Black Swan taking off (Cygnus atratus) South Island, New Zealand (Photo by: VWPics/Universal Images … [+]
VWPics/Universal Images Group via Getty Images
The equity market finally had a reaction to the effects of the coronavirus (Covid-19) last week, and it was significant with the S&P 500 falling 252 points (7.4%) from its record high close on Valentine’s Day. As of this writing, most of the fall (209 points) came on Monday and Tuesday, February 24 and 25. The coronavirus, and the economic uncertainties surrounding it, have dominated every news cycle (except for the Nevada Democratic Caucuses for a few hours). At this writing, there are 80,200+ known cases with 2,700+ deaths (3.3%). Conditions are unstable and the number of cases may well approach 100,000 over the next week. Worse, the pandemic nature of this virus is no longer confined to China, and while the daily increases in cases there have now started to fall, there is now a rapid growth of infections in Italy, Japan, South Korea, and Iran. This isn’t going to be over for quite some time.
The Economic Impacts
Given the economic disruptions already in flight plus the emergence of the inevitable “avoidance” response (people stay home during the outbreak and long after it is no longer a threat), the economic impacts are going to be considerable even if the virus’ spread is soon halted as was thought early on. But, as the days have progressed, the view that the virus’ spread can be quickly halted has faded, and researchers now say that there is a significant probability that this ends up as a pandemic (meaning 40%-70% of the population gets infected). A recent headline on CNBC’s Coronavirus Blog read, “U.S. Prepares for Pandemic.”
The economic headlines mainly discuss specific impacts the virus is having on publicly traded companies. These headlines are omnipresent. For example, “Coronavirus flight cancellations top 200,000.” Besides airlines, the rest of the travel and leisure industry is being devastated. Conferences are being cancelled, Macau partially shut down, and there is now talk of cancelling or postponing the Tokyo Olympics. With Japan emerging as a new infection hotbed, foreign visitors to those Olympic games this summer may simply elect to stay home and watch it on TV! The original thought that this was a temporary phenomenon and that consumption would just be delayed has been replaced by the realization that lost sales in the services sectors are permanent.
Bonds Have the Economics Correct
Unlike equities, the bond market has recognized the potential economic impacts for quite some time. The 30-year T-Bond, as high as a 2.20% yield on January 24th and 2.43% on November 8th, is, as of this writing, closer to 1.8%, an historic record low. Given the weakness in the world’s economies, pre-virus, it looks like such yields are going even lower. The story is similar for the 10-year T-Note (the basis for mortgage rates). Its yield is now near 1.3%. The magnitude of the fall in rates, too, is record breaking over such a short time span. And, while the Fed’s minutes and spokespeople insist the Fed is done moving rates lower, Wall Street gives strong odds of three rate cuts in 2020, the first as early as June or sooner, as Wall Street now talks of an “Intermeeting” cut. The inversion of the yield curve (short-term rates higher than longer-term rates) means the market is telling the Fed that they are lagging.
The financial media does a good job of hyping stock prices and equity returns. They do display bond yields prominently on their screens. It is easy to look up the 30-year T-Bond or the 10-year T-Note yields. But they never discuss the “annual returns” from holding these assets like they do for the S&P 500, Nasdaq, or the DJIA. In fact, most investors shy away from bonds because of today’s historically low yields. Here’s the truth: For the one-year period ending February 25, the S&P 500 return is about 12%; but if you bought and held the 30-year Treasury Bond for the same period, your return was closer to 30%. Bonds, sometimes, really do have more fun!
Some of the “sentiment” indexes appear healthy, like the University of Michigan’s Consumer Sentiment Index or the Conference board’s Consumer Confidence Index, both of which rose modestly in February. A lot of the sentiment indexes are influenced by the equity markets, so, with the S&P 500 making new highs through Valentine’s Day, the sentiment was positive. But, in fact, almost all the hard data we have indicates weakness, not strength, and, the data we have is all pre-virus. Below is a list of such data. Remember, none of it includes the travel bans, cancelled flights, closed ports, quarantined ships, cancelled conventions, closed cities, falling oil demand, closed factories…
- U.S.: Industrial Production: -0.3% (Jan. M/M); -0.4% (Dec.); if AAPL, GOOGL; MSFT and FB were eliminated from the S&P 500 results, the other 496 companies show GAAP earning in Q4 of -7.5%;
- EU: Construction Activity: -3.1% (Dec. M/M); -3.7% Y/Y; Auto Sales: -7.4% (Jan. Y/Y);
- Germany: Q4 real GDP growth: +0.1% (not significantly different from zero);
- Japan: Q4 real GDP growth: -1.6% (Q/Q); -6.3% (annualized); Exports: -2.6% (Dec. Y/Y); Imports: -3.6% (Dec. Y/Y);
- Indonesia: Exports: -3.7% (Jan. Y/Y); Imports: -4.8% (Jan. Y/Y);
- Walmart: missed on EPS and revenues; its same store sales grew a meager +1.9% in Q4 (about the same as the rate of inflation)(vs. +4.2% in the year earlier quarter);
- HSBC: laying off 35,000 workers worldwide due to poor financial performance for 2019.
We are just starting to see the impacts of “avoidance” behavior in China’s early February data. Passenger traffic on public conveyances is down 85% (some of this due to business shut-downs), and auto sales are off a mind numbing 92%. Both numbers are Y/Y comparisons. Factories remain closed or on part-time shifts (and many employees are simply not showing up). China, and especially Hubei province, is a hub in the world’s supply chains, especially for high tech parts. Apple, for example, recently guided lower for both revenue and profits, blaming supply chain issues. China, the world’s second largest economy, is surely in the throes of a significant recession.
As indicated in the opening paragraph, financial markets have finally realized that the coronavirus is going to have a significant impact on most major world economies, which, pre-virus, were already weakening. For sure, February and March data will show significant virus impacts, and these are going to have negative consequences for a large segment of corporate revenues and earnings. Prepare for continued financial market volatility.