales have plummeted.

Light Vehicle Sales

Low vehicle sales and less travel also means lower tire sales.

DJ US Tires

Oil Producers in Affected Regions

The IEA graph below shows producing regions that are uneconomic at varying prices/barrel (x-axis). If we take $25/barrel as the average over the next two years, North American producers would suffer the most, followed by Asia-Pacific and Latin America.

Uneconomic Crude Production by Country

Middle-Eastern producers enjoy the lowest extraction costs and are mostly still profitable at lower prices.

Avoiding Value Traps

Value opportunities abound in industries that are badly affected by the economic contraction and falling crude prices — as well as by those industries that stand to benefit from low oil prices. Some affected industries, however, are going to struggle to survive without state assistance.

The problem with value stocks is that, although they may seem cheap, prices can fall a lot further. That is why we use both technical and fundamental analysis to evaluate opportunities.

There are many stocks that are trading well below our assessment of fair value at present but we will not buy until the technical outlook turns bullish. It takes plenty of patience. But helps to avoid value traps.

The stock market remains an exceptionally efficient mechanism
for the transfer of wealth from the impatient to the patient.

~ Warren Buffett

Coronavirus: “We are all Keynesians now”

An economic depression requires a 10% (or more) decline in real GDP or a prolonged recession that lasts two or more years.

The current contraction, sparked by the global coronavirus outbreak, is likely to be severe but its magnitude and duration are still uncertain. After an initial spike in cases, with devastating consequences in many countries — both in terms of the number of deaths and the massive economic impact — the rate of contagion is expected to drop significantly. But we could witness further flare-ups, as with SARS.

Development of a vaccine is the only viable long-term defense against the coronavirus but health experts warn that this is at least 12 to 18 months away — still extremely fast when compared to normal vaccine development programs.

The economic impact may soften after the initial shutdown but some industries such as travel, airlines, hotels, cruise lines, shopping malls, and cinemas are likely to experience lasting changes in consumer behavior. The direct consequences will be with us for some time. So will the indirect consequences: small business and corporate failures, widespread unemployment, collapsing real estate prices, and solvency issues within the financial system. The Fed is going to be busy putting out fires. While it can fix liquidity issues with its printing press, it can’t fix solvency issues.

There are three key factors that are likely to determine whether countries end up with a depression or a recession:

1. Leadership during the crisis

Many countries were caught by surprise and the rapid spread of the virus from its source in Wuhan, China. South Korea, Singapore and Taiwan were best prepared, after dealing with the SARS outbreak in the early 2000s. Extensive testing, tracing and an effective quarantine program helped South Korea to bring the spread under control, after initially being one of the worst-hit.

Daily Increase - South Korea

South Korea: Initial Cases of Coronavirus COVID-19 (JHU)

The World Health Organization (WHO) did little to help, delaying declaration of a pandemic to appease the CCP. Economic and political self-interest has been the root cause of many failures along the way, including China’s failure to alert global authorities of the outbreak (they had already shut down Wuhan Naval College on January 1st). But this was aided by failure of many leaders to heed warnings from infectious disease experts in late January/early February. When they finally did wake up to the threat, many were totally unprepared, resulting in a massive spike in cases across Europe and North America.

Testing is a major bottleneck, with the FDA fast-tracking approval of new tests, but production volumes are still limited. Abbott recently obtained FDA approval for a new 5-minute test kit that can be used in temporary screening locations, outside of a hospital, but production is currently limited to 50,000 per day. A drop in the ocean. It would take 6 months to produce 9 million kits for New York alone.

Daily Increase - USA

USA: Initial Cases of Coronavirus COVID-19 (JHU)

Daily Increase - UK

UK: Initial Cases of Coronavirus COVID-19 (JHU)

Daily Increase - Germany

Germany: Initial Cases of Coronavirus COVID-19 (JHU)

Daily Increase - Italy

Italy: Initial Cases of Coronavirus COVID-19 (JHU)

Widespread testing and tracing, social-distancing, and effective quarantine methods have enabled some countries to flatten the curve. Australia may be succeeding in reducing the number of new cases but inadequate testing and tracing could lead to further flare-ups. One of the biggest dangers is asymptomatic carriers who can infect others. Flattening the curve is the first step, but keeping it flat is essential, and requires widespread testing and tracing.

