Adversity Creates Opportunity
The financial markets are reacting to the breakout of the coronavirus in China which has unfortunately moved to other parts of the world including the United States. This is a tragic event which could not have happened at a worse time as China begins celebrating its Lunar New Year Golden week which is normally a period of celebration and tremendous consumer spending. China has taken actions having quarantined several cities, restricted travel, opened up new hospitals with doctors trained appropriately to handle viral outbreaks, closed common areas like movie theaters and the Great Wall, and much more to contain the epidemic. All of the government’s actions plus that of private corporations such as Disney, McDonald’s, cruise lines and others will negatively impact their economy and that of the global economy near term, including the U.S, until the spread of the virus is contained and an all-clear is issued.
We do not want to minimize the impact of a spreading virus that kills people. At the same time, it is our responsibility to manage clients’ assets every day through both the good and the bad. We must, therefore, always be willing to reevaluate our investment strategy as events change such as now. We must factor into our thinking about the impact this human tragedy has on the global economies.
The bottom line is that we have not altered our longer-term view that the global economy will improve sequentially as we move through 2020 into 2021, But clearly the first part of the year will be even slower than we had initially thought as it will be negatively impacted by the virus in China, the devastating fires in Australia penalizing industrial commodity exports, and Boeing’s problems getting the Max reinstated. While we had already adjusted down our near-term view of global economic growth last week, clearly we had not factored in the spreading of the virus which causes us to reduce even further our growth expectations for the first half of 2020. Our base case is that the virus will be contained over the next few months.
Notwithstanding, we continue to believe that the global economy will reaccelerate by the third and fourth quarters of 2020 into 2021 bolstered by aggressive monetary ease everywhere; major fiscal stimulus in China, Japan, Australia and the U.S; the closure of at least 11 trade deals between the U.S and other major countries including Phase 1 with China, the USMCA with Canada and Mexico, a deal with Japan, Europe postponing actions against our large tech companies, an impending deal with India, etc.; a likely Brexit deal; Boeing Max getting reinstated by mid-year; and Trump’s willingness to do everything in his power to win the election which means he will need both a strong economy and higher stock market in the summer and fall of 2020.
The full benefits of the trade deals plus Boeing’s Max reinstatement could alone add well over 0.7% to annualized 2020 U.S. GNP by the third and fourth quarters moving the annualized GNP growth rates to or above 3.0% annualized from much lower growth rates in the first half of the year. So, it’s time to look over the near-term valley, take advantage of the current weakness and invest with a one to two-year time frame. Rarely do you get a second bite of the apple-like now.
Adversity creates opportunities for investors. Lower economic growth than anticipated for the first half, for the reasons cited, will result in interest rates being lower, too. In fact, both the 10- and 30-year bond yields hit new lows for the year at 1.695% and 2.145% respectively, on Friday. Remember that the stock market is far more leveraged to changes in interest rates than earnings so even though earnings will not pick up meaningfully until the second half of 2020, lower interest rates will result in a higher multiple and overall stock prices near term as occurred in 2019. Be patient and buy slowly. Watch for updates on the virus.
We made a mild shift in our portfolios early last week slightly reducing our more economically sensitive stocks, including financials while adding to technology on Friday, which will be mostly immune to slower first half 2020 growth; credit card companies, which are benefitting from the growth in the internet plus entrance into China; and some special situations whose future valuations have nothing to do with the economy. We fully expect to shift this slightly more defensive position back to more economically sensitive stocks as we move through the first quarter and gain more information on the near- and longer-term impact of the virus on economic growth in China and elsewhere.
It was not surprising that the pundits/experts did another 180 last week becoming negative almost overnight after the virus breakout saying that they really have been bearish all along. Yeah, right. The truth is that they are technicians/traders–not investors. If you do the analysis, the market remains undervalued even if the 10-year treasury reaches 2.1% by the fourth quarter 2020 (it’s under 1.7% today) with S & P earnings running at an annualized rate well over $170 per share by the end of the year which we feel is still very conservative especially if the Boeing strike ends mid-year, as even the head of the FAA says now, and the benefits of all the trade deals finally begin to kick in. Also, we need to see the virus contained, at a minimum. We see no reason to alter our range of 3400-3600 for the S & P in 2020 at this time.
Adversities creates opportunities have happened time and again. We fully get that it is difficult buying/adding exposure in uncertain times but if history is any guide, it is the right thing to do as an investor willing to look over the valley. Remember the old adage, buy down when everyone is panicking and sell up when there is euphoria in the air. Now is such a time to add to positions but go slowly and average in.
One thing is for sure: all of the global monetary authorities will keep the spigots wide open as possible not knowing the potential economic impacts of the virus in China. We expect the Fed next week to maintain an overly accommodative stance mentioning that they have an eye on China worried about the potential hit to our and global growth. Expect the Bank of China to make further accommodative moves too and the government to add additional fiscal stimulus to help offset the near term hit to growth at the absolutely worst time, the Lunar New Year.
Since money makes the world go around, all of this monetary accommodation happening as near-term growth is in question due to the virus means that far more money is being created than needed in the real economy. Where will it go? Risk assets. Sounds like the story of 2019 when global growth slowed, interest rates went down and stock markets soared.
The difference today is that the global growth is ready to reaccelerate for all the reasons stated above and over the last few weeks. Once we get a handle on the real impact of the virus and it gets contained which is our base case, watch what happens to global growth. It will really move forward at a growing sequential rate into 2021 and beyond until the monetary authorities begin stepping on the brakes. BUT don’t expect that anytime soon!
We, along with everyone else, are saddened and worried by the outbreak of coronavirus in China. It is a tragedy of the highest proportions and we really feel for the Chinese people and all those directly and indirectly affected. We are confident that President Xi is moving as quickly as possible to care for those affected, control the outbreak from spreading, and minimize the impact on his people and their economy. But don’t expect this to end overnight. Be patient. Be willing to look over the valley and think as an investor.
The global economy, including China, was clearly on the cusp of growth reacceleration. Unfortunately, it may now be delayed until the outbreak is contained. But it will happen, as has been the case many times before, when other viral outbreaks have occurred around the world. We take solace knowing that there are tremendous resources, knowledge, and focus being used to solve /contain this outbreak.
Our portfolios remain concentrated in technology, especially the semis, as it is the right place to invest for all seasons; global industrial, capital goods and machinery companies who will benefit from fiscal stimulus and an acceleration in global growth; financials, especially U.S money center banks, who are undervalued earning 15+% return on equity, high dividends, and increasing buybacks; low cost, high yielding industrial commodity companies as supply growth is below demand growth which will lead to higher price realizations; agricultural companies; some retail, especially housing-related; and many special situations whose intrinsic value is far above current prices. We own no bonds and are flat the dollar.
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Remember to review all the facts; pause, reflect and consider mindset shifts; turn off the pundits/experts; look at your asset mix with risk controls; listen to as many company earnings’ calls as possible; do independent research and…
Paix et Prospérité LLC