Just like that. You saw this coming. I understand, it never feels all that great once it sinks in. Sinks in that one has no choice but to fight. That said, you will answer the bell, as you always have. You will be challenged as you have been before. You will rise, as you always have before, and I will stand with you. We will show appropriate concern. We are sentient, and we will act that way. Fear is the tool of the wicked. Fear will not drive us from our mission, or apart for that matter.
The financial markets have finally reached the point of fear. The move to this place should have been more gradual, but is not an incorrect determination of price discovery. Hopefully, everyone is now more defensive than they were two weeks ago. I understand that some likely are not. Market participants took the S&P 500, in aggregate to 19 times forward looking earnings just last Wednesday. Those same markets have now spent two days taking risk off, with a third day (probably a doozie) waiting in the on-deck circle. That third risk-off day has moved from pretty darned gnarly at zero-dark thirty to downright ugly at zero-six, by the way.
What gives? You already know the answer to that. The Covid-19 virus that put a headlock on not just the Chinese economy, but the Chinese way of life for the past month, is on the move. Remember folks, that economics is at its core, very simply, the measured human response to conditions of both surplus and/or scarcity. These conditions can be created through natural causes, or crafted through artificial means (policy). Human response is now being impacted well beyond Chinese borders.
At least 10 municipalities in northern Italy have now been quarantined as carnivals, and professional sporting events have been cancelled. The last data that I see at the Johns Hopkins website shows 157 having fallen ill within Italy resulting in three deaths. Now, French health officials are prepping for the likeliness of a worsening of conditions in that nation.
Then there is the case of Iran, where eight have died out of 43 confirmed cases. If an 18% mortality rate seems awfully high, it is indeed. Knowing nothing of those Iranians who have passed such as their health history, or ages, the statistical assumption would be that there might be a considerable number of unreported cases in that nation. Both Iraq and Turkey have closed their borders with Iran. Closer to China, it becomes clear to see that South Korea is now up against a greater impact from the virus. There are now 833 confirmed infections in South Korea, with none reported in North Korea, which lies in between China and South Korea. Is that even possible?
So, it is that the epicenter of this virus is on the move, as is the very human fear of becoming infected, which is natural. That said, this is the material of measured human response. The IMF acknowledged over the weekend that the impact of this virus could take Chinese GDP for 2020 down to 5.6% from an expected 6.0%, resulting in a 0.1% reduction in global GDP. Forgive me, if I see this possibility as (very, very) overly optimistic. Yes, I understand, that even if this coronavirus proves to be seasonal as we all hope, that there will be a second quarter wave of pent-up demand unleashed across many economies. Understand this though. While this may prove true on a macro-economic scale as far as industrial commodities might be concerned that on the micro-level, humans will not consume what is discretionary in excess once there is an all clear. Humans will not eat more, drink more, travel more, seek more group entertainment simply because they can. Those sales are lost forever.
As China tries to get back to work, the threat would be now that the rest of eastern Asia, western Asia, and the European Union face even greater economic slow-down. As supply lines are "potentially" rebuilt (more on that below), does demand now whither? As folks move from worrying about global economic welfare to worrying about getting sick themselves, or about loved ones, as in all things we slow down this situation before us, so that we are able to make reasoned decisions. We, to the best of our ability must remove all emotion from the process. Cold as Ice. We...
Understand... That both demand and supply have been, and will be impacted further. Apple (AAPL) has already told us this. More firms will. Large cap earnings as well as revenue generation will be impacted by shortages in material that will result in sharp changes in price. This will likely reach the U.S. consumer even if the virus never does in large numbers.
Identify... Both areas of opportunity as well as danger. Is value a better bet suddenly than growth? Have dividend yields suddenly become the holy grail of investment? Are the highest gold prices in four years for real? Are these Treasury yields even sustainable? You know I hate an inverted curve.
Adapt... Nervous? Then adjust. Is it really that simple? Yes, it really is. Outperform the S&P 500? Big deal. Preserve your ability to fight on? Much bigger deal. Always remember that aggressive behavior allows outperformance in both directions. A conservative approach usually ensures less portfolio volatility. Having trouble sleeping at night? Checking the Dow every few minutes? These are signals that someone who does something else occupationally might be overexposed. Appetite for risk is personal. Know what you are comfortable with.
