In the fourth quarter of 2019, after Fed Powell said the committee will do whatever it takes to boost inflation so that it sustainably stays above 2%, fund managers globally started allocating money to "value," such as energy and mining -- commodities that are the biggest beneficiaries of the reflationary trade, as it is called. Investors took comfort in the fact that the Fed's not-QE QE (or QE4, whatever acronym is preferred as long as you are not the Fed) will stimulate growth and boost risky asset prices further. Global growth and inflation expectations picked up notably in Q4 2019. Then 2020 happened.
Fears of an outright Coronavirus outbreak spread as the Chinese hid most of the details from the public and tried to contain a virus that first spread back in December. As things spiralled out of control, the country and about 400 million people came to a grounding halt. It was as though someone threw a spanner in the wheels of motion as global growth, businesses and factories literally came to a full stop. We are not just talking a slowdown, we are talking about a full stop, with a restart unclear. That is seriously damaging for anything China wants to buy, mostly commodities like oil, steel, iron-ore and copper.
As traders, we are taught to sell first and ask questions later during a crisis, because rather than catch the falling knife, it is better to preserve your capital so that you can load up when the storm passes. Given that, prices and asset classes tend to get exaggerated to the downside due to the fear factor. In the latest Bank of America Global Fund Manager Survey, global growth expectations have u-turned, as only 18% of investors surveyed expect global growth to rebound over the next 12 months vs. 36% in the last survey. Investors also slashed their inflation expectations down from 57% down to 40% expecting higher inflation in the next year.
Value stocks were in vogue over growth stocks towards the end of last year, but have been completely hammered this year since public knowledge of the virus spread. Low and behold, investors expect growth stocks to now outperform value stocks -- the biggest jump in growth stocks since December 2014. As a result, energy/mining/banks/cyclical stocks have been crushed at the expense of technology/dollar/bonds/short volatility/gold -- the deflationary trade.
I'm not entirely sure why the market is so obsessed with either technology or energy, why not have a mixed basket of stocks from both categories? It seems an absurd notion to most, but not to absolute performance managers. Technology rose another 9% in its allocation, standing at a net 40% overweight position -- the highest level since October 2016. Despite the warning from Apple $ (AAPL) , it seems the market's appetite for this sector remains insatiable for now.
So, will Modern Monetary Theory (MMT) save the day? It seems there is no end in sight until at least April or Q2 2020. The Federal Reserve just added another $90.8 billion in short-term money markets yesterday during the repo auctions. The balance sheet stands around $4.18 trillion as of Wednesday vs. lows of $3.8 trillion in September. What is their target is anyone's guess, but all the Fed says is they expect it to reach a "comfortable"level by April following these operations? They have not fixed the problem, they just keep throwing more money at it. Growth hasn't picked up nor has inflation, so why not do even more as long as asset prices continue grinding higher. There is no point trying to fight the Fed but we can certainly try to understand its shortcomings.
As of this morning, eight provinces in China reported 0 new cases of the virus -- including Shanghai, Hainan, Qinghai, etc. according to the National Health Commission. Other provinces reported single-digit increases in cases, implying the rate of change has slowed down. And 1824 people recovered and discharged. Even though a cure has not been found, whatever measures the government is taking is working to contain/slow the virus. It is taking time to bring everyone back to work, but it is happening surely and slowly. According to the American Chamber of Commerce in Shanghai, 78% of companies do not have sufficient staff to return to full production. We are expected to hear of more supply chain disruptions as companies start to come back. But China is fully aware of this and have been taking aggressive measures in the back to insulate the fallout from this virus.
The ministry of Finance said value-add tax will be exempted from delivery of contracts to support the opening of commodity futures markets. They will cut pension contributions and fees to help companies cope with costs. Some cities will get subsidies to entice new car buyers, Foshan was the first city to announce such a stimulus to ease the impact on the auto market. According to President Xi Jinping, China can meet its economic growth target in 2020 despite the impact of the virus. This is a very important point, as when China says it will do something, it will be done. Now if some like Morgan Stanley are forecasting China Q1'20 GDP to fall as low as 3.5%, then to meet their 5.5%-6% annual target, how much stimulus and boost will be needed? Ouch.
It is never smart to fight the central banks, especially the likes of China. We can be cerebral all we want, but liquidity supersedes logic and fundamentals at times. We have already seen cuts in MLF/LPR rates, it is a matter of time we will see more reserve requirement ratio (RRR) cuts with a target to support private firms, as this is the sector that provides job creation, which is key to providing social stability.
Oil prices are crushed but are firmly hugging the $55/bbl Brent level, which is very important as we are below breakeven in some key projects for most countries. Places like Oman and Bahrain are already under water, as their breakeven Brent price is closer towards $87.60 and $91.80/bbl, respectively. Saudi Arabia is also watching this price closely, as the price is closely linked to their future growth plans to diversify away from oil. If oil stays here past Q1, it can have some serious repercussions for the region. Hence OPEC+ is monitoring the price and will most likely put forth deeper cuts to maintain price stability.
With central banks cutting rates aggressively and China and the U.S. pumping even more liquidity at a time of the market's longest 10-year bull run expansion, it almost seems like a rocket is about to take off. Be careful of being too bearish, as there are physical fundamental reasons why the oil price is supportive below $50/bbl WTI and $55/bbl Brent. It only takes a bit of calm as the virus fears subside before stocks regain their highs of Q4 2019. And most importantly, everyone has bailed out of them once again.