- China's economy is experiencing a severe economic recession which, in a best case scenario, will last at least two quarters.
- A global recession is certain to be sparked by China's deep recession and it will last at least two quarters in a best case scenario.
- The rapid and widespread international contagion of COVID-19 will deepen the global recession further, to an extent that is highly uncertain, making the timing of recovery highly difficult to forecast.
- The degree of incompetence, on the part of Wall Street economists and strategists that is currently being demonstrated by their failure to gauge the severity and extent of the global economic damage caused by the COVID-19 fallout, is astounding.
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In my article published one month ago I warned my readers and my subscribers about the fact that Wall Street consensus - highly influenced by the opinions of bulge-bracket economists and strategists - was severely miscalculating the actual and potential economic impacts of the COVID-19 outbreak in China. I also issued a warning about the correlative risk of severe global economic disruptions sparked by the severe economic downturn in China. Finally, I warned that due to the specific characteristics of the COVID-19 virus, it was quite likely that the disease would spread on a global scale, thereby magnifying damage to the global economy.
In this follow-up article to that prior piece ("Coronavirus Poses A Serious Threat To The Chinese Economy and Your Portfolio") I will update readers on my views, focusing on the economic impacts of developments related to COVID-19 in China and the rest of the world.
A Recession in China is Now Certain
The majority of Wall Street economists and strategists are still forecasting that developments related to COVID-19 will merely cause a slowdown the growth of China’s GDP growth in the first quarter. Furthermore, the majority of Wall Street economists and strategists are still forecasting that China will experience a “V-shaped” economic recovery beginning in the second quarter and that GDP growth for full-year 2020 will merely decelerate by about 0.50% or so.
This state of affairs represents the most blatant and severe case of incompetence on the part of Wall Street economists and strategists that I have ever experienced in my 25+ year career in trading and investing – a situation that is even more embarrassing than their inability to foresee the financial crisis (when it was already inevitable) in 2007-2008.
Consider the following facts about China’s economy:
1. 50% of China’s workforce is idled. Roughly 50% (plus or minus 10%) of China’s workers are not back to work. The first cause of this is that less than one-third of China’s migrant workers are back to work. This means that roughly 25% of China’s total workforce is completely idle/unemployed.
An additional 25% of China’s workforce is not able to work for one or more of the following reasons:
A) Residential restrictions and other local and national restrictions on movement of the population.
B) Voluntary restraint. Many Chinese simply are refusing to go back to work or re-open business due to fear of infection, avoidance of actual or potential quarantines, or a variety of other reasons associated with the COVIC-19 crisis.
C) Mass layoffs and involuntary unemployment. Layoffs are massive in businesses in all sizes and in virtually all types of industries in the private sector. However, layoffs in the small business sector are particularly massive.
2. Small business devastated. Small and medium-sized firms in China – which generate about 60% of GDP and 80% of employment – have been absolutely devastated. Numerous surveys indicate that roughly 60%-70% of Chinese small businesses are completely shut down. For example, according to official data released on Thursday, production has only resumed at 32.8% of China’s small and medium-sized firms, as of Wednesday. And even small and medium-sized firms that are open for business, are operating at well below their normal capacity.
Data on the disruption to small and medium sized businesses abound. For example, according to one recent survey of Beijing restaurants, 69% of restaurants are completely closed. The remaining 31% are operating at below 50% of capacity, on average. Overall restaurant revenues are down by more than 80%. Auto sales have collapsed by over 80% in the first three weeks in February. Movie theater sales, a reasonably good proxy of going on with retail commerce at China’s shopping malls, are down by over 90%.
3. Supply chain disruptions. Even businesses that are able to operate with minimal staffing are hobbled due to shortage of inputs from suppliers.
4. Consumption economy is paralyzed. Private consumption directly contributes just under 40% of China’s GDP – and indirectly contributes much more due to its impact on investment expenditure. Due to various restrictions on the movement of people, the consumption patterns of people in China have been extremely disrupted and curtailed. Even more important than the official restrictions, due to fears of contagion, Chinese citizens are staying at home and refusing to frequent public places such as shopping centers, shops and restaurants. This situation will only become normalized after people feel no fear of contracting COVID-19. Even in a best-case scenario, this will not happen until the end of June.
And this is only a very partial list of the problems facing the Chinese economy.
Now, let us do some simple arithmetic, taking into account only the known facts about the disruptions in the Chinese economy :
- January’s GDP in China experienced a huge contraction due to severely curtailed consumption during the Chinese New Year season and other disruptions which were already affecting the economy at that time.
- Regarding February, we know from a variety of statistics (some of which I cited above) that during the course of the entire month, about half of China’s economy was completely paralyzed due to the idling of roughly half of its workers. Furthermore, the non-idled part of the economy was operating way below capacity. This suggests a year-over-year contraction of at least 50% in Chinese GDP.
- In forecasting March, even if we assume an optimistic scenario in which China’s economy get’s its operating supply rates (particularly labor) back to 100% in a linear fashion by April 30 (two months), this still implies a contraction in China’s GDP of over 30% in the month of March.
So, just doing very simple arithmetic, there is no way that the contraction in China’s GDP in the first’s quarter of 2020 - if it were properly measured - will be any less than -20%.
Surely, China’s official statistics will not report this sort of a dramatic figure. But this will nonetheless be the reality, which will be experienced by China’s economy and which will deal a mighty blow to the entire global economy. This is the economic reality which Wall Street economists and strategists should ultimately care about, which will be fully reflected by many national and international indicators of global economic growth (which China’s government cannot manipulate). And it is the reality which will be reflected in a severe decline in corporate earnings reported by companies all over the world.
