Apples warning dominated price action yesterday, however Asian equities have been quick to shake of any concerns choosing to ignore the warnings of potential supply shocks that could ripple through supply chains and production lines. Havens assets remain bid and treasuries are holding gains indicating in at least some subsections of the markets caution and risk aversion persists. USDCNH also remains above the 7 handle, with the weaker yuan acutely watched by traders as a barometer of risk. The PBOC today fixed the yuan above 7 per dollar at 7.0012 today for the first time since December. With USDCNH breaking out, risk will remain on edge.
Equities are to date resilient and not reflecting the state of demand destruction in China and hit to growth. Instead focussing on a cocktail of dual stimulus measures as a cure all. We still maintain that this attitude is complacent given the capacity for non-linear secondary effects to cascade as shutdowns and quarantines become more protracted. Monetary stimulus and tax cuts will not be effective whilst people are quarantined and factories continue to operate at reduced capacity.
News of continued state support from China has buoyed Asian indices further this afternoon, as officials are reportedly considering direct cash injections and mergers to bail out the battered airline industry.
Additional stimulus measures are heavily on the minds of traders and still on the cards as President Xi has again affirmed China’s 2020 economic targets. Repeated pledges from officials that vow to meet these growth targets underscores the sentiment that authorities will prioritise short term growth over financial stability and deleveraging goals and will not tolerate any growth collapse. Although they will tread a fine line given financial risks already in system and likely maintain a more judicious approach than in previous bouts of stimulus. Continued policy support, both fiscal and monetary, will be required in China to mitigate downside risks from the coronavirus outbreak and promote a self-sustaining trajectory for growth. On that basis we expect more RRR cuts, along with further cuts in the MLF/LPR with more support for private firms as this sector continues to drive job creation, accounting for 80% of jobs and more than 90% of new jobs, according to the National Development and Reform Commission of the People's Republic of China. Limiting job losses is as ever a key focus as employment remains key for social stability.
Non-linear supply side effects like production bottlenecks are the real wildcard in terms of further forecast downgrades to growth and earnings and longer term disruptions. There is the added issue of a lack of reliable data with which to generate robust forecasts which adds to the uncertainty. This lends the potential for the recovery and ripple effects to be much more drawn out than is currently anticipated.
A survey from the American Chamber of Commerce in Shanghai confirms that China is by no means close to returning to full operating capacity. According to AmCham Shanghai’s survey of 109 members, as of February 14, “78% of companies do not have sufficient staff to run a full production line.”
And according to officials in China post the Lunar New Year holiday approximately only 30% of workers have returned to cities to work “the number of migrant workers returning is about 300 million, and about 80 million have been returned so far.”.
Another article from Bloomberg outlines that “a growing number of China’s private companies have cut wages, delayed pay checks or stopped paying staff completely.” These data don’t point to a speedy recovery and are keeping with our previous observations that restoring production back to full capacity will not be an easy task and activity will resume in dribs and drabs. Real-time data like property sales, coal consumption and road congestion displays a worrying picture for those expecting a quick return to capacity. Shutdowns in China are now more prolonged than many original expectations, many factories have not resumed production and cities are still on lockdown as measures are taken to limit the virus spread.
If, as we expect, the recovery is more protracted, we will see continued downward guidance from companies dependant on Chinese supply chains which would stoke risk-off sentiment once more. There is an increased risk of continued downgrades to growth and earnings, as hard data catches down to the realities of the present disruptions to economic activity, travel and supply chains which could see volatility pick up over the next month. But contextualizing this with a longer term outlook, the impact will not permanently dent global growth (at this stage). As such, we stick with our original assumptions that in the current investment paradigm, this bad news is good news as investors anticipate ample liquidity to keep on flowing. Allowing equities to diverge further from economic fundamentals. But, given the complete lack of reliable data we must balance complacent markets with elevated tail risks, namely, the impact of the virus outbreak being far greater than is currently discounted across equities. So participating in the upside momentum and maintaining optionality/tail risk hedging with respect to potentially much more negative outcomes.
Although 2019 saw multiple downwards revision to global growth and earnings forecasts, the S&P 500 returned 30% as the Fed and a raft of other central banks across the globe pivoted their policy stance early in the year. This served as a costly reminder for many not to fight liquidity. And heading into 2020, financial conditions remained accommodative following the aforementioned pivot from multiple central banks throughout 2019 which has led to underlying upside momentum remaining strong. Rate hikes/”normalisation” of monetary policy comes with an increasingly high bar. And as investors re-calibrate long term interest rate expectations at current levels, large amounts of capital is enticed up the risk spectrum. With lower rates also feeding into valuation models, justifying higher multiples, and fuelling asset price inflation.