Daily Increase - Australia

Australia: Initial Cases of Coronavirus COVID-19 (JHU)

The curves for North America and Europe remain exponential. They may even spike a lot higher if hospital facilities are overrun. Success in flattening the curve is critical, not just in minimizing the number of deaths but in containing the economic impact.

2. Economic rescue measures during the crisis

Rescue measures amounting to roughly 10% of annual GDP have been introduced in several countries, including the US and Australia, to soften the economic impact of the shutdown. More Keynesian stimulus may be needed if the coronavirus curve is not flattened. Layoffs have spiked and many small businesses will be unable to recover without substantial support.

3. Economic stimulus after the crisis

This is not a time for half-measures and the $2 trillion infrastructure program proposed in the US is also appropriate in the circumstances. Australia is likely to need a similar program (10% of GDP) but it is essential that the money be spent on productive infrastructure assets. Productive assets must generate a market-related return on investment ….or generate an equivalent increase in government tax revenue but this is much more difficult to measure. Investment in unproductive assets would leave the country with a sizable debt and no ready means of repaying it (much like Donald Trump’s 2017 tax cuts).

Conclusion

Social-distancing and effective quarantine measures are necessary to flatten the curve but widespread testing and tracing is essential to prevent further flare-ups. Development of a vaccine could take two years or more. Until then there is likely to be an on-going economic impact, long after the initial shock. This is likely to be compounded by a solvency crisis in small and large businesses, threatening the stability of the financial system. The best we can hope for, in the circumstances, is to escape with a recession — less than 10% contraction in GDP and less than two year duration — but this will require strong leadership, public cooperation and skillful prioritization of resources.

—–

“We are all Keynesians now.” ~ Richard Nixon (after 1971 collapse of the gold standard)

Lessons from the Panic of 1907

I have read The Panic of 1907 (by Robert Bruner & Sean Carr) four or five times — I read it at every market crash.

The crash occurred more than 100 years ago and is one of many banking crises that beset the United States in the 19th and early 20th century. What made 1907 stand out is that the financial system was saved by the leadership of a private individual, John Pierpont Morgan, head of the banking firm that later became known as J.P. Morgan & Co. Without the 70-year old Morgan’s force of will, the entire financial system would have imploded.

John Pierpont Morgan
John Pierpont Morgan – source: Wikipedia

The crisis led to formation of the Federal Reserve Bank in 1913. The US had not had a central bank since President Andrew Jackson withdrew the charter for the second Bank of the United States in 1837. Bank clearing houses prior to 1913 were private arrangements created by syndicates of banks and were poorly-equipped to deal with the challenges of a banking crisis.

The lessons of 1907 are still relevant today. The authors of the book suggest that “financial crises result from a convergence of forces, a ‘perfect storm’ at work in financial markets.”

They identify seven elements that converged to create a perfect storm in 1907:

  1. Complex Financial Architecture makes it “difficult to know what is going on and establishes linkages that enable contagion of the crisis to spread.”
  2. Buoyant Growth. “Economic expansion creates rising demands for capital and liquidity and ….excessive mistakes that eventually must be corrected.”
  3. Inadequate Safety Buffers. “In the late stages of an economic expansion, borrowers and creditors overreach in their use of debt, lowering the margin of safety in the financial system.”
  4. Adverse Leadership. “Prominent people in the public and private spheres implement policies that raise uncertainty, which impairs confidence and elevates risk.”
  5. Real Economic Shock. “Unexpected events hit the economy and financial system, causing a sudden reversal in the outlook of investors and depositors.”
  6. Undue Fear, Greed and other Behavioral Aberrations. “….a shift from optimism to pessimism that creates a self-reinforcing downward spiral. The more bad news, the more behavior (erupts) that generates bad news.”
  7. Failure of Collective Action. “The best-intended responses by people on the scene prove inadequate to the challenge of the crisis.”

Compare these seven elements to the current crisis in March 2020:

Complex Financial Systems

The global financial system is far more complex than the gold-based financial system of 1907. Regulation has not kept pace with the growth in complexity, with many products designed to avoid regulation and lower costs. The ability to build firebreaks to stop the spread of contagion in unregulated or lightly regulated areas of the financial system is severely limited. And that is where the fires tend to start.

