We are living in interesting times – as the ancient Chinese curse says. The biggest news at the moment is the coronavirus. (It’s great that it isn’t Trump for a while). Let’s review this information about coronavirus against a basic rule of investing – it is effecting earnings, interest rates and/or inflation.
Earnings:
There is a lot of concern about coronavirus and its effect on growth. We are seeing a lot of companies using the coronavirus to downgrade earnings (particularly in the US).
This is quite reasonable given the fact that China has grown in importance to the world. In 2003 China represented only about 4 per cent of the global economy but today it constitutes more than 14 per cent. China is now very important to global activity. Factories, offices and other Chinese businesses are still on lockdown. These regions in lockdown represent 70% of China’s GDP and 80% of exports – leading to lots of stress and uncertainty.
Supply chains are still in disarray as Chinese suppliers can’t commit to anything. Logistics are problematic due to airlines suspending flights and relocating capacity to other routes. This move has cut a lot of capacity in and out of China thereby creating logistics and production delays.
The lockdown is having a ripple effect and reminds us how dependent we all are on China as a source of cheap production.
It’s also worth remembering that China’s economic activity had been weakened by the 2 year trade war with the US. Combined with coronavirus (and potentially the bird flu) it makes the further slowing of the growth rate of the world’s second-largest economy inevitable. China is by far the biggest contributor to global growth.
…. The big question is when will China’s migrant workers, factory workers and office workers go back to work?
Interest rates and Inflation:
There is talk now about labour shortages and cost increases which will be passed on to the end consumer. We understand that 2/3rds of Chinese small companies have only 2 months of cash for operations on their balance sheet. We believe that even though these companies can’t operate due to a governmental decree they still have to pay wages. If this lockdown lasts for more than 2 months this may mean that 2/3rd of small companies may not survive. This will have impacts.
Markets:
Why are the stock markets still making new highs? As I wrote last week – the Chinese stimulus. China’s central bank cut the interest rate on lending to lower borrowing costs and ease financial strains on companies hit by the coronavirus outbreak. Stock markets have taken the view that they will be saved by central bank initiatives. It’s the great central bank put option. China has done this several times in the past dozen years.
Let’s remember – whilst the spread of coronavirus is quick and there isn’t a vaccine, the Flu infected 42,900,000 people and killed 61,200 in the US alone last flu season. The mortality rate is higher with Coronavirus, but we are seeing relatively few deaths at this point.
With the lockdown being insisted, on the pain is spreading for earnings and growth around the globe. Volatility is the name of the game as sentiment and emotions abound. Pythagoras uses these emotions and cuts through the issues to make the mathematical decisions to profit.
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