Virus Malaise

It seemed, for a couple of days
That the stock market’s virus malaise
Had finally broken
But now, not unspoken,
Concerns grow in multiple ways

The upshot is risk’s in retreat
And currencies cannot compete
With strength in the greenback
Which this week’s been on track
For, every prediction, to beat

As we head into another weekend, investors and traders have once again demonstrated concern over a shock change in the Covid-19 story and correspondingly have reduced their risk holdings in most markets. While the Chinese government continues to try to pump massive amounts of stimulus into their economy, the actual results may not be as impressive as the numbers suggest. For example, last night the PBOC released their Money supply data, granted a number that has lost much of its luster over the years, but one which still helps explain what is happening in the monetary system there. After all, without a robust monetary system, real economic growth is virtually impossible. And M1, the narrow measure, registered “growth” of 0.0% in January, which means it was at the same level as January 2019. That was a shockingly low outcome (forecasts were for 4.5% growth) and likely indicative of just how little economic activity is occurring in China right now. The other nasty data point was auto sales, which fell, wait for it, 92% in the first half of February. Remember, China is the world’s largest auto market, with annual sales having approached 25 million in 2017, although that number slipped to 21.5 million last year. But a 92% decline, if it persists for another month only, implies that sales will fall below 20 million, and if things don’t get better soon, that number can be much lower. The point is regardless of how much stimulus the Chinese government pumps into the economy, if people remain quarantined and cannot go out and spend it, the economy is going to suffer for a long time.

On top of the Chinese data, the other growing fear is that Covid-19 is starting to spread more widely outside of China. To date, the bulk of the infections have been in Hubei province, although the entire nation is on alert. But last night we heard of more infections in both South Korea and Japan, while the death toll continues to climb alongside the overall infection count. And for the 3rd time this month, the Chinese changed the way they count infections, which pretty much guarantees that whatever numbers they release are hogwash. I fear the virus is much more widespread than publicized, and that it will take far longer than another month for things to return to any semblance of normal in China. There is no ‘V’ shaped recovery coming in Q2, I don’t even think there is a ‘U’ shaped one on the horizon. I fear the Chinese recovery, at least for 2020, may well be ‘L’ shaped.

So, with those cheerful thoughts in mind, let’s look at markets and what they have done both overnight, and all week. Starting with equity markets, last night saw weakness in Asia (Nikkei -0.4%, Hang Seng -1.1%, KOSPI -1.5%) which took their weekly losses to -1.3%, -1.8% and -3.6% respectively. Shanghai, on the other hand, was slightly positive overnight (+0.3%) taking its weekly advance to 4.2%. Of course, Shanghai is the epicenter of a massive inflow of liquidity, so while the real economy may be cratering, new monetary stimulus can easily find its way into the stock market as people trade from home.

European markets have fared somewhat better, with the DAX (0.0%, -0.6% this week), CAC (-0.1%, -0.3%) and FTSE 100 (-0.2%, +0.2%) all biding their time as none of these countries have yet been severely impacted by the virus directly, although obviously, exports to China will have suffered greatly. Meanwhile, in the US, leading up to today’s session, the DJIA has fallen 1.1% this week and the S&P 500 is -0.2%, although the NASDAQ is actually higher by 0.25%. That said, futures markets in all three are pointing lower this morning.

Other key risk indicators are also showing significant gains this week, notably gold (+0.9% today, +3.2% this week) and Treasury bonds, where the 10-year yield is at 1.49% (-2.5bps this morning and 9bps this week).

Finally there is the dollar, which has outperformed virtually every currency this week, with only the Swiss franc even breaking even. In the rest of the G10 space, the yen is the week’s big loser, having fallen 2.0%, a true blow to its status as a safe haven. As I wrote yesterday, it appears that Japanese exporters have stepped away from the market, while leading up to fiscal year end in Japan, there has been an increase in outward investment on an unhedged basis, meaning Japanese lifers and pension funds are buying dollars to buy USD assets and unconcerned about the dollar falling. But both AUD (-1.6%) and NZD (-1.9%) also had a rough week, as the fact that China seems to have come to a virtual standstill will have an immediate negative impact on both those economies.

In the EMG bloc, LATAM currencies have been under the most pressure this week, with BRL (-2.5%), CLP (-2.35%) and MXN (-2.3%) all feeling the impacts of slowing growth in China as the first two are reliant on exports to China for a significant amount of economic activity, while Mexico, which has been holding up extremely well until this week, seems to be feeling the pain of overly extended carry positions amid a risk reduction period. MXN futures are the largest outstanding long positions on the IMM, as many investors seek to earn the 500bps of positive carry. However, as can be seen from the movement just yesterday and today, all that carry can be offset in the blink of an eye when things turn. Given how large the long MXN positions still are, do not be surprised to see the peso weaken much further going forward.

Away from LATAM, it can be no surprise that KRW (-2.1% this week) and THB (-1.6% this week) are also under pressure as the direct Covid-19 impact is greatest in those nations that do the most business with China. And not to be outdone, CNY (-0.65% this week) is trading well back through the 7.00 level and seems unlikely to reverse course until we get unequivocally better news regarding Covid-19.

On the data front, yesterday’s Philly Fed number was spectacular, 36.7 vs. 11.0 forecast, indicating that the US growth story has not yet felt any real effects of the virus. Overnight saw weakness in Australian and Japanese PMI data, again no real surprise, but better than expected results out of Europe and the UK. It seems that the signing of the phase one trade deal was seen as quite a positive, and while Eurozone (and German and French) Manufacturing all remain in contraction with PMI’s below 50.0, the levels have rebounded significantly from their low prints several months ago. This morning brings the US PMI (exp 51.5 for Manufacturing, 53.4 for Services) although this market is far more focused on next week’s ISM data. We also see Existing Home Sales (5.44M) which continue to perform well given the combination of incredibly low Unemployment and incredibly low mortgage rates.

On the day, the dollar is more mixed, having ceded some of its weekly gains vs. the euro and pound, but sentiment appears to continue to point to further risk reduction and further dollar strength as the week comes to a close.

Good luck