In 1907 the fire started with poorly regulated trust companies that dominated the financial landscape: making loans, receiving deposits, and operating as an effective shadow-banking system. A run on trust companies threatened to engulf the entire financial system.

In 2020 it started with hedge funds leveraged to the hilt through repo markets but soon threatened to spread to other unregulated (or lightly regulated) areas of our shadow banking system:

  • Leveraged hedge funds
  • Risk parity funds
  • International banks lending and taking deposits in the unregulated $6.5 trillion Eurodollar market (these banks are offshore and outside the Fed’s jurisdiction).
  • Money market funds
  • Muni funds
  • Commercial paper markets
  • Leveraged credit
  • Bond ETFs

Many of these offer the attraction of low costs and higher returns, often enhanced through leverage, but what investors are blind to (or choose to ignore) are the risks from lack of proper supervision and the lack of liquidity when money is tight.

Maturity mis-match is often used to boost returns. Short-term investors are channeled into long-term securities such as Treasuries, corporate bonds, munis or credit instruments, with the promise of easy sale or redemption when they require their funds. But this tends to fail when there is a liquidity squeeze, forcing a sell-off in the underlying securities and steeply falling prices.

Rapid Growth

We all welcome strong economic growth but should beware of the attendant risks, especially when financial markets are administered more stimulants than a Russian weightlifter for purely political ends.

Excessive use of Debt

Corporate borrowings are far higher today and rising debt has warned of a coming recession for some time.

Corporate Debt/Profits Before Tax

Public debt is growing even faster, with US federal debt at 98.6% of GDP.

Public Debt/GDP

Adverse Leadership

In the early 1900s, President Teddy Roosevelt led a populist drive to break the big money corporations through Anti-Trust prosecutions. This cast a shadow of uncertainty that fueled the sudden reversal in investor sentiment.

President Theodor Roosevelt

In 2020, we have another populist in the White House. Frequent changes in direction, spats with allies, imposition of trade tariffs, impeachment efforts by Congress, and a heavy-handed approach to trade negotiations have all elevated the level of uncertainty.

Donald Trump

Economic Shock

The great San Francisco earthquake and fire of 1906 created an economic shock that was felt across the Atlantic. The earthquake ruptured gas mains, setting off fires, while fractured water mains hampered firefighting. Over 80% of the city was destroyed. Much of the insurance was carried in London and Europe and led to a sell-off of securities in order to meet claims. The Bank of England became increasingly concerned about the outflow of gold from the UK and hiked its benchmark interest rate from 3.5% to 6.0%. London was then the hub of global financial markets and money became tight.

In 2020 we have the coronavirus impact on global manufacturing, services and financial systems: the mother of all demand and supply shocks.

JHU - CV Confirmed Cases

Undue Fear and Greed

Collapse of highly leveraged ventures in 1907 — with an attempted short squeeze on United Copper shares by connected corporations, banks and broking houses — stirred fears that a leading Trust company was going to fail. The panic soon spread and started a run on a number of trust companies.

A spike in the repo rate in September last year revealed that hedge funds had used repo to leverage their relatively meager capital into a rumored $650 billion exposure to US Treasuries. The Fed had to dive in with liquidity to settle the repo markets, lifeblood of short-term funding by primary dealers. But financial markets were on edge and concerns about funding difficulties in the unregulated $6.5 trillion offshore Eurodollar market and leveraged credit in the US started to grow.  But the coronavirus outbreak in Europe and North America was the eventual spark that set off the conflagration.

Failure of Collective Action

Tust companies failed to organize an effective defense in 1907 against a run on their largest member, The Knickerbocker Trust Company, fueling a panic that threatened to engulf other trusts. Responding to appeals for help, J.P. Morgan intervened and marshaled the banking industry and surviving trusts to mount an effective defense.

Today that role falls to the Federal Reserve. Chairman Jay Powell moved quickly and purposefully to flood financial markets with liquidity, but the Fed was forced to reach far outside their normal ambit — increasing dollar swap lines with foreign central banks (to supply liquidity to international banks operating in the Eurodollar market) and providing liquidity to money market funds, muni funds, commercial paper markets, bond funds, hedge funds (through repo markets) and more. In effect, the Fed had to bail out the shadow banking system.

