The Beginning Of The End?John Leiper - Head of Portfolio Management - 3rd April 2020
The coronavirus has brought economic activity to a virtual stand-still and transformed a strong global economy, with lots of debt, to a weak economy… with lots of debt. As a result, financial markets have sold-off in dramatic fashion.
Yet despite all that, and as shown in the chart below, the S&P 500 remains in a long-term uptrend. This trend has existed, uninterrupted, for over 70 years having endured the 2007-2008 financial crisis and 1973-1974 oil shock.
The chart below shows the Chinese manufacturing and non-manufacturing PMI numbers. PMI stands for purchasing managers index and is a monthly survey of managers in private sector companies to determine the health of the economy. Values above 50 are considered expansionary and below 50 are contractionary. Both indices recently surged back after falling dramatically the prior month. This could point to strong economic recovery in China.
The chart below shows the performance of the Shanghai Stock Exchange relative to other developed and emerging market equities. Chinese equities have outperformed by a considerable margin since the onset of the coronavirus in early February.
Since early February Chinese government bonds have outperformed the benchmark (relative performance in white) as well as European (purple) and Japanese (red) government bonds.
Meanwhile, the European political response to the crisis has been found wanting and the US is now heading into a “very painful” two-week period in which confirmed cases and deaths are expected to continue to climb. Therefore, relative to European and US assets, we think it makes sense to invest in China and other Asian countries.
Why have Asian countries suffered less from the coronavirus?
This is a difficult question to answer. But three potential reasons stand out:
The first is superior policy implementation. Simply put, Asian countries are better suited to dealing with global pandemics than other regions because they have experienced more of them. Prior crises brought temperature monitoring devices to airports and governments monitored mobile phone data to reduce the spread of the virus.
The second reason is herd immunity. The Sars outbreak of 2003, to which many Asian populations were exposed, was caused by Sars-CoV. The current outbreak, COVID-19, is caused by Sars-CoV-2 and therefore Asian populations may have some degree of built-in immunity.
Thirdly, certain Asian hospitals appear better funded and more adequately prepared to handle the virus than other healthcare systems.
If Asian economies can ride out the coronavirus better than their western peers, then the fall in economic activity will be less severe and the recovery quicker.
What about the longer term?
Dramatic events bring dramatic change. The big question is how long it will take to beat the coronavirus. The longer it lasts, and the greater its impact on western countries relative to Asia, the greater the probability the coronavirus will act as a catalyst for the decline of the US and rise of China as the next hegemonic power.
This battle is already raging. It is why Donald Trump imposed sanctions on China and accused them of intellectual property theft.
The answer to this question comes down to economic power and currency. The US is the strongest economy in the world. As such it enjoys the “exorbitant privilege” of having the global reserve currency, the US dollar. This is a huge advantage to the US economy.
However, nothing lasts forever. The US took the mantle from the British in 1945, following the devastation of the second world war. Before that, it was the French, who dominated Europe from the early 1600s until the Battle of Waterloo in 1815.
China is next in line. The country has contributed the most to global economic growth since 2008 and in 2015 the International Monetary Fund named the Chinese yuan a global reserve currency. Further, a growing number of countries including China, Russia and the European Union are increasingly looking to move away from the US dollar: (CNBC)
The ultimate transition from the US to China probably remains a long way off. Since becoming President, Donald Trump has eschewed the foreign policy of prior Presidents and aggressively asserted a form of US nationalism. The immense monetary and fiscal fire power we saw last month will likely keep the US on top for the foreseeable future.
However, the “exorbitant privilege” the US enjoys from the global reserve currency has now morphed into an “exorbitant burden” as the Fed is forced to do all it can to support the global economy. This is shown in the chart below which shows the level of purchases under QE4, which now matches the financial crisis in 2008.
This chart shows the total assets of Federal Reserve Banks and how this has grown through several rounds of quantitative easing following the financial crisis in 2008.
