With over 400 million people across multiple cities in China in lockdown as a result of the coronavirus pandemic, with supply chains and businesses coming to a grinding halt, the billion dollar question on everyone's minds is, "Is it time to buy or sell this market?"
Over the past 40 years, China has grown to now become the world's second largest economy with a GDP of $13.6 trillion vs. the U.S. of $20.5 trillion. It is the largest trader of merchandise in the world, and central to global supply chains as a host of world's raw materials are consumed by China to then turn them into finished manufactured goods. China accounts for roughly 16% of world GDP. With most factories and businesses shut for weeks, due to open as late as 14th February, there will no doubt be an impact to Q1 GDP. According to Reuters, Apple's (AAPL) main iPhone production partner, Foxconn, had received Chinese government approval to resume production at a key plant in northern China city of Zhengzhou, where 50% of the world's iPhones are made. There was some suggestion at the end of last week that they would not be allowed to reopen till 19th February, so this comes as a welcome surprise.
According to China's National Health Commission, daily increase of coronavirus cases across China excluding Hubei province has been falling, 444 on 9th Feb and 509, 558, 696, 707, 731, and 890 for the previous six days. China confirmed 40171 cases by end of 9th Feb with the death toll rising to 908. This virus has a much lower fatality rate than SARS even though the rate of transmission is much more severe. According to a Bloomberg article today, the virus may infect up to 500,000 people before peaking in mid to late February. There was a headline today suggesting a vaccine was developed by Chinese scientists which had been tested on animals and the clinical trial is likely to be launched in April.
China's economy grew by 6% GDP last year, the lowest rate in 30 years. After the Phase One trade deal was signed, it was hoped that 2020 would be a recovery year. Those hopes are now clearly dashed. However, if China is to meet its 5.5%-6% GDP target, with Q1 reporting even sub 5%, it can only mean one thing: massive monetary easing to boost growth to get the average higher in the coming quarters. Last week China injected about 1.7 trillion yuan in liquidity, some was to offset reverse maturing repos, cut 7-day and 14-day repo rates, as well as lowered tariffs on $75 billion worth of U.S. goods imported. The PBOC is taking measures to make sure the economy is insulated from any long-lasting effects from the virus slowdown.
But how much ammunition does China really have? This morning it reported its January CPI (Consumer Price Inflation) at 5.4% year over year, highest print in nine years, driven by a surge in pork prices. China's food CPI rose 20.6% in January. These are concerning numbers as it ties the hands of the government to inflate the economy, lest inflation spirals out of control. A delicate balance to say the least. There is also growing concern of more bank defaults and subprime structures that all rest in the financial system like a house of cards. Any further delay or protracted slowdown can cause a ruffle in broader asset classes which can exacerbate the slowdown.
One thing is certain, a lot of the hibernating bears are out and about highlighting all the valid reasons why this market should fall, but yet it is not because most investors are waiting for a pullback only to buy more. Sod's law, when one waits for that, never happens. It almost appears that the pain trade is higher from here, not lower. The Fed has also extended its repo operations till April. To debate the veracity of this is beyond my pay grade as the problem is shoved under the carpet for a bit longer, and the Fed knows it. Regardless, liquidity is the key to where markets and asset classes go from here. For now, both the Fed and PBOC are injecting money into the market.
The oil sector and its stocks have gotten hit the hardest as Chinese Oil demand is set to reduce by ~ 4mln bpd. In a market that was already dealing with excess inventories and delicately balanced with OPEC+ cuts, this can be a big hit if the virus is not contained in a matter of weeks, let alone businesses restart towards end of February. Last week OPEC+ recommended a cut of 600k bpd to start as soon as March which could very well support the market as Libyan Oil has dropped as well. Be careful what you wish for as a toxic cocktail of OPEC+ cuts, central bank liquidity together with U.S. shale production plateauing or even slowing, could very well be the harbinger of a massive squeeze in Oil in a short period of time. Copper only fell 10% in comparison to Oil, but then again it is a market in severe deficit assuming very conservative demand assumptions.
The markets may have been holding up, but Commodity stocks are valued extremely cheaply. The investment case rests on the rate of spread of the virus slowing to almost being contained and central banks supporting the market. Barring a new type of transmission or increased global cases, these stocks are a buy now. Not to forget the whole world was talking about the Fed/reflation trade back in December as they will not raise rates, possibly even cut lower to boost inflation sustainably above 2%. What has changed now that these stocks are 25% cheaper?