One thing that strikes me about financial crises is that each one is different, but some things never change:

  • artificially low interest rates;
  • rampant speculation;
  • excessive use of debt;
  • unregulated and highly leveraged shadow-banking with hidden linkages through the financial system;
  • financial engineering (the latest examples are leveraged credit and covenant-lite loans, hedge funds running leveraged arbitrage, risk parity funds with targeted volatility, and management using stock buybacks to enhance earnings per share, support prices and boost their stock-based compensation);
  • misuse of fiscal stimulus (to fund corporate tax cuts while running a $1.4 trillion fiscal deficit);
  • misuse of monetary policy (cutting interest rates when unemployment was at record lows);
  • yield curve inversion; and
  • misallocation of investment (to fund unproductive assets)

Jim Grant (Grant’s Interest Rate Observer) sums up the problem:

“The Fed has intervened at ever-closer intervals to suppress the symptoms of misallocation of resources and the mis-pricing of credit. These radical interventions have become ever-more drastic and the ‘doctor-feel-goods’ of our central banks have worked to destroy the pricing mechanism in credit.

….[credit and equity markets] have become administered government-set indicators, rather than sensitive- and information-rich prices… and we are paying the price for that through the misallocation of resources…..

Is there no salutary role for recessions and bear markets? …..they separate the sound from the unsound, they separate the well-financed from the over-leveraged and if we never have these episodes of economic pain, we will be much the worse for it.”

We haven’t learned much at all in the last 100 years.

Dow: Not so fast WSJ

We were surprised to receive this from The Wall Street Journal this morning:

Markets Alert

Dow Industrials Rally, Ending Bear Market

A new bull market has begun. The Dow Jones Industrial Average has rallied more than 20% since hitting a low three days ago, ending the shortest bear market ever.

Dow Jones Industrial Average

That is news to us. A 20% reversal is a quick rule of thumb used by brokers. It is not part of Dow Theory. To suggest that we are now in a bull market is ludicrous.

Dow Theory tracks secondary movements in the index which last from ten to sixty days (Nelson, 1903). Only if the secondary movement forms a higher trough followed by a higher peak does that signal reversal to an up-trend. And the same pattern has to occur on the Transport Average to confirm the change.

A three-day rally is a normal part of a bear market and, with volatility near record highs, it is likely that some rallies are going to reach 20 per cent.

Dow Jones Industrial Average

Bear markets are more volatile than bull markets. You can see this from the volatility spikes above in 1991, 2000-2003, 2008, and 2020. Stocks go up on the escalator and down in the elevator.

According to data from S&P Dow Jones Indices, most days with the biggest gains occur in a bear market. Eighteen of the top twenty biggest daily % gains on the Dow occurred in a bear market. Only two (marked in blue) were in a bull market.

Dow Jones Industrial Average

The largest gains in the 1930s bear market were as high as 15% in a single day!

Interesting that eighteen of the top twenty biggest daily % losses on the Dow also occurred in a bear market (red).

Dow Jones Industrial Average

That is because volatility is a lot higher in bear markets than in bull markets.

So expect big moves in both directions.

Bailout time

Boeing has applied to the Federal government for a $60 billion bailout. The troubled aircraft manufacturer is in need of rescuing but has indulged in $54.9 billion of stock buybacks in support of its stock price.

Former UN ambassador and ex-South Carolina governor, Nikki Halley resigned from Boeing’s board, saying that she opposes federal support for Boeing. Smart political move. Public anger is growing.

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Many corporations used stock buybacks to boost earnings per share after earnings growth slowed in 2014/15. Boeing was no exception.

Stock Buybacks and LT Debt

The company had a reputation for engineering fine aircraft but in recent years that focus has shifted to financial engineering and cost-cutting to boost earnings per share. Free cash flow was squandered on stock buybacks, dividends and executive bonuses. No reserves were accumulated for a rainy day.

