• James J. Hargan

Covid 19 Update 1

I've included below some comments and links from various economists and companies on the impact and potential strategies going forward as it relates to the corona virus. I'd be happy to discuss.

Overall, we would suggest that from an economic perspective the coronavirus is likely to be disruptive to growth, but not destructive to growth. As such, the economic impact may likely lead to weaker earnings growth in Asian markets, with some spillover to US equities through the first half of 2020. We expect this to be followed by an economic and earnings rebound as we have seen in the past. We would not suggest a shift in one’s asset allocation merely in response to the current epidemic as we believe a recovery will follow in short order. For the time being, we continue to focus on the fundamentals and remain mindful of current equity valuations while looking for signals of a more meaningful earnings rebound in equities. Philip Petursson, CIM Chief Investment Strategist - Manulife Investments Full commentary: https://retail.manulifeinvestmentmgmt.com/ca/en/viewpoints/capital-markets-strategy/coronavirus-a-disruptive-not-destructive-event?rid=61302091&jobid=5429862&ch=eml&cname=20200227-75707-NWS-INFO-EN-Info TD Managing Director and Head of Public Equities David Sykes on BNN. His conversation can be watched here. Damian Fernandes also makes an appearance.  He has a lot of great charts and explained them in a way that should help instill investor confidence.    

  • Think about the last 10 years; despite all the negative narratives that have been out there (US Debt downgrade, Eurozone Debt Crisis, Oil Price collapse, Brexit, Trump winning US presidency, etc.) we've had an explosion in earnings

  • Is this going to impair the long term compounded earnings? "I don't think this does unless this affects US consumption…" à As of now, consumption hasn't been impacted

  • Earnings drive stock prices as indicated in the chart below;

  • From what companies have said so far, this quarter is going to be a "write off"

  • Most impacted industries so far have been commodity driven (Airlines, Hotels, Casinos, etc.)…this isn't what the US economy is known for

  • Largest companies in the US market right now are Tech companies; not a lot of capital investment, tied to themes independent of the virus

  • Interesting opportunities right now;

  • Home Depot à Low rates means higher housing activity

  • Microsoft à Oligopoly with Amazon for Cloud Adoption

Lastly, a frequent question being asked the last few days is whether clients should be moving to a more conservative risk profile.  The answer is no.  To bring it back to what David Sykes said, it's about your plan and objectives.  Unless those plans/goals have changed, this short term headline shouldn't have an impact on what risk profile they should be in.  The below article was posted to Bloomberg today; "Canada Notches Record Low Corporate Coupon." Is gold the place to be? From Bloomberg America's Edition Five Things To Start Your Day: "Earlier this week I wrote about gold and how it's a good volatility hedge, but only up to a point. It stops being a good volatility hedge when you start getting anxious about managing cash flow and paying your bills. Since the world runs on U.S.-dollar denominated liabilities, when the bill collector (or the tax collector, or the margin clerk, or the landlord) comes knocking, you need cash. And selling gold might be one of your only options. We might be seeing a little bit of that effect emerge. This morning markets are selling off again, and Treasuries are surging, and yet gold is red. Gold was red yesterday too. It's something to watch." TD Securities Commentary COVID-19, commonly known as the Coronavirus, has spread rapidly since news broke in mid-January of its discovery in Wuhan, China. The reaction in financial markets, for the most part, has been swift, though perhaps not always consistent. Since mid-January, US 10yr Treasury yields have fallen around 50bps, 10yr Bund yields by 30bps, and the USD has rallied at the cost of EUR and JPY. Oil prices are down almost 20%, and gold up over 5%. Equities were late to the game, but the S&P has now corrected below its mid-January level. Some EM Asia central banks have eased policy, while others have decided to wait and see how much damage is done. As we discuss below, it's not clear that central banks are the right antidote to the economic effects of the virus. While markets have been quick to react to the uncertainty of the COVID-19 outbreak, the impact on the global economy has yet to be fully felt. While China and some EM Asia supply chains remained shut down long after the lunar new year holiday, firms in many parts of the world have yet to feel any impact at all-though it is in all likelihood coming. As we highlighted in early January, global economic momentum was on the rebound in late-2019, and while we thought it was too early to call for a sustained increase in global growth, signs had started pointing in the right direction. It is too early to have a firm view on the growth impact of the virus, so we present two scenarios for Chinese growth in this note (see below). In both cases, Chinese growth remains below trend through the first half of the year before returning to trend in the second half, leaving annual growth somewhere between 4 and 5%. We expect spillovers to hit the global economy through 2020H1 in particular, with some residual disruptions likely in the second half of the year. We have downgraded our forecast for 2020 global growth, and now expect growth to come in between 2.6% and 2.75% (was 3.0%) depending on the China growth scenario, and close to the "recession-consistent" growth rate of 2.5% and far from the global economy's 3.3% trend. At this stage it is difficult to be overly precise about the timing and magnitude of COVID-19's impact on the global economy. When thinking through the impact of the outbreak, we look at three characteristics of the economic shock. In order of increasing levels of uncertainty, we discuss (see chart): • The initial timing of the shock • The size of the shock • The length of the recovery and its degree of catch-up 1) Initial Timing of the Shock The shock from COVID-19 will be felt via many channels. Until recently, focus has been on the impact via indirect, external spillovers from China via goods and services exports. By this metric, Germany in particular is highly exposed (see above chart). However, as events in Italy and South Korea unfolded over the weekend, market attention quickly turned to possible direct, internal G10 shocks as the virus spreads. The initial onset of the economic impact from lower external Chinese demand is likely to be staggered, and has yet to appear in "hard" economic data. This will come in due course, but is likely to show up in different sectors at different times. The Early, Proportional Hit: Tourism and Travel A decline in Chinese tourism has already hit service sector demand in G10 economies. The impact in this sector is likely to be relatively proportional to Chinese tourism in G10 economies (of course, others outside China may also choose not to travel because of risks of virus exposure, amplifying this impact somewhat). This would imply weaker demand for tourism and travel services in G10 economies from early February--something that the UK's February flash PMI Services released indicated, for example. The chart above shows the share of services exported to China in key G10 economies. While we expect this sector to be hit most quickly, the reduction in tourism and travel consumption by Chinese tourists is likely to be broadly proportional to their share of tourism in each economy. Furthermore, for countries where data is available (such as the US), about half of Chinese "tourism and travel" exports are actually Chinese students studying in the US. So the shock may be somewhat mitigated by this compositional effect. Recovery to an adverse tourism shock, however, might take some time as travel plans are often made long in advance and uncertainty weighs over how persistent the COVID-19 shock will be. Anecdotal evidence from the travel industry suggests demand is sagging for travel throughout 2020. The Chain that Could Break: Manufacturing The real uncertainty lies in the manufacturing sector. Some firms have already started to face shortages and have been creative in their solutions. Others are yet to feel the pinch, and might not do so as long as their employees are able to report to work. Recent data from relatively highly-exposed manufacturing sectors like in Germany point to mixed evidence. The February ZEW sentiment indicator revealed grave concerns in the auto and electronic manufacturing industries, but little concern elsewhere. The Manufacturing PMI and IFO Expectations Index this month were both stronger than expected. That said, it is too early for most manufacturing firms in developed economies to feel the pinch. In our view, the negative shock to this sector is likely in March and April. A typical cargo ship takes up to 8 weeks to reach Europe from China, and 5 weeks to reach Los Angeles, including loading/unloading times (90% of global trade in goods is done via shipping). Furthermore, on account of the Lunar New Year (LNY), many firms with Chinese supply chains would have built up not only enough stock to cover the lower activity levels during LNY, but a further buffer to cover the relatively common disruptions in supply heading as firms shut down for the holiday. This means they may be able to cope with input shortages for a longer time. The Direct Hit As the virus spreads--it is now growing faster outside of China than in--countries are likely to feel the sting from a domestic-driven reduction in demand. Whether this comes from the impact of regional lockdowns like those in Italy and South Korea, or from lower domestic consumption of services such as restaurants and cultural events as people stay out of public spaces, the impact here is much harder to quantify. From a household balance sheet perspective, less money spent on services will either be saved or spent elsewhere. It is too early to have an accurate assessment of just how much and how persistently consumers' behaviour will change. 2) How Bad Will the Data Get? The size of the economic shock remains uncertain as the situation is still evolving globally. Early estimates suggest COVID-19 could take about half a percentage point (annualised) off US 2020Q1 growth, and slightly more off euro area growth. But doubts over official Chinese statistics means any mapping through to activity in G10 economies remains nebulous at best until hard data has been released in the spring in developed economies. Furthermore, we simply don't yet know where bottlenecks in supply chains might occur. By our calculations, an extra week of typical LNY-style shutdown in China leads to a 15% drop in imports. It is not easy to map LNY shutdowns into COVID-19-related production disruptions, but the figure does indicate that trade is likely to be severely impacted in 20Q1, something we've already seen evidence of (for China at least) in South Korean's trade data for the first 20 days of February. 3) How Long Will it Last? Finally, the length of time that the global economy will be disrupted is impossible to know at this juncture. COVID-19 cases continue to rise on a daily basis, and are spreading outside of China at a rapid rate. With Chinese production only just starting up in some regions, and likely hampered into March, it suggests at least a 1-month-long impact on G10 economies, though elevated inventories and creative sourcing of alternative parts might help buffer against production disruptions in some sectors. The major shock would be if the virus' spread accelerated even more rapidly in other countries, leading to regional production disruptions outside of China and EM Asia. This may already be happening. Of course, once the drag from disruptions has dissipated, there is likely to be a rebound in activity as firms make up for lost production and activity in early 2020. We expect COVID-19 to weigh on growth through all of 2020H1, with the rebound concentrated in the second half of this year. The H2 bounceback will help offset some of the weakness in H1 growth, but COVID-19 will weigh on 2020 growth as a whole. A question hanging over the rebound in activity is whether households and firms will "make up" for lost spending earlier in the year or simply return to their usual spending patterns. The former would dampen the negative shock over the year.

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