Bedrock’s Newsletter for Friday 7th of February, 2020
7 February 2020


 Friday, 7th of February 2020

”Are you allowed to impeach a President for gross incompetence?”


– Donald Trump (about Obama) in 2014





Markets have been in recovery mode for much of the week as investors bet on central banks being able to immunise the global economy (or portfolios at least) from the worst effects of the novel coronavirus outbreak. On Monday, Asian indices sold-off sharply sending a ripple through markets the world over as Chinese traders returned from the Lunar New Year holiday and local exchanges re-opened for the first time in over a week. The Chinese government regulator had pre-emptively banned investors from short selling in an attempt to forestall the inevitable drawdown, but the CSI 300 Index of domestic stocks still fell -9.4% (in dollar terms) at the market open. The People’s Bank of China also announced that it would inject a massive 1.2tn yuan into money markets via reverse repo operations on Monday, which has done much to calm nerves. So much so, in fact, that this intervention has pushed the CSI 300 Index back up to ~3900, just 100 points shy of where it was when the Shanghai-Shenzhen exchange shut up shop for the holidays on 23 January. Outside China, investors have also become increasingly confident that the Fed, ECB, and others will take similar action if serious economic harm from the virus shows up in local data. Thus, even as cases of coronavirus continue to spiral – topping 30,000 at the last count – the S&P 500 has managed to climb to another all-time high of 3348 intraday on Tuesday. The central bank liquidity backstop remains the only game in town. Even the cast-iron guarantee of (perhaps very serious) economic damage from lower aggregate demand and disrupted supply chains this quarter is not enough to irk investors who are drunk on liquidity and hankering for yield. If you doubt the irrationality of the current market, just look at the bubbly price action in Tesla shares which have doubled in value since the company reported its first ever back-to-back quarterly profit (on a less stringent, non-GAAP basis) last month. Tesla is a company which has not made a profit in any year since it was listed in 2010, but which is now on a trend similar to bitcoin in 2017 just because of the earnings announcement. This is reminiscent of the 1999 tech bubble mania – and that did not end well. When disappointing data trips up investors later in the month a market reversion is likely, so we see little reason to abandon our more defensive positioning. China has delayed its January trade figures until next month, presumably so as not to spook the revellers, but other countries cannot suppress information and change the subject so easily and corporates still have to file. The impact from coronavirus will be felt.


Speaking of bad economic news, a raft of European manufacturing data came out this morning and the numbers were truly hideous. In Germany, industrial production in December slumped -6.8% YoY (and -3.5% MoM), while the annual figure for November was revised 10bps higher (hooray!) to -2.5% YoY. This is way below expectations and underscores the profound challenges facing this erstwhile export-powerhouse at Europe’s core. France, meanwhile, experienced a -3.0% YoY (and -2.8% MoM) fall in industrial production in December amid strikes and industrial action to protest the government’s pension reforms. Despite an improvement in business sentiment in the run-up to the US-China trade agreement, the hard numbers speak to a European economy still deep in the doldrums. A pick-up in PMI data for December, particularly in the UK, had previously suggested that a recovery was on the cards in Q1. However, given Europe’s close economic links to China and the disruption that the coronavirus is causing in this crucial export market, the outlook is much less favourable today.


Across the pond, however, the US economy shows few signs of contagion so far. The labour market in particular is booming, with 225k jobs created in January (vs. 165k expected) while wages grew at +3.1% YoY. Even the ISM manufacturing PMI (which has shown the sector contracting for several months) registered a surprisingly positive print of 50.9 (vs. 48.5 expected) in January amid a surge of new orders by American businesses. This data lends support to our view that the US will outperform Europe this year, with the Trump Administration doing everything in its power to keep the economic engine roaring through November at least. Despite the positive data, buoyant sentiment, and a phase one US-China trade deal having been signed last month, we nonetheless expect the Fed to keep rates on hold for now given economic weakness abroad and dovish positioning by foreign central banks. This will add to the momentum behind the US economy. Medium-term, the intellectual tide in monetary policy circles is turning more dovish and a new inflation-targeting regime that lets core CPI run hot if it has been weak in the recent past has even been mooted. As such, we expect the Fed to maintain current policy even if inflation rises modestly above 2%. Despite the US central bank being more dovish in its interpretation of inflation data going forward, this does not alter our positive dollar view – particularly against the euro. Given the striking difference in economic fundamentals between the two blocks, it is no surprise to see the EURUSD down below 1.10 mark.


The biggest political news of the week was the decision by the US Senate to acquit President Trump on two charges – abuse of power and obstruction of Congress. The Republican-dominated chamber refused to call any witnesses or review any new documents not already considered by the House and the trial was over within three angry weeks. In the end, the only Republican Senator to back impeachment was Mitt Romney. Although the vote was a shoo-in for Trump – no one expected the GOP to remove him from office before the election in November – his acquittal is being spun by the White House as a complete vindication of his behaviour with regards to Ukraine. That seems dubious, but the voters will soon have their say. With an economy like the one he has today, the wallets could win it for Trump. Moreover, between the ill-advised decision by the House Speaker Nancy Pelosi to rip up the President’s State of the Union speech and the disastrous Iowa caucus results delay the Democrats have given the Donald much to celebrate this week.