As China battles with the spread of coronavirus in its country, leaving 300 million migrant workers at risk of not returning to work, restarting factories and restoring production, there is a real risk that it does not meet even its lowered 3.5% Q1 GDP number. If it is to meet its annual 5.5%-6% GDP target, can you imagine what Q220 growth will have be to make the numbers work? Simple elementary math will tell you that Q220 would have to grow to about 10%+ just to meet the annual average. Ouch! Now that would have to be turbo growth, inflationary on a whole new level.
As China is desperate to contain the outbreak and limit the economic impact of the quarantine on its manufacturing slowdown, it has been throwing trillions in yuan in liquidity in the market, lowering loan prime rates, offering subsidies to car manufactures and small business enterprises, even lowering bank lending standards to insulate the economy from going into full blown recession. That is how scared they are, that they are willing to unwind all the hard work of the deleveraging of the past few years, ridding it off shadow banking lending and dubious practices. Even though the rate of cases in China have passed its peak of worst case infections and as the virus spreads to various corners of the world, it is almost inevitable that a containment might not be possible. Just time and weather will be needed till this flu wears down, giving healthcare professionals time to find a cure. And so, this morning China announced a whole new set of infrastructure projects aimed at boosting spending in Beijing, Fujian, Hennan, Yunnan, and Jiangsu for projects in 2020. When in doubt, how best to get v-shaped economic growth and recovery? Construction and infrastructure spending! The demand increase will immediately be seen in various commodity markets as it soaks up all the inventory in a short space of time leading to higher prices, and hence the illusion of demand.
At the start of the year, Emerging Markets ($EEM) and China ($FXI) indices fell 10% with the darling S&P 500 resilient, and President Trump tweeting that no harm can come to the U.S. companies. Despite the U.S. breaking away from globalization trends and wanting to isolate itself, it is still to a large degree dependent on China. When China sneezes, the U.S. will catch a cold (pun is certainly intended!). Low and behold as supply chains are disrupted and various technology companies have sent warnings for their Q120 earnings, the U.S. S&P fell 7% this week from highs of 3375 down to 3250 level, only to fall yet again down to 3060 overnight after a brief valiant effort to squeeze higher yesterday. Of course, with the U.S. Fed suggesting an earlier phasing out of their repo operations and Treasury bill buying, it did not help matters given this market was fueled by massive amounts of liquidity since last September. Now the U.S. market is down as well, in line with the recent moves in China, where to from here?
For one thing, President Trump is furious. After all his presidency relies on a higher stock market by November, so one cannot blame him for pointing fingers at anyone he can find responsible for this market collapse. He has now put Vice President Mike Pence in charge of dealing with this outbreak. One can hear not only the president but even the market whisper desperate screams of "Powell, cut rates now please" as the market took another leg lower last night to hit down to its 200-day moving average of 3050.
The selling first starts with fast money traders, then as it gets worse, institutions get involved. We all know asset managers have been very long and levered. CTA and machine algorithms are now flashing red warning signs as their breakeven prices are closer to 3139 (according to Nomura's Charlie McElligot's recent note). What that means is that below this level the machines unemotionally have to start selling to avoid losses and preserve their capital. This can be extremely fast and vicious given the extreme positioning.
The U.S. bond market is in a dire situation with the yield curve having inverted with the 10-year yield falling below 1.3% yesterday and 30-year yield below 1.80%. The odds for two rate cuts in 2020 alone have reached more than 80% now. The Fed FOMC March meeting held on the March 17th will make for a very interesting viewing. It is a shame they threw all their ammunition in Q419 as repo overnight lending rates spiked up to 10%, and increased the balance sheet upwards of $500 billion (not-QE). With now the market having given up most of the gains of the past six months only to see the market back where it was at the start of September 2019. The past few days we have had Yellen talk about how the Fed has many options in its toolkit including buying stocks. If that wasn't an indication of total collapse of free market capitalism, not sure what is. Either way it seems the Fed will have to do something, it is a question of when not if. Is a 10% fall enough for them to come out guns blazing, or lower?
One thing is clear, as soon as coronavirus outbreak fears subside and businesses start to return to work, given the amount of liquidity splurged into the system, especially China, we can see the mother of all rallies, perhaps even more sharp than 2015/2016 deflation. Given its infrastructure focus, copper will be the one commodity to greatly benefit given its tight demand/supply dynamics. It is worth sitting on the sidelines but at around 3050 on the S&P 500 it may be worth going long for a tactical long trade. The market is all about technicals now. The real buying will only come once the virus is contained or Fed goes all in, as China seems to be willing to do so at all costs.