How about full-year 2020 GDP? Economists and strategists are virtually all talking about a quick V-shaped recovery. However, basic economic theory and economic history shows that economic shocks of this magnitude do not tend to produce V-shaped recoveries. These types of massive economic shocks tend to produce severe second and third-order effects in subsequent quarters. This is particularly true if there are high levels of indebtedness, speculative activity, and macro/micro economic imbalances as exist in China. Fiscal and monetary stimulus can only partly counteract such a profound shock - and with a lag.
The knock-on effects from the first quarter shock (even assuming the virus and disruptive efforts to contain it totally disappear by March 31) will extend recessionary conditions in China at least through the second quarter, in the best-case scenario.
In addition, there are other issues to keep in mind. First, on the supply-side, there is no reasonable scenario where China’s economy will be operating at full capacity for the entire second quarter. In a best-case scenario, it will take at least until the end of June to get back to full employment and a full normalization of business supply chains.
Second, on the demand side, given the highly contagious characteristics of #COVID-19 and people’s fear of contagion, there is no reasonable scenario by which China’s consumption patterns will be normalized before the end of June.
Given the availability of the aforementioned facts and elementary inferences, the fact that most Wall Street economists and strategists are still talking about a mere slowdown in China’s GDP growth in the first quarter and a v-shaped recovery from the second quarter onward is absolutely mind-boggling.
Current Wall Street consensus regarding the Chinese economy is the most shocking example I have ever witnessed of generalized and systemic professional incompetence.
Global Recession Is Certain
A deep decline in China’s GDP, by itself, would certainly be enough to trigger a global recession - generally defined as global GDP growth of less than 2.0%, for at least two quarters during 2020. However, this outcome is even more obvious due to the following factors:
1. Japan’s economy, the third largest in the world, was already contracting at an annualized rate of more than -4.0% in the fourth quarter of 2019, prior to experiencing any of the impacts of COVID-19 on its economy. Due to knock-on effects from China, combined with Japan’s own troubles with a potential COVID-19 outbreak, Japan’s GDP is certain to contract even more deeply during the first and second quarters of 2020.
2. Major COVID-19 outbreaks in South Korea, Italy and other countries are certain to trigger contractions in GDP growth in those nations during the first half of 2020.
3. Manufacturing activity, in every major country in the world will experience severe contractions in production due to the major supply chain disruptions in China and potentially various other nations. Manufacturing will also suffer from the severe shock to demand -particularly demand for durable goods and capital goods. This will most severely impact major economies highly dependent on global manufacturing supply chains (e.g. Germany and Mexico).
4. Developing nations tend to be highly vulnerable to shocks emanating from major economies (e.g. China and Japan). This is particularly true of commodity exporting nations in Latin America and Africa. This is also true of nations - the nations in Southeast Asia being a prime example - whose economies are highly intertwined with the global manufacturing economy, and China’s economy in particular.
5. Countries with large financial vulnerabilities, such as India and Turkey, will experience severe economic difficulties as the global financial system seizes up and risk appetite vanishes.
Virtually no Wall Street global economist or strategist that I am aware of is forecasting a global recession for the entire first half of 2020 – despite the fact that, at this point, this is virtually an inevitable certainty, given all that I have pointed out above.
The only interesting question that economists and strategists should be asking, at this point, is whether and to what extent the deep global recession in the first half of 2020 will extend into the second half of 2020.
While the global economy is literally in the midst of a severe free fall, virtually all Wall Street economists and strategists are still insisting that the impact of the global COVID-19 crisis will be minor for full-year 2020 and are merely tinkering with their global growth forecasts for full-year 2020 - typically reducing them by only 10 or 20 basis points. Given all of the facts and elementary inferences referenced above, Wall Street economists and strategists are collectively displaying breathtaking incompetence.
The global economic crisis triggered by the COVID-19 outbreak in China, and the subsequent global spread of the virus, is placing the professional incompetence of most Wall Street economists and strategists on full display.
A few months from now, it will be clear that the vast majority of Wall Street head economists and head strategists deserve to get fired, or at least demoted. If a head global economist and/or strategist is not able to forecast a major economic crisis when this eventuality has already become as obvious as it is now, then it is pretty clear that they are professionally incompetent.
Today, more than ever, individual investors require specialized knowledge, skill and experience to help the navigate massive market risks and massive market opportunities over the course of the next 12 months which will be characterized both by a severe global recession and a difficult-to-forecast economic recovery filled with potential pitfalls.
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This article was written by
Kostohryz started his investment career as an analyst at one of the world's largest asset management firms covering sectors as diverse as emerging markets, banking, energy, construction, real estate, metals and mining. Later, Kostohryz became Global Portfolio Strategist and Head of International Investments for a major investment bank.
Kostohryz currently manages JK Investment Consulting, a firm specializing in: 1) Global portfolio strategy; 2) Risk analytics; 3) Macro forecasting; 4) Business cycle analysis; 5) Quantitative analytics. Kostohryz is also founder and CEO of Investor Acumen, a service dedicated to empowering individual investors to achieve their investment goals.
Born in Mexico, Kostohryz grew up in Colombia and South Texas. He graduated with honors from both Stanford University and Harvard Law School. He is a former NCAA and international-class decathlete and has stayed active in a variety of sports. Kostohryz pursues various intellectual interests and is currently writing a book about the impact of culture on economic development.
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