Worst Chinese Economic Indicator Ever: What's Next
Summary
- The S&P500 dropped by +10% as fear for the impact of the Coronavirus on the economy intensifies. It is too early to estimate the impact on the US economy.
- However, the recent horrible Chinese PMI read-out shows that the impact on the economy can't be underestimated. This reliable indicator was even worse than during the financial crisis.
- The early development of worldwide Coronavirus cases look less bad compared to China. However, my graphs show that the worldwide trend of infected cases is growing exponentially.
- If this trend continues its path, the worldwide economy could land in a recession. I advise investors to approach the market carefully by waiting out US economic indicators. Buying Gilead could hedge your portfolio significantly.
In the week of 24 to 28 February, the S&P500 (SP500) experienced its worst week since the 2008 financial crisis due to an increase in fear for the impact of the Coronavirus on the worldwide economy. In fact, the fear & greed index plunged from 95 (extreme greed) at the beginning of 2020 to 10 (extreme fear) last week. Many investors are shrugging off those fears by minimalizing its impact. They are arguing that the virus is less worse than the flu and call this drop a 'buying opportunity'. In the other camp, we have the more cautious investors who believe that the economic impact could be severe and in its worst case could lead to a worldwide recession. Over the last days, the ex-China situation has worsened significantly, but correctly estimating the impact on the US economy is way too early. However, on 02/28 China revealed its Purchase Managers Index ("PMI") for February, which is very informative to predict the impact of the virus on the worldwide economy. Astonishingly, the PMI came in at 35.7 which missed the expectations by a staggering 10.3 and was even worse than during the big financial crisis. In this article, I will discuss the importance of this PMI read-out for the world economy. Second, I will give my opinion about the best investment strategy for the coming months.
(Source: Tradingview.com)
China February 2020 PMI read-out: worst in history
The Chinese Purchase Managers Index or PMI is a composite of questionnaires to 700 Chinese industrial companies, which gives an indication about its economic activity. A value above 50 is seen as economic expansion, a value under 50 as contraction. The PMI is seen as a reliable indicator as it has an 85% correlation with GDP on a quarterly basis. Astonishingly, the February number came in at 35.7 vs an already bearish consensus of 46. This is the worst Chinese PMI in history, being 2.1 under the worst read-out during the financial crisis. Moreover, export orders came in at 28.7 which shows that the virus has broken the world-wide supply chain significantly. This could impact international economic numbers as well.
(Source: Investing.com)
Implications for impact Coronavirus on US and worldwide economy
This data shows that the fear of significant economic consequences by the Coronavirus is not overblown. In fact, it looks like analysts underestimated the impact in China. This surprising number has two implications for the US and worldwide economy.
1) Supply chain problems
The very low export orders number shows that export from China was significantly impacted by the virus. In fact, China is by far the biggest exporting country in the world. As a consequence, world-wide supply chains got interrupted significantly, potentially leading to lower sales in the USA and other parts of the world. It is important to bear in mind that this has a lagging effect. Multinationals will start feeling this supply chain interruption when they run out of inventories, which could take weeks or even months.
2) Higher potential economic impact
Second, the read-out shows that if the number of infected people increases significantly, it has a huge impact on the domestic economy. The virus may indeed not be the worst one based on the number of mortalities etc. However, the lack of knowledge about this virus and the ease of spreading, makes countries take big measures, impacting the economy significantly. If the number of worldwide cases would show a similar trajectory compared to China in the coming weeks, it is definitely probable that worldwide economic growth would turn negative. So let's compare the gravity of the virus ex-China with China to try to estimate the future worldwide economic impact. Therefore, it is important to understand that the development of the virus spread is lagging China by approximately one month. I included some interesting graphs, starting from the day during which there were 1000 cases confirmed. Interestingly, early indications imply that the situation outside of China looks less worrying than it was in China. An explanation could be the very high population density in China compared to the rest of the world. However, it looks like the number of worldwide cases is growing exponentially compared to a more steady growth in China. This is very important to keep an eye on. If this trend continues, the situation ex-China could become as problematic as in China, impacting the worldwide economy drastically. I ensure you, you don't want the PMI of the USA dropping to the level of the financial crisis...
(Source: Robbe Delaet based on John Hopkins' data; days after 1000 cases have been reported)
(Source: Robbe Delaet based on John Hopkins' data; days after 1000 cases have been reported)
Specifically for the USA, investors could argue that there are less than 100 cases diagnosed, which is negligible. They could also believe statements from Trump like "There is no need to panic. Everything will be OK". However, in my opinion, denying the importance of the virus is not the way to go. Yes, today the virus does not look to have a major impact in the USA. However, this could change drastically over the coming days/weeks. Dr. Matt McCarthy, an infectious disease physician described the current situation very well at CNBC:
We don't have a diagnostic test available. In New York State, we have only been able to do 32 tests, which is a national scandal. In some countries they are doing thousands of tests a day, but we can't get this of the ground. A week or two from now we will start to begin to see information in the USA.
I would rather believe an infection specialist than President Trump in this case. Let's wait out more information over the coming weeks, both on the medical side but also on the economic side, as the current numbers are not relevant given the earliness of the disease and negligible amount of tests done.
Long term implications
Above, we have discussed the short term implications of the Coronavirus. However, will it have an impact on the longer term, which is more important for investors? Recently, the number of new cases in China looks to have stabilized as it slumped from 500 new cases on 02/25 to 300 on 02/28. This would be very positive as it implies that the virus could vanish in the mid-term. Unfortunately, the number of new cases flared up again to 500. If this trend continues, the Coronavirus could as well have a significant mid-term impact on the economy. A second factor to keep track of is Gilead's (GILD) drug Remdesivir, which has already been used for Ebola and other viruses and could be approved as soon as at the end of April. Gilead is a well-known company which has tackled many similar diseases such as HCV and HIV. If Remdesivir's phase 3 results are succesful, this drug could cure the disease and have a meaningful impact on the worldwide economy. You can read a very interesting article about its probability of success here. However, even if the Coronavirus would fade away in a couple of months, the worldwide economy could already be in recession-mode, which could persist a lot longer. The economy is in its longest bull-market ever and desperately needed a downward cycle. The Coronavirus crisis could potentially initiate a recession.
My investment strategy
Over the last months, I advised readers to sell some overvalued stocks like Apple (AAPL) and Alphabet (GOOG) approaching the 30x free cash flow benchmark and increase their cash position slightly. I believe that at this moment, it is not time yet to buy stocks as China's PMI read-out shows the huge consequences of the virus on its domestic economy. The exponential increase in Coronavirus cases makