Friday, 3rd of April 2020
“There are three types of lies – lies, damn lies, and statistics.”
– Benjamin Disraeli
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The first quarter of 2020 will go down as one of the most extraordinary quarters in living memory. At the start of the year, a ‘phase one’ US-China trade deal looked likely to have stemmed the economic bloodletting and rescued those industries struggling under the weight of supply chain uncertainty, frosty international relations, and weak business and consumer confidence. However, from where we now stand at the beginning of April, battered and bruised by subsequent events and locked down at home while police patrol the largely empty streets outside, all the trade war gesticulation looks rather quaint. Whether the weighted average tariff on Chinese auto parts entering the US is 8% or 20% matters little if the relevant factories are closed, travel is banned, and millions of consumers have been furloughed. Democratic governments have taken what were previously unthinkable measures to halt the spread of the coronavirus and have found a well of support among populations at large. Indeed, poll numbers for most leaders have shot up amid the crisis. This new environment breeds new questions for investors and citizens alike. What are the long-term implications of the global lockdown for state-society relations, particularly if it lasts for many months to come? Will some governments take advantage of the new powers to erode checks and balances and/or pursue only a partial rollback of emergency measures when the crisis has abated? Now two decades into the Asian Century, have we all become just that little bit more like China? The coronavirus pandemic is also a reminder that despite vast wealth creation, technological development, and moral progress, our biological nature still haunts us – and can wreck economies and upturn political orthodoxies in the blink of an eye. With some 4bn people packed into the vertical battery farms that many cities around the world have become, we could well be in for more pandemics down the line. We suggest you prepare; and buy healthcare stocks.
For markets Q1 was a rollercoaster ride as investors witnessed some of the largest single day moves (both up and down) since the 1930s. These daily market spasms regularly eclipsed those seen at the very peak of the Global Financial Crisis and were driven by indiscriminate selling, portfolio deleveraging, and widespread panic in the face of crushing economic uncertainty. Indeed, the VIX, which measures the level of implied volatility used to price S&P500 Index options and is seen by many as a gauge of market fear, closed at 82.69 on 16 March – the highest level recorded since its inception in 1990. The benchmark US equity index itself was down -20.0% during the first quarter, having rallied >10% in the final few days against a backdrop of extraordinary fiscal and monetary support, while the STOXX 600 Index of large-cap European corporates fell -23.0%. Emerging markets fared little better than their developed peers, despite the seeds of recovery having been sown in China with the lifting of the Wuhan quarantine: the MSCI EM Index was down -19.3% (and -23.9% in USD) by quarter-end. That said, there was significant returns dispersion within EM, given the oil price shock that hit many producer countries in March after the collapse of the OPEC+ Alliance. Brazil’s IBOVESPA Index, for example, fell -37.9% (and -51.8% in USD) in the first three months of the year, while China’s domestic CSI 300 Index was down just -10.0% (and -11.6% in USD). These are massive moves in troubling times, but are they justified when taking a long-term view? Our sense is that despite inevitable short-term volatility, the opportunity set for investors today has rarely been more attractive.
Although you hardly need economic data to tell you that the world is facing recession (just look outside), figures do help quantify just how severe that recession is likely to be. This week investors were treated to a trove of such data, offering mixed messages about the state of the global economy and its future. Hot on the heels of last week’s flash PMIs, the final March numbers for Europe, the US, and China were all released from Wednesday to Friday. The European PMIs, in particular, are terrible. For the Eurozone as a whole, the PMI composite index of manufacturing and services industries fell from 51.6 in February to 29.7 in March, the lowest reading ever recorded in the 22-year history of the index. Unsurprisingly, services led the decline with a PMI of just 26.4 for the month (vs. 52.6 for February). Manufacturing, meanwhile, fell less to 44.5 in March (vs. 49.2 for February). These numbers are little changed from the preliminary readings from last week. However, those for Italy and Spain are new as neither produces a flash print – and they are abysmal. Italy saw its services PMI index crater to just 17.4 in March (vs. 52.1 for February), while the latter’s services PMI came in a little higher at 23.0 (also vs. 52.1). With most European countries just a few weeks behind Italy and Spain in terms of case numbers and restrictions we can expect much more economic pain to come.
The US, meanwhile, saw its final March PMIs beat expectations with a composite PMI of 40.9 (vs. 49.6 for February), a services PMI of 39.8 (vs. 49.4) and a manufacturing PMI of 49.1 (vs. 50.1). However, given the less advanced state of the outbreak in North America, the better results will almost certainly prove temporary. The crisis in the US is only just beginning, something that the Trump Administration finally admitted this week when the President stated that 100k deaths from covid-19 over the next few weeks would be a ‘good job’. Trump has also now abandoned any suggestion that he will seek to re-open the American economy until the crisis has passed. Inevitably, therefore, the economic damage will be very much like in Europe. Already this week some 6.6m US workers joined the country’s dole queues, a 10x increase on the highest weekly total during the 2008-2009 crisis. As this virus travels from country to country each appears to suffer the same harsh economic fate. And with outbreaks now in India and Africa – where there are few doctors let alone ventilators – a human catastrophe could yet unfold.
Despite the dismal economic performance of the West, there was one bright spot in the data this week: China, where this grim chapter in world history all began. The official figures released on Monday hinted at a rebound as the country eases restrictions and people return to work, but it was easy to dismiss this data as propaganda. Indeed, reports over the weekend suggested that the Chinese authorities may have lied about the scale of the outbreak by a factor of 15-40x. Nevertheless, the rebound narrative has now been supported by the independent Caixin manufacturing PMI which printed at 50.1 for March (vs. 40.3 for February) and the services PMI which came in at 43.0 (vs. 26.5). If China can avoid a second wave of infections and this economic rebound proves sustainable then a V-shaped recovery may be possible after all. And given that the coronavirus outbreak is likely to have been very much more severe than the Chinese authorities will ever admit, the country’s economic trajectory may be a reasonable model for the rest of the world as they reach a similar point on the curve. If so, asset prices have overshot many times over and there will be a bumper second half of the year for investors, helped along by the Fed and the ECB of course. Missing the rebound would be a disaster. What’s more, the snapback could be sharp. Since the Fed intervened to quell fears of a liquidity crunch in money and dollar bond markets last week, we have already seen a 120bps move in US IG spreads (from wides of 400bps over treasuries to 280bps today). That still leaves considerable runway for further tightening given that spreads normally hover in the range of 100-200bps, but it highlights how fast mispricing can evaporate.
We finish this week’s newsletter on the subject of the oil price, which collapsed mid-March after quotas for OPEC+ countries expired without members having agreed on a framework to replace them. Saudi Arabia’s subsequent decision to pump at maximum capacity in order to seize market share from other producers (right when the world was on the brink of a recession and demand was tanking) then drove the sell-off. Initially, none of the big players looked likely to budge. However, on Thursday, the Donald tweeted that after holding talks with Saudi Arabia and Russia he now expects there to be a significant oil production cut (of 10m-15m bpd) announced in the next few days. WTI and Brent climbed +24.7% and +21.0% on the news and are now both up double digits for Friday too. The Thursday move was the largest single-day % increase ever both for Brent (with data going back to 1988) and for WTI (with data going back to 1982). What could Trump have offered Russia to get the ball rolling so quickly? Will he play his best card (i.e., sanctions relief) in exchange for substantial cuts? There was no immediate confirmation from Saudi Arabia or Russia that a deal had been reached, but the Kingdom has since called an “urgent” meeting of OPEC and non-OPEC oil producers set for 6 April. If an agreement has been made (or the talks collapse again), oil could yet set new records this month.
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