Some investment commentators had been relaxed about the Chinese virus, reading into the official numbers the idea that new cases had peaked. The Fed, the Bank of Japan, the European Central Bank and the People’s Bank of China are all running supportive policies, putting money into markets in various ways. As this money helped drive up asset prices, some were minded to explain it by taking a more optimistic view on what might happen next on economies and activity. The Fed forecasts 2% growth this year for the US, and the Eurozone expects there to be some growth overall. China has not yet revised down its official 6% forecast for 2020.
Meanwhile, the US ten-year Treasury bond yield had fallen from 1.9% at the end of last year to 1.6%. Baltic dry cargo freight rates had more than halved so far this year. The German Manufacturing PMI was last seen at 45.3, well below the 50 needed to avoid recession. Last year, German car output fell to 4.66 million vehicles compared to the 5.5 million or so that was achieved a few years earlier.
The downside mounts
Many airlines have halted flights to Asian destinations for fear of exposing more people to the virus. International conferences are being cancelled or delayed. Oil prices have fallen by a fifth and OPEC has met to consider larger production cuts to try to keep the price up. All this is evidence that economies are going to slow more, with downward pressure on revenues, margins and reported profits of companies. Some in these markets are warning of a possible recession.
On Thursday, the Chinese authorities advised the world that they had not been counting all of the people affected by the virus, nor all those that have been dying from it. They made a sharp upward revision to the numbers, explaining that they had not tested all people involved and did not attribute illness to the virus until someone had tested positive. This sent shock waves through those who had become complacent about the extent and duration of this epidemic, with markets selling off a bit from their recent highs.
It looks as if the virus is still spreading. We have to be prepared for it to get worse before it gets better. This will mean substantial damage to the Chinese economy. Whilst this week the Chinese were asked to return to work after a prolonged New Year holiday, it is quite likely production is still adversely affected by the sickness. Some companies will not reopen on time. Some will find their workforce is depleted through people being ill or self-isolating because they have been in contact with someone who has caught the disease. Some factories will be held up by insufficient delivery of raw materials or components from others.
Markets should expect Chinese output to be seriously affected by what has happened so far and what could happen in the next few weeks. The Chinese authorities face a difficult conundrum. Do they intensify attempts to stifle the virus with more isolation and a longer period of shutdown in the worst affected places, or do they give more attention to economic activity and tell people to take more risks by going to work as normal? How do the authorities keep normal supply going in places like Wuhan badly affected by the outbreak?
Trading partner woes
This will have a knock on to countries with a big trade with China. Germany will feel the reduced demand for its exports there. The US will see her attempts to stimulate more trade between the two countries after the trade spat slowed by the illness. The Chinese issues are probably going to prolong the recession in industrial products like vehicles for longer.
We have been warning about Chinese share investment for some time. The uncertain response to the virus and the economic problems it creates leads us to reiterate our cautious approach. We have also advised to reduce risks a bit in portfolios against this news background. There is a growing gap between share valuations and likely earnings and dividend outcomes this year.
Equity markets have been heavily dependent on the upwards progress of the US technology giants, who have powered the US indices higher which in turn have led the world. Investors have wanted to invest in shares because the monetary easing and the positive policy outlook in most parts of the world argue for growth to come. On the other hand, investors have seen the downsides in industrial, energy and mining activities against the current background. They have seen the need to be on the right side of the digital and green revolutions, which are making big differences in revenue growth and earning power between companies and sectors.
It is too early to say whether after a few more days or weeks the virus will peak in China without spreading too much elsewhere, or whether we will be facing a big increase in cases outside China and no early end to the Chinese agonies. All we can conclude is this is a negative for shares. Anything which depends on physical travel and trade with China and domestic activity in that country will be disproportionately hit. The falls will be cushioned by the generous supply of cash to markets from the leading central banks, and from the knowledge that these epidemics do pass in due course.
The above article was previously published by Charles Stanley on 14th February 2020