Well, a rainy day finally arrived in 2018. The Boeing 737 MAX airliner, which began service in 2017, was involved in two fatal accidents, Lion Air on October 29, 2018, and Ethiopian Airlines on March 10, 2019, caused by a malfunction of the aircraft’s new MCAS automated control system. The aircraft was grounded by airline authorities around the world and Boeing suspended production in December 2019. After a software bug was discovered in January, the return to service was delayed. Despite an outstanding issue over non-compliant wiring bundles the FAA has indicated that they expect the 737 Max to return to service in the second half of 2020.

The company had to raise almost $10 billion in bonds to help it weather the setback. CEO Dennis Muilenburg was ousted in late 2019 but still walked away with a golden parachute of up to $50 million.

A hit from the 2020 Coronavirus outbreak has put the company into difficulties, with the stock getting pounded. Boeing has been forced to apply for a government bailout.

Stock Buybacks and LT Debt

The company is a strategic asset of the United States and should be protected.

But rewarding bad behavior would promote moral hazard on a wide scale. To give management and stockholders a free ride would encourage risk-taking by other companies — with the expectation that they will be bailed out if something goes wrong.

Support the company but hurt the stockholders

Management and existing stockholders need to feel the pain.

Offer support in the form of $60 billion of convertible bonds or preference shares, ranking behind creditors but ahead of stockholders. Conversion into ordinary shares should be in 10 years time but at the current stock price of $100. Stockholders and management awards will take a huge hit,  while taxpayers can look forward to a sizeable gain when the company recovers.

Support should be non-voting (bonds or prefs) to keep political interference to a minimum.

Buybacks

Preventing future buybacks is a completely separate issue that should be addressed on a national basis and not by placing restrictions on individual companies. For the record, we are against buybacks because they can be used to artificially support stock prices. Companies that need to return capital to stockholders should declare a special dividend.

Avoid a Domino-effect

There are a string of companies lining up with bailout requests. It is important to put emotions aside and save those that are still viable businesses and not just strategic assets like Boeing. Millions of jobs are at stake. And disruption to credit markets could have a Lehman-like domino effect.

Just ensure that it is on terms that favor the taxpayer, so that stockholders will think twice about future profligacy.

Fed brings out the big bazooka

The Fed is on a war footing.

The FOMC announced that it will cut the funds rate to zero. Timing of the announcement — Sunday, March 15th at 5:00 p.m. — signals the level of urgency.

“Consistent with its statutory mandate, the [FOMC] Committee seeks to foster maximum employment and price stability. The effects of the coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook. In light of these developments, the Committee decided to lower the target range for the federal funds rate to 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”

Bond markets have been anticipating this cut since March 4th, when the 3-month T-bill rate plunged to 33 basis points.

Fed Funds Rate, Interest on Excess Reserves and 3-Month T-bills

The Fed also announced further QE of $700 billion, expanding its balance sheet by $500 billion in Treasury securities and $200 billion in mortgage-backed securities (MBS). This is in addition to the $1.5 trillion repo operations announced earlier in the week.

Fed Balance Sheet: Total Assets and Excess Reserves on Deposit

In a related announcement, the Fed is also encouraging banks to use the discount window, cutting the primary credit rate by 150 basis points to 0.25 percent, effective March 16, 2020.

“Narrowing the spread of the primary credit rate relative to the general level of overnight interest rates should help encourage more active use of the window by depository institutions to meet unexpected funding needs. To further enhance the role of the discount window as a tool for banks in addressing potential funding pressures, the Board also today announced that depository institutions may borrow from the discount window for periods as long as 90 days, prepayable and renewable by the borrower on a daily basis. The Federal Reserve continues to accept the same broad range of collateral for discount window loans…”

Not all the $1.5T repo facility is likely to be taken up — the Fed just used a big number for dramatic effect, to get everyone’s attention — but we expect the Fed’s balance sheet expansion to get close to $6 trillion (compared to $4.3T on March 11th) before this is over.

While these rescue operations are normally announced as temporary, they soon become permanent as the market resists any efforts to unwind the Fed’s role.

As I said on Saturday: “To infinity and beyond…

The Fed has no vaccine for COVID-19

The World Health Organization has not yet declared the COVID-19 coronavirus a global pandemic but investors are not waiting.

