The Full Story
Markets retreated on yet another fearful Friday this week after hitting new all-time highs on Wednesday. The coronavirus again dominated headlines as confirmed cases rose and economic and corporate releases began quantifying negative impacts. Interest rates worldwide slid to melancholy levels in response, with the 30-year U.S. Treasury bond hitting an all-time low yield of 1.89%. Remember, low yields support higher valuations, but only in times of growth. Low yields cannot protect high valuations when earnings fall. Earnings will fall when the economy recesses. The tension between all-time highs for stock markets and all-time lows for bond markets will not ease until investors gain clarity on just how sick the Chinese economy can get.
Coronavirus statistics have gotten confusing lately as case counting and changes to the criteria for case counting occur simultaneously. According to the World Health Organization, 76,769 people worldwide have contracted the virus of which 75,569 reside within China. Of those, 62,662 reside within the Hubei province. Outside of China, the number of infected totals 1,200. So, for the moment, this remains a Chinese story and more specifically a Hubei story.
Fifty-eight million Chinese inhabit the Hubei province, and nearly 10 million of those live within the city of Wuhan, the epicenter of the outbreak. The province plays an important role within China given its central location and its placement along the Yangtze. Wuhan, Hubei’s largest city and the epicenter of the coronavirus breakout, has been designated as the most important transportation hub in central China, with the largest inland port, the largest airport in central China and the largest hydroelectric powerplant on the planet, The Three Gorges Dam. Economically, Hubei has a growth rate higher than the national average and ranks 8th in China with a total GDP of approximately $500 billion, roughly the size of Michigan’s. Per the Chinese government, residents of the Hubei peninsula must remain at home in quarantine to limit further spread of the coronavirus. In some locations, one member of the family can venture out once every three days to collect food and other essential items. In other locations, approved committee members deliver necessities door to door. All businesses not providing essential items have been closed, and only transportation vehicles carrying essential items are allowed on the roads. For now, Hubei is closed. Beyond Hubei, there are travel restrictions covering most of the country and unofficial containment measures as individuals choose isolation. Air traffic across China has fallen 85% and road usage by 25% according to Morgan Stanley and Capital Economics. Given the vast size of China’s migratory workforce, and the timing of the outbreak around the travel-heavy Lunar New Year, factories capable of production are short-staffed as Apple bemoaned to analysts this week. While the quarantines may stop the spread of the coronavirus beyond China, they also ensure the spread of economic ills through disrupted global supply chains.
With a meaningful portion of the Chinese economy quarantined, the Chinese government has initiated offsetting stimulus measures. The Peoples Bank of China has cut interest rates twice so far and has injected approximately $200 billion in liquidity (QE). Social insurance fees on businesses have been suspended, amounting to sizable and immediate tax cuts. At more local levels, officials have removed limitations on auto purchases in congested areas, provided chartered transports for migrant workers and relaxed property market curbs. On Friday, Politburo members met and signaled that further larger-scale stimulus measures were in development. Beyond offsetting the economic impact of the coronavirus, the PRC has additional stimulus incentive. The party will celebrate its 100th birthday in 2021 and committed 10 years ago to creating a “comprehensive well-off society” measured by an increase in per-capita GDP above $10,000 and a doubling in national GDP overall. To achieve these objectives, the Chinese economy must grow by at least 5.6% in 2020. Admittedly, that’s lower than the 6.1% achieved in 2019, but with the coronavirus sapping as much as half of China’s GDP growth in Q1, the party may need to deploy super-sized stimulus to meet their own targets. While debt levels overall in China have grown considerably over the last decade, the government still has the fiscal space to spend a lot.