Saving the global economy will involve unprecedented levels of monetary and fiscal policy as well as a weaker US dollar. As such, the US dollar may no longer serve as a beacon of financial rectitude, nor as an effective store of value (one of the necessary requirements of a global reserve currency). If the world is forced to look for an alternative reserve currency this would undermine the US and benefit China.
The US dollar is already overvalued. Since the 1960s the US dollar has moved in 17-year cycles, rising and falling in value relative to a basket of developed market peers. We are now at a point in the cycle where the currency is likely to depreciate over the coming years. This cyclical tendency will coincide with the afore-mentioned policy specifically designed to weaken the dollar. Given the correlation to US equities, this would signal an end to US equity outperformance as the rest of the world, led by China, catches-up.
The US dollar index (in white) typically moves in a 17-year cycle as demonstrated by the red arcs. Movements in the US dollar are correlated with the relative performance of US equities (in blue).
The coronavirus is unique in the level of uncertainty it has un-leashed, in such a short space of time, on our personal lives and on the economy.
This uncertainty has caused ruptures across financial markets. What is required, to break the deadlock, is clear visibility that the end is in sight.
With that in mind, the following interview, published Thursday evening, is very positive (skip to 5 minutes): Foxnews.com.
In the interview Stephen Smith, the founder of the Smith Center for Infectious Diseases and Urban Health claims to have made a breakthrough using hydroxychloroquine on infected patients.
In his words, “I think this is the beginning of the end”.
John Leiper – Head of Portfolio Management
This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.
Want to know more about the Equity Markets?
Please contact us here:
In last week’s blog we discussed the ‘Nasdaq whale’, Softbank, and the role it played, alongside an army of retail investors, driving tech prices ever higher prior to the recent correction. These short-term ‘technical’ flows are driven by the options market as traders look to hedge their underlying exposure, amplifying moves both lower and higher.
In a speech for the history books, last week Fed chairman Jerome Powell announced a significant change to the way it conducts monetary policy by formally announcing ‘average inflation targeting’. This means the Fed will now allow inflation to overshoot its official 2% target to compensate for prior years where inflation failed to reach that level.
Despite the fact the coronavirus has plunged many countries into recession, global equity markets are now back at all-time highs, as measured by the Bloomberg World Exchange Market Capitalisation index.
In The Return Of Inflation (5th June 2020) we made the case for a transition from the existing deflationary narrative to one in which markets start to price-in inflation.
Having identified, and benefited from, the 7% fall in the value of the US dollar index since late April, we have now turned tactically cautious.
In last week’s blog, This Time It’s Different (24 July 2020), I suggested the US dollar was on the cusp of crashing through its decade-long uptrend.
There are growing signs that the US dollar may finally roll over.
Welcome to the Q3-2020 ‘Quarterly Perspectives’ publication.
The 10 year US Treasury yield has remained remarkably steady over the last few months, particularly as inflation expectations have gradually risen.
Those stocks that outperformed during the corona crisis are the same ‘winners’ that outperformed before the crisis.
The recovery in US equity prices, from the corona crisis, has been one of the most rapid in history.
China’s economy has transitioned, from an industrial export-led model, towards services.
Commodities are nothing if not cyclical. They rise and fall in value with remarkable consistency over time.
Quantitative easing, or QE, is where a central bank creates money to buy bonds. The goal is to keep interest rates low and to stimulate the economy during periods of economic stress.
In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.
Over the last decade, the Fed has increasingly resorted to unconventional monetary policy, such as quantitative easing, or QE, to stimulate the economy.
In response to the corona crisis, global central banks have unleashed a tidal wave of liquidity.
One question I get from advisers and clients, more than any other, is why global equity markets have bounced back so far.
In the early stages of the Corona Crisis of 2020, the global economy faced a liquidity crisis.
In an unprecedented day in the history of oil trading the price of the front month contract for West Texas Intermediate (WTI) oil fell below zero to -$37.63.
As the world’s reserve currency, the US dollar is the go-to currency. It is used to price assets, complete transactions and as a store of value.