Spooked by the rapid explosion of cases outside of China — South Korea now has 2,931 confirmed cases and Italy 889; — and dire warnings from health professionals, investors are fleeing to safety.

The CDC on February 21st announced:

“We are not seeing community spread here in the United States, yet. But it is very possible, even likely, that it may eventually happen.

…..This new virus represents a tremendous public health threat. We don’t yet have a vaccine ….nor do we have a medicine to treat it specifically.

…..We are now taking, and will continue to take, unprecedented aggressive actions to reduce the impact of this virus.”

China claims to have the disease under control, reporting a sharp decline in new cases. But they have zero credibility after the massive suppression of information, frequent revision of statistics, and rapid disappearance of anyone who contradicts the official CCP line.

This report from Trivium China shows how CCP temporizing allowed the virus to spread:

China’s National Health Commission website published minutes from a meeting the NHC held with its provincial branches on January 14:

  • “The epidemic prevention and control situation has undergone important changes, and the spread of the epidemic may increase significantly, especially with the arrival of the Spring Festival……
  • [We must] implement the most stringent measures, control the epidemic locally, and do our best to avoid the spread of the epidemic in Wuhan.”
  • But the NHC didn’t give any public warning about the virus before January 20.

Severity of the disease should also not be underestimated. Of 43,940 active cases, 18% are listed as serious or critical, while 7% of 39,439 closed cases have died. The growing number of relapses, after the patient initially recovered, is also concerning.

China is going to find it difficult to restore business as usual with the constant threat of another outbreak. Activity remains well below normal levels.

China coal consumption

Official PMI figures point to a “brutal contraction” for China. February Manufacturing PMI plunged to 35.7, while Services were even lower at 29.6.

China PMI

It is difficult to estimate the economic impact of COVID-19 on the global economy. Profs. Warwick McKibbin and David Levine take a stab:

The novel coronavirus COVID-19 may become a footnote in history – a disaster narrowly averted. It could also become a global pandemic similar to some of the worst pandemics of the twentieth century. For example, assume the COVID-19 is as easy to spread and as dangerous as the 1957 Asian flu. Based on the epidemiological estimates of mortality and morbidity rates from that experience, our best estimate from a 2006 study on pandemics was that such a virus might kill more than 14 million people and shrink global GDP by more than $500 billion. These estimates are far higher than the costs were in 1957 because our world is increasingly connected and urban. Preliminary results currently being updated in 2020 suggest even higher numbers for worse case COVID-19…..[Brookings]

This is not a problem that the Fed can handle.

No doubt they will cut interest rates. Short-term Treasury yields (gray) are already falling in anticipation of another rate cut (green).

Effective Fed Funds Rate (EFFR), Interest on Excess Reserves (IOER), and 3-Month Treasury Yield

When consumers are scared, rate cuts will not restore normal consumption patterns. This is both a demand and a supply shock. A virus outbreak would cause consumers to drastically curtail demand: use of public transport, holiday travel, business travel, hotel occupancy, visits to restaurants, shopping malls, sporting events and other public venues. Fast food consumption and discretionary shopping would be especially hard hit.

But supply is also likely to contract due to interruptions to supply chains and shipping logistics, slowing manufacturing output.

Donald Trump may call this a “hoax” but I don’t see him taking any hospital tours, to review preparations. If the virus does spread as anticipated, he is unlikely to win re-election.

ASX catches a virus

It’s not a pretty sight. The ASX 200 fell close to 10% in a single week. The severity of the fall suggests that sellers are committed and buyers are scarce. Breach of support at 6400 is highly likely and would offer a target of 5400 (a 25% draw-down).

ASX 200

A V-shaped recovery is unlikely.

The ASX 300 Metals & Mining index broke primary support at 4100, completing a double-top reversal with a target of 3400.

ASX 300 Metals & Mining

The Aussie Dollar is also getting smashed, headed for a target of 64 cents after breaking support at 67.

AUDUSD

The ASX 300 Banks index is headed for a test of 7250/7300. Breach is likely and would offer a test of 6750.

ASX 300 Banks

Our conclusion hasn’t changed from last week:

Threats continue to outweigh opportunities in our view and we retain a bearish view on the global and domestic economies. Our focus remains on defensive and contra-cyclical (gold) stocks.