Overcome... Taking action is the key. As long-term overbought equity markets quickly become short-term oversold, forcing both the U.S. dollar and U.S. Treasuries to extreme valuations themselves it becomes easy to overreact. Everything thought out. Everything for a reason that you could explain to a child if you had to. Will everything be okay in the end? For the human race, I think so. For every single human? Of course not.
The Flow of Capital
Where does the money go, now? Keep in mind that algorithms don't get sick the way humans do. Money moves on decisions made regarding fiscal or monetary policy in the heat of the moment (or should I say millisecond?) Important input such as sentiment, valuation, and cross-border trade conditions all matter greatly, but in a more lasting way. The battle at the point of sale is fought by keyword reading algorithms that will respond to actions taken, or even words spoken by policy makers.
Just what does this mean to us? I think it probably means that central bankers around the globe will both act as well as speak aggressively. While further easing of monetary or fiscal policy could grease the wheels of economic activity in normal times, or when normalcy returns, easier policy will accomplish little toward the means of sustaining the velocity of money as nations lock down, and fear deters transaction.
Does, a natural disaster unlike those that communities can immediately rebuild from, even require an economic response? Let that sink in, because I really do not know if I know the answer. Are planet earth's central banks already at the point where there must be some acceptance that asset prices can not always find support in policy? Is there a point where monetary debasement or the monetization of debt must pause, or allow for economic down-turn when the catalyst is not in itself economic in nature? In short, does non-economic negative output require affirmative economic response?
I told you that I don't know the answer. I do want you to think, though. Does ever increasing artificial manipulation in free market pricing ever become too dangerous? Is the short-term result (reduced economic strain) worthy of the long-term expense, that being a semi-permanent cap on growth, and productivity, which in itself results in even more reliance on this artificial participation? Food for thought.
Flowers Among The Weeds
I hear you. You have been told that the manufacturing economy in the U.S. is dead, and has been for quite some time. There is and has been an over-reliance upon China (or any cheaper labor force) to provide multinational large cap firms with the manufacture or assembly of their finished goods. Just what if this virus actually accomplishes what the trade war set out to do? What if this "plague" forces U.S. large caps to shorten supply lines?
Last week, for February, the Philadelphia Fed posted its best headline number for its manufacturing index since June of 2017. This came on top of a month of January that itself was the best seen since last August. The strength in this report came exactly from where you need it to be. New Orders. Shipments, Unfilled Orders, and Inventories. The New York Fed also surprised to the upside for a second month in a row for that district's manufacturing survey. Again, the strength seen is in New Orders, Shipments, Unfilled Orders, and Inventories. Hmm.
Is something going on here? Philadelphia is the most important regional manufacturing survey in our great nation. Dallas, Kansas City, and Richmond all report this week. Dallas is energy focused. Kansas City is less closely watched. Richmond is important though. Richmond goes to the tape on Tuesday (tomorrow) and Richmond surprised huge to the upside in January.
They say that manufacturing only comprises 12% to 13% of the U.S. economy, so that its not really important? That said, as Markit's flash PMI for the U.S. service sector showed some rare contraction for January, does manufacturing have to stay mired at 12% to 13%, and if some of these orders are migrating toward North America where are just 44 confirmed cases of this virus across the continent (and by my count, 18 of those came from the cruise ship Diamond Princess), than would this not drive increased production resulting in elevated wages for the U.S. middle class? Just a thought. It's going to be rough for a while, but it's never all good, nor all bad. Of course, keeping this virus off-continent may prove increasingly difficult. There are supposedly vaccines out there that are in the works. There are ... flowers among the weeds.
Sarge Is Watching...
... The 50 day SMA for Walt Disney (DIS) for potential initiation.
... The 50 day SMA for Zscaler (ZS) for a further sale.
Economics (All Times Eastern)
10:30 - Dallas Fed Manufacturing Index (Feb): Expecting 11.8, Last -0.2.
The Fed (All Times Eastern)
15:00 - Speaker: Cleveland Fed Pres. Loretta Mester.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (DDS) (2.85)