The First Battlefield

The data from China revealed
This bug, is in fact, the windshield
It splattered the hope
That ‘war’ was a trope
Instead ‘twas the first battlefield

China released its main grouping of March data last night and the picture was not pretty. Q1 GDP fell 9.8% Q/Q and was 6.8% below Q1 2019. Those are staggeringly large contractions of economic activity and likely portend what we will begin to see throughout the rest of the world over the next several weeks. The other key data points were Retail Sales (-15.8%), Fixed Asset Investment (-16.1%), both with record declines, and then surprisingly, Industrial Production, which fell just 1.1% in March from last year’s results, though has declined 8.4% thus far in 2020. The official spin of the data was that while February was abysmal, given the nation was essentially completely closed that month, things have started to pick up again and the future is bright. While Q2 seems likely to be better than Q1, bright may overstate the case a bit. After all, the Chinese economy remains highly dependent on its export industries, and the last I checked, most of its major western markets like the US and Europe remain closed for business. So even if Chinese factories are restarting and producing goods again, their client base is not yet in the market for consuming most things.

Excitement is starting to build
And President Trump’s clearly thrilled
That plans are afoot
To increase output
In states where Covid has been chilled

But as important as that data is, and despite the harbingers it brings regarding the rest of the world in Q1 and Q2, market focus is clearly on an even more important subject, the timing of the reopening of the US economy. Last evening, in his daily press conference, the President explained that there will be a three-step approach outlined for individual states to follow in order to try to return to more normal conditions. The idea is that when reported infections show a downward trend over a two-week period, that would be an appropriate time to allow certain businesses (e.g. restaurants, movie theaters, gyms and places of worship) to reopen amid strict social distancing guidelines. Assuming no relapse in the data, phase two would include the allowance of non-essential travel with bars and schools reopening, while phase three, also assuming a continued downward slope of the infection curve, would allow the bulk of the remaining economy to reopen, while observing ongoing social distancing.

At least, that is the gist of the idea. Each state will be able to decide for itself when it reaches appropriate milestones to expand allowable activities with the Federal government not imposing any specific restrictions. While the exact timing of these activities remains uncertain, there are likely some states that will be ready to start phase one before the end of April, while others will take much longer to get there.

Investors, though, see one thing only, that the worst is behind us and that if the US is going to reopen, then so, soon, will the rest of the world. After all, Europe was inundated with the virus earlier than the US. Thus, the prospect of restarting economic activity combined with the extraordinary stimulus measures undertaken by governments around the world has encouraged the investment community to race back into equity markets before they get too rich! At least that is what it seems like this morning.

Fear has taken a back seat to greed and stock markets around the world are higher. So, we saw Asian markets (Nikkei +3.1%, Hang Seng +1.6%, Shanghai +0.7%) all perform well despite the Chinese data. Europe has been even better, with the DAX +4.2%, CAC +4.0% and FTSE 100 + 3.4%, and US futures are closely following Europe with all three indices up well more than 2.0% at this point in the session. In other words, earnings collapses are now seen to be one-time impacts and will soon be reversed. At the same time, pent-up demand will restore much of the luster to so many beaten down stocks, especially in the retail and consumer space.

This seems a tad aggressive for two reasons. First, though undoubtedly reopening the economy will result in better outcomes, it is not clear that the future will resemble the past that closely. After all, are we going to see a much greater use of telecommuting, thus less need for daily transport? Will restaurant and bar business pick up in the same way as prior to the virus’s onset? Will shopping malls ever recover? All these questions are critical to valuations, and answers will not be known for many months. But second, the one thing of which we can be pretty certain, at least in the short run, is that share repurchase programs are going to be thin on the ground for quite a while, and given the more than $1 trillion of spending that we have been seeing in that space, it seems that a key pillar of equity market support will have gone missing. So, while today is clearly all about risk being acquired, it will be a bumpy ride at best.

Speaking of risk-on, a quick look at the FX market shows that the dollar, for the first time in a week is under pressure this morning, having fallen against all its G10 peers. NZD is the leading gainer today, up 0.75%, as kiwi appears to be the highest beta currency in the group and is responding to the US reopening story. Aussie is next on the list, +0.45%, with its beta second only to kiwi, and then the rest of the bloc is higher but in a more limited fashion.

EMG currencies, too, are showing life this morning with IDR in the lead, having rallied 1.1% alongside TRY up a similar amount. The rupiah seems to be the beneficiary of the announcement by the central bank there that they are going to begin direct purchases of government bonds, i.e. monetizing the debt, on Monday, which is apparently a positive statistic in the beginning of the process. Meanwhile, on this risk-on day, Turkey’s 8%+ yields remain extremely attractive for investors, drawing funds into the country. But essentially, the entire bloc is firmer today, even the Mexican peso, which has been one of the absolutely worst performing currencies around. It has rallied 0.25%, its first gain in more than a week.

Today’s narrative is clearly that whatever damage has been incurred by Covid-19, the worst is behind us. Investors are looking forward and anxious to take part in the next up cycle. Alas, the curmudgeon in me sees a scenario where it will take far longer to regain previous levels of activity than the market currently seems to be pricing, and so risk attitudes have room to reverse, yet again, in the not too distant future. But as long as the narrative is the future is bright, the dollar should soften while equity markets rally.

Good luck, good weekend and stay safe
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Ere Prices Explode

The pace of infection has slowed
In Europe, and thus has bestowed
A signal its clear
To shift to high gear
And buy stocks ere prices explode

In the markets’ collective mind, it appears that the peak of concern has been achieved. At least, that is what the price action for the past two days is indicating as risk is once again being aggressively absorbed by investors. Equity prices in the US soared yesterday, up more than 7.0% and that rally followed through overnight in Asia (Nikkei, Hang Seng and Shanghai all +2%) and Europe (DAX +3.2%, CAC +2.8) as the latest data indicate that the pace of infection growth may have reached an inflection point and started to turn lower. At least, that is certainly the market’s fervent hope. The question that comes to mind, though, is just how badly the global economy has been damaged by the health measures taken to slow the spread of the virus. After all, entire industries have been shuttered, millions upon millions have been thrown out of work, and arguably most importantly, individual attitudes about large crowds and mingling with strangers have been dramatically altered. Ask yourself this: how keen are you to go to watch a baseball game this summer with 50,000 other fans, none of whom you know?

Consider the poor misanthrope
Whose previous role was to mope
‘bout Facebook and Twitter
While growing more bitter
With Covid, his views are in scope

It does not seem hard to make the case that the market has moved far ahead of the curve with respect to the eventual recovery of the economy. If anything, the economic data we have seen has indicated that the depth of the recession is going to be greater, not lesser than previously expected, while the length of that recession remains completely unknown. One thing we have seen from the nations who were the early sites of infection; China, Japan, Singapore and South Korea, is that once they started to relax early restrictions, the pace of infection increased again. In fact, in Japan, PM Abe has declared a state of emergency in 6 prefectures for the next month, to impose restrictions on businesses and crowds. Similarly, Singapore has seen a revival in the infection rate and has imposed tighter restrictions to last through the rest of April.

The point is, a possible inflection point in the pace of growth in cases, while a potential positive, doesn’t seem worthy of a 10% rally in stock prices. The one thing of which we can all be sure is that the recession, when it is eventually measured, is going to be remarkably deep. It is almost certain to be much worse than the GFC as the amount of leverage in the real economy is so much greater and will cause much more damage to Main Street. Recall, the GFC was a financial crisis, and once the Fed supported the banks, things were able to get back to previous operating standards. It is not clear that outcome will be the case this time. So, does it really make sense to chase after risk assets right now? Bear markets historically last far longer than a month, and it is not uncommon for sharp rallies to occur within the longer term bear market. Alas, I see more pain in the future so be careful.

And with that in mind, let us turn our attention to the FX market, where the dollar is lower versus every other currency of note. In the G10 bloc, NOK is today’s leader, +2.2%, as hopes that an OPEC+ agreement will be reached this week have helped oil prices rise more than 3.0%, thus ensuring a benefit to this most petro-focused of currencies. But it’s not just NOK, AUD is higher by 1.5% after the RBA left rates on hold, as expected, and announced that they have purchased A$36 billion of bonds via QE thus far. The rest of the bloc has seen gains ranging from 0.6% (CHF) to 1.1% (SEK) as the overall attitude is simply add risk. The one exception is the yen, which has barely edged higher by 0.1%, ceding earlier gains in the wake of the state of emergency announcement.

Turning to the emerging markets, CZK and ZAR are the frontrunners, with the former up a robust 2.4% while the rand is higher by 2.1%. It seems that the Czech story is merely one of a broad-based positive view of the country’s fiscal house, which shows substantial reserves and the best combined ability to deal with the crisis and prevent capital flight of all EM currencies. Meanwhile, the rand has been a beneficiary of inflows into their government bond market, which are currently competing with the SARB who is also buying bonds. Perhaps the most encouraging sight is that of MXN, where the peso is higher by 1.5% this morning as it is finally receiving the benefit of the rebound in oil prices. In addition, key data to be released this morning includes the nation’s international reserves, a number which has grown in importance during the ongoing crisis. We have already seen some significant drawdowns in EMG reserve data as countries like Indonesia and Brazil seek to stem the weakness in their currencies. That has not yet been the case in Mexico, but given the peso’s phenomenal weakness, it has fallen 25% since March 1, many pundits are questioning when the central bank will be in the market.

Overall, though, it is a risk-on day and the dollar is suffering for it. Data this morning has already shown that the NFIB Small Business Optimism index is not so optimistic, falling 8 points to 96.4, back to levels seen just prior to the 2016 presidential election, which ushered in a significant increase in optimism. We also get the JOLT’s jobs data (exp 6.5M) but that is a February number, and obviously of little value as an economic indicator now.

It appears to me that the market is pricing in a lot of remarkably positive data and a happy ending much sooner than seems likely. Cash flow hedgers need to keep that in mind as they consider their next steps.

Good luck
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