Early data from the Hong Kong tourism board shows that less than 3,000 people per day are expected to visit the island in February. That is a nearly 99% drop from February of last year when about 200,000 people visited per day.
The Coronavirus has already brought China’s economy—the world’s second largest—to a halt. This eye-popping chart suggests there will likely be a strong ripple effect around the world. Airlines, hotels, and tourist destinations will feel the immediate impact from the virus, but it will spread well beyond tourism and business travel. Already, one in five S&P 500 companies that have reported earnings have cited the virus as a risk to 2020 earnings.
Trouble Brews for Chinese Steel
Another industry feeling the early effects of the Coronavirus is the commodity markets. China is by far the largest consumer of several important raw materials. It accounts for at least half of all global demand for steel, cement, coal, nickel, and copper. The Coronavirus has most of China on lockdown, which has completely disrupted many commodity markets. This chart shows the record levels of inventories building at Chinese steel mills, and offers a glimpse into the trouble that’s brewing.
Chinese steel mills have been forced to rent external storage sites or leave shipments on boats at the ports. The mills have warned that they will be forced to cut output completely if the logistics don’t improve soon. That would deliver a blow to the Australian and Brazilian economies because Chinese mills import most of their iron ore from these countries. Hopefully, the worst of the Coronavirus is behind us. Unfortunately, we’re probably just starting to see its true economic impact.
Investors were continuing to monitor the outbreak’s impact on global growth and corporate profits.
Goldman Sachs warned clients about a possible correction in equities as investors underestimate how much of an impact the virus may have on the stock market.
“We believe the greater risk is that the impact of the Coronavirus on earnings may well be underestimated in current stock prices, suggesting that the risks of a correction are high,” Goldman strategist Peter Oppenheimer wrote in a note.
A.P. Moeller-Maersk, the Danish shipping giant, was the latest company to issue a warning related to the virus, saying Thursday that the outbreak gave it limited visibility into the rest of 2020.
The February composite SMI report from World Economics shows the extent of the Coronavirus impact on China’s business activity.
Car sales tumbled in the first two weeks of February.
Good News
Residential construction continues to surprise to the upside. The January housing starts and building permits exceeded market expectations.
Market Concerns
Market Leverage
One way to look at “leverage,” as it relates to the financial markets, is through “margin debt,” and in particular, the level of “free cash” investors have to deploy. In periods of “high speculation,” investors are likely to be levered (borrow money) to invest, which leaves them with “negative” cash balances. (SB Here: The “We are here” and “We’d be better off here” are my notations. Also note the high margin/low free cash balance in January 2000 and look at all the positive free cash at the bottom of the Great Financial Crisis in 2008–09.)
Market Earnings
The last time the market finished a year up nearly 30%, 2013, over the next two years, the market consolidated with a near-zero rate of return.
Pay attention to the chart above.
- Earnings declined in 2019 and are projected to continue to decline into 2021.
- Investors are not discounting the decline in earnings, and rising valuations, which will eventually become problematic.
With equities now more than 30% higher than they were then, the Fed mostly on hold in terms of rate cuts, and “repo” operations starting to slow, it certainly seems that expectations for substantially higher market values may be a bit optimistic.
Furthermore, as noted above, earnings expectations declined for the entirety of 2019. However, the impact of the “Coronavirus” has not been adopted into these reduced estimates as of yet. These estimates WILL fall, and likely markedly so, which as stated above, is going to make justifying record asset prices more problematic.
Market Valuation
The Fed
In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s. As shown in the chart below, when the Fed has lifted the short-term lending rates to a level higher than the 2-year rate, bad ‘stuff’ has historically followed.
We have just gone through the first decade in US history without a recession. They also note the New York Fed recession probability is getting uncomfortably high.
Many 2020 forecasts are for slower growth but no recession. But now we may be getting that exogenous shock via China’s Coronavirus. The potential for an exogenous shock is higher now than at any time in the last 10 years. Hopefully, modern medicine will come up with a vaccine quickly. There is reason to be hopeful on that front—possible vaccines are already in animal trials in both the US and China. But the economic impact won’t wait.
The US Dollar and Gold Relationship
One of the side-effects of a rising U.S dollar is weaker commodity prices. And that’s been the case so far this year as a four-month high in the U.S. Dollar Index has pushed commodity price indexes sharply lower. There is one major commodity market that’s actually gained ground along with the dollar, And that’s gold.
THEY USUALLY TREND IN OPPOSITE DIRECTIONS... The weekly bars in Chart 1 compare the price gold (brown bars) to the U.S. Dollar Index (green bars) over the last ten years and it shows them usually trending in opposite directions. You’ll see that turning points in the dollar usually led to turning points in gold in the opposite direction (see arrows). A falling dollar usually corresponded with higher gold; while a rising dollar usually resulted in lower gold prices. That negative correlation between the two is confirmed by the 60-week Correlation Coefficient in the lower box, which was negative for most of those ten years, especially during the years between 2014 and 2018. Then their relationship started to change during the second half of 2018 as both started rising together.
WHY THE CHANGE?… Gold started rising during the second half of 2018 while the dollar was also rising (vertical green line). That caused the Correlation Coefficient line to start rising before eventually turning positive by the highest amount in a decade. Why the change? When one intermarket relationship changes, it’s usually because another intermarket relationship is intervening. Our next chart will attempt to show what that other relationship might be.
The direction of bond yields also impacts the price of gold. That’s because gold is a non-yielding asset that pays no interest. That gives it more value when competing bond yields are falling; and hurts the metal when bond yields are rising. Chart 2 compares the 10-Year Treasury yield (green line) to the price of gold (brown bars); and shows them trending in opposite directions over the last three years. It may explain why the price of gold starting rising during the second half of 2018 (while the dollar was also rising). The chart suggests that the unusually steep drop in Treasury yields from the second half of 2018 to the present has boosted the price of gold; and helped offset the usual depressing impact of a rising dollar.
The daily bars in Chart 3 below show how the three markets have interacted since last September. The lower box shows the price of gold (brown bars) and the 10-Year Treasury yield (TNX) (green bars) moving in opposite directions during the entire period. Each rebound in the TNX weakened gold; while each TNX downturn gave gold a boost. It also shows that the last downturn in the green bars during December coincided with another up leg in gold. This is where it gets more interesting. The dollar has also rallied since the start of the year.
Dollar weakness during December may have also lent support to gold; but the U.S. Dollar Index (upper box) has rallied since the start of the year to a four-month high (upper box), while gold has also gained ground. But that doesn’t mean that the rising dollar hasn’t had restraining effect on gold. Although gold has gained +4% since the start of the year, the boxed area shows that the rising dollar has slowed its advance over the past six weeks. So has a modest rebound in bond yields. The Dollar Index is nearing a test of its October high. That will be an important test for it, and maybe for gold as well. So will the direction of Treasury yields, and the stock market.
Gold is often viewed as both commodity and a currency. As such, it responds to trends in currency markets and commodities, as well as to the trend of interest rates as shown above. It also responds to the trend of stocks. Investors usually buy gold when they’re nervous about stocks, or when stocks are in a serious correction. That’s why gold and bonds are often bought during periods of stock market volatility. Despite its unusually long bull run and somewhat over-extended technical condition, the stock market is still in an uptrend. But investors have been buying defensive stock market sectors like consumer staples, utilities, and REITs; as well as traditional safe havens like Treasury bonds since the start of the year. They may be buying gold for the same reasons.
Trump’s Budget Proposal
President Trump just proposed his latest $4.8 Trillion budget, and suggests the deficit will decrease over the next 10-years.
The White House makes the case that this is affordable and that the deficit will start to fall, dropping below $1 trillion in the 2021 fiscal year, and that the budget will be balanced by 2035. That projection relies on rosy assumptions about growth and the accumulation of new federal debt — both areas where the administration’s past predictions have proved to be overconfident.
The new budget forecasts a growth rate for the United States economy of 2.8 percent this year — or, by the metric the administration prefers to cite, a 3.1 percent rate. That is more than a half percentage point higher than forecasters at the Federal Reserve and the Congressional Budget Office predict.
It then predicts growth above 3 percent annually for the next several years if the administration’s economic policies are enacted. The Fed, the budget office and others all see growth falling below 2 percent annually in that time. By 2030, the administration predicts the economy will be more than 15 percent larger than forecasters at the budget office do.
Past administrations have also dressed up their budget forecasts with economic projections that proved far too good to be true. In its fiscal year 2011 budget, for example, the Obama administration predicted several years of growth topping 4 percent in the aftermath of the 2008 financial crisis — a number it never came close to reaching even once.
Debt Slows Economic Growth
There is a long-standing addiction in Washington to debt. Every year, we continue to pile on more debt with the expectation that economic growth will soon follow.
However, excessive borrowing by governments, companies, or households, lies at the root of almost every economic crisis of the past four decades, from Mexico to Japan, and from East Asia to Russia, Venezuela, and Argentina. It’s not just countries, but companies as well. You don’t have to look too far back to see Enron, GM, Bear Stearns, Lehman, and a litany of others brought down by surging debt levels and simple “greed.” Households, too, have seen their fair share of debt burden related disaster, from mortgages, to credit cards, to massive losses of personal wealth.
It would seem that after nearly 40-years, some lessons would have been learned. For government “deficit” spending to be effective, the “payback” from investments made must yield a higher rate of return than the interest rate on the debt used to fund it.
The relevance of debt growth versus economic growth is all too evident. When debt issuance exploded under the Obama administration, and accelerated under President Trump, it has taken an ever-increasing amount of debt to generate $1 of economic growth.
If you subtract the debt, there has not been any organic economic growth since 1990.
US Manufacturing
The recovery in the nation’s manufacturing output remains tepid.
Industrial production (monthly changes)
Year-over-year changes in manufacturing output:
Europe has slowed too. The Eurozone (slowest growth since 2013):
Japan also. Last quarter’s GDP growth surprised to the downside.
Market Data
- The S&P 500 registered a bearish divergence, which indicates slowing upside momentum. The percentage of S&P 500 stocks above their 50-day moving average has declined over the past month.
- Never more confident. Preliminary readings for February suggest that consumers are uber-confident that stocks will continue to rise. The latest University of Michigan poll shows a record high in respondents who are 100% confident that stocks will be higher a year from now.
Sentiment – See below
All content is the opinion of Brian Decker
