Bedrock’s Newsletter for Friday 14th of February, 2020
14 February 2020


 Friday, 14th of February 2020

“Markets can remain irrational longer than you can remain solvent.”


– John Maynard Keynes




Happy Valentine’s Day to all of our readers! Love is in the air and we hope that you find a suitably kitsch way to celebrate – whether you are with family, friends, partners, colleagues, or even a lucky stranger.


Unfortunately, love is not the only contagious bug to have swept the globe this week. The coronavirus, officially named ‘covid-19’ by the World Health Organisation on Tuesday, has also been spreading fast. Having first emerged at a wet market in China’s Hubei province less than two months ago, the deadly virus has now reached many neighbouring countries, as well as Europe, Australasia, and North America. Africa and South America have so far been spared, perhaps by the hot and sticky weather that prevails at this time of year, but an outbreak on either continent could prove hard to contain – and turn very tragic very quickly – given the fragility of local healthcare systems and infrastructure. As of this morning, covid-19 has claimed a total of 1,380 lives (mostly in China) while more than 64,000 cases have been confirmed worldwide. On Thursday, the Hubei Provincial Health Committee revised its virus diagnostics methodology leading to a significant spike in the number of confirmed cases, but there has been little change in the underlying trend. The province remains the epicentre of infection with some 60m people subject to travel restrictions and other quarantine measures.


Unsurprisingly, these restrictions have brought the Hubei economy to a complete standstill. However, activity across the rest of China has also slowed sharply due to the outbreak, with many companies choosing to close offices and factories in affected regions rather than put their employees’ health at risk. For example, multinational tech companies such as Samsung, Microsoft, Tesla, Apple, and Google have closed all their mainland China offices, while Foxconn has shut its huge plant in Zhengzhou where 350,000 people make half of the world’s iPhones. The scale of office, port and factory closures is playing havoc with global supply chains and trade and could have lasting effects on how companies operate and organise production in the region. Indeed, it has pushed the Baltic Dry Index (the shipping market bellwether) to an all-time low, while even the medical face masks needed to help combat the spread of the coronavirus are now in short supply outside China (where the bulk of them are made)! At the same time, the once booming Chinese tourism industry has disappeared overnight, hitting popular destination countries like Singapore. The city-state is braced for a massive 25-30% fall in tourists (and thus tourist spending) this year according to the chief executive of the Tourism Board. Looking ahead, it is beyond doubt that the economic cost of the covid-19 outbreak will be very large indeed. And it is still far too early to predict how and when this pandemic will end. Should containment fail somewhere in Europe, for example, the coronavirus could cause economic chaos all across the continent, exacerbated by the free movement of people. In short, a bad outlook could get a lot worse before it gets any better.


So how have markets responded to the collapse of Chinese economic activity and the risk that Europe (already on its knees) or another region with a weaker healthcare system (India, perhaps) succumbs to the coronavirus next? By hitting all-time highs, of course. To be fair, there was a brief wobble after the spike in coronavirus cases was reported on Thursday, but investors were soon buying back into the market and inflating asset prices further. Many people seem happy to inhabit a dreamworld where fundamentals are irrelevant so long as the Fed, the ECB, and the other big central banks keep the liquidity taps running. In case you needed any more convincing that this is true, the yield on the Greek government 10Y bond just fell below 1% (from >40% in 2012). Clearly monetary policy matters and you would be a fool (and a lot poorer) to have discounted its role in driving markets for the last 10 years, but something real needs to support asset prices over any significant time horizon or investors will soon find the ground disappearing beneath them. The market’s reality-bypass today is reminiscent of the tech stock mania of the late 1990s and could end the same way. Our feeling is that, once the Q1 economic data shows how much damage this outbreak has caused, investors will not be able to ignore it for long and a sell-off could ensue. As such, we see no reason to abandon our more defensive positioning even as the market takes off again.