Wednesday, 20 May 2020 04:53

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Choppy waters ahead:

Coronavirus epidemic caught most of us off guard. It is a black swan event or exogenous effect on the global economy. Markets were flying high in the first 45 days of the years and had severe 35% correction in thirty-three days.  

Immediately Federal Reserve slashed the short-term rate by 100 basis points to 0-0.25% and planned to buy $700 billion of bonds. The Federal Reserve has offered more than $3 trillion in loans and asset purchases in recent weeks to stop the US financial system from seizing up. Federal Reserve might consider controlling the yield curve under which Fed pledges to buy unlimited volumes of the treasuries to keep the 10-year yield below 1 percent.

On March 27th, Congress passed a massive Corona relief package for individuals, small businesses, and big corporations. Congress has approved more than $2.6 trillion in several economic assistance. Both expansionary fiscal policy and easy monetary policy gave confidence to the markets.

By May 19th, 2020 (as of today), markets recovered most of the losses and down only 8% year to date, probably one of the quickest rebounds in the near history.

Unfortunately, the coronavirus lockdown has pummeled the US economy, with over 30 million job losses and trillions of dollars of output and loss of wealth. Real gross domestic product (GDP) decreased at an annual rate of 4.8 percent in the first quarter of 2020. The decline in GDP is the first since 2014 and the worst quarterly contraction since 2008.

GDP change

This quarterly annualized growth rate was significantly lower than the +2.1 percent growth rate reported in Q4 2019. It is expected a much deeper contraction of between -38.8 and -43.7 percent (annualized) in Q2. The growth forecasts for Q3 and Q4 are also profoundly ambiguous and will depend on new infection rates, treatment options, testing availability, and government policies.

 

imf projections

The International Monetary Fund (IMF) released its latest World Economic Outlook in early April with substantial changes to its global projections due to COVID-19. After expanding an estimated 2.9% in 2019, Global GDP expected to contract by 3.0% in 2020 and then rebound in 2021 with a 5.8% expansion. This forecast is significantly different from the IMF’s interim projections published in January.

The IMF is projecting massive economic contractions in developed countries in 2020. The US economy expected to decline by 5.9%, the Eurozone by 7.5%, and the UK by 6.5%. At the same time, emerging countries such as China and India will grow at much lower growth rates than these nations have seen in recent years. China expected to grow by just 1.2% compared to 6.1% in 2019, while India will grow by only 1.9% following a 4.2% expansion last year.

The IMF is predicting that the global economy will experience its worst recession since the Great Depression, much worse than what we saw ten years ago with the global financial crisis.     

Deflation ahead?

CP42020

Despite the lower interest rates and massive fiscal spending, there are no signs of inflation, due to sluggish spending by consumers and cost-conscious corporations.

The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.8 percent in April on a seasonally adjusted basis, the most significant monthly decline since December 2008. A 20.6-percent decline in the gasoline index was the most significant contributor to the monthly decrease. The indexes for apparel, motor vehicle insurance, airline fares, and lodging away from home all fell sharply.

The 12-month percent change of CPI ending April for all items was 0.3%. In the past 12 months, prices for food, shelter, and medical services increased by 3.5%, 2.6%, and 5.8%, respectively. Energy (Gasoline), Apparel, and Airline fares declined by 32%, 5.7%, and 24.3%, respectively.

Leading economic indicators

Leading economic indicators show potential signs of change before economies show any material changes in their headline lagging indicators.  An increase in the leading economic index is a sign of future economic expansion, and a drop in the leading index, obviously an indication of future economic troubles. Historically the leading economic indicators gave clear signals when the economy is changing its course.

Globally Japan, UK, and German, leading Indicators were showing weakness since late last year. Now, these leading indicators abruptly changed the direction to lower in both developing countries like China and India to developed countries like the US and EU areas.

LEI2020Apr

Leading Economic Index ® (LEI) for the US declined 6.7 percent in March to 104.2 (2016 = 100), following a 0.2 percent decrease in February, and a 0.4 percent increase in January, which is the most significant decline in its 60-year history. The sudden deterioration of LEI was due to unprecedented initial unemployment insurance claims and a drop in March stock prices. However, markets are under the illusion(false) and recovering rapidly. The leading data and market reactions are quite the opposite of each other.

Cash is King

Once the legendary investor Warren Buffett famously said, ‘It’s only when the tide goes out that you will learn who has been swimming naked”.  During the economic distress period, debt-laden companies go bankrupt and strong firms only survive.

The entire airline industry is in trouble, almost all the airline companies except for Southwest showing signs of weakness. American Airlines has only 30 days of cash on its balance sheet by the end of March. It is a clear sign to get into bankruptcy. Companies like JC Penney, Neiman Marcus may not survive. Several upstream companies in the energy sector are deep in debt; persistent lower oil prices, many of them going to get bankrupt soon.

Outlook:

Recent market recovery does not reflect the underlying economy. Expect much severe market price adjustments when the analysts and pundits realize the forthcoming numbers do not match their expectations. The Coronavirus profoundly changed how we live and how we spend. Movies theaters, restaurants, apparel, Cruises, and amusement parks are struggling to survive.

General merchandise, wholesale clubs, e-commerce, online grocers, food delivery, streaming, and gaming companies will thrive in this lockdown or semi-free environment. The business will not be usual for an extended period, assuming both fiscal and monetary policies do not change their course until we see the signs of economic progress. Until the signs of growth appear, it is good to stay defensive by holding liquid assets and defensive stocks.

 

 

 

 

 

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