“Fixed fortifications are a monument to the stupidity of man.”
-General George Patton
Keith and I are up in Quebec City this week coaching in the 61st annual Quebec Pee Wee Hockey tournament. One of the best things we’ve done this week is take our team to an outdoor rink and just let them play the game. It’s amazing the lessons that can be learned from unscripted competition.
Quebec City, with its European flare, is one of the last remaining walled cities in North America, and the only one north of Mexico. As the walls are called in la belle province, “The Remparts of Quebec” were originally built in the late 1600s. The British then refortified the walls in 1759 after they took the city from French in the Battle of the Plains of Abraham.
The moral of this story is that a walled city, much like a diversified or hedged portfolio, still has a risk of being taken over or getting blown up. As you build walls, write options against your portfolio, or attempt to protect your assets ... risk does not go away and it almost always comes in unexpected forms.
Even just going back the last couple years, thinking about the #Quad4 sell off in Q4 2018, the volatility spike of Feb 2018, the natural gas short squeeze of November 2018, or the squeeze in repo rates of September 2019, we know that when risk happens, it happens all at once. And even the best laid fortifications can offer limited protection.
Back to the Global Macro Grind…
The global risk of the day, of course, is COVID-19, the novel coronavirus that emerged from Wuhan in late 2019. This risk was starting to seem manageable just a week ago, until the Chinese changed how they were reporting numbers causing the case count to skyrocket.
The current case count in China is just under 75,000 and, so far, COVID-19 seems to be largely contained within. However, by surpassing the SARS case count by close to 10x, the economic impact the virus has on China is real and continues to reverberate throughout the globe.
My colleague and esteemed demographer Neil Howe wrote a fascinating article outlining his thoughts on COVID-19. Neil’s view is that one major underappreciated risk is that the Chinese are still misreporting the number of cases. As he writes:
“My outlook is that we should expect a lot more of these big upward corrections.The reason is that the public misunderstands what's wrong with the official statistics. The problem is not just that they greatly under-report what they are supposed to be reporting--all seriously symptomatic cases. It's also that these types of cases vastly under-represent the total number of infected persons. Why? Because most infected persons show few or no obvious symptoms.”
Whether Neil’s prognostication proves correct or not, and we hope for the Chinese people that it doesn’t, in practical terms the volatility of the reported numbers and continued opaqueness of the situation on the ground means this risk will continue percolating in markets for weeks to come, at a minimum.
The biggest issue with this novel coronavirus is that it has hit at a time when global growth was already sputtering and equity markets were at all time highs. In the Chart of the Day, we’ve summarized the key global economic data points with the ones in red noted as such because the economic data is decelerating. Obviously, the story is not good. The highlights, to name a few, include:
- Japanese GDP falling -6.3% quarter-over-quarter on the back of a consumption tax, typhoons and the trade war. This was followed up with a core machine orders number that fell -12.5%;
- Germany reporting a 0.0% growth rate in Q4 GDP on Friday and then following it up a Zew Survey of confidence that missed expectations by a country mile; and
- Meanwhile in the EU generally, car sales slumped by -7.5% year-over-year, which is the worst start since 2013.
The benefit in our rate of change analysis is that eventually bad data morphs into easy comps, which can lead to economies accelerating on a rate of change basis and shifting us into Quads that are more favorable to equity returns and general risk taking.
But until the rate of change turns positive, keep those portfolio heavily fortified with some our favorite #Quad4 plays like Utilities, Reits, Treasuries and Gold.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.50-1.66% (bearish)
SPX 3 (bullish)
RUT 1 (bearish)
NASDAQ 9 (bullish)
Utilities (XLU) 68.15-71.37 (bullish)
REITS (VNQ) 95.46-100.87 (bullish)
Consumer Staples (XLP) 63.78-65.11 (bullish)
Tech (XLK) 97.98-102.86 (bullish)
Shanghai Comp 2 (bearish)
Nikkei 23005-23654 (bearish)
USD 97.90-99.60 (bullish)
Oil (WTI) 49.02-53.50 (bearish)
Nat Gas 1.74-2.05 (bearish)
Gold 1 (bullish)
Copper 2.52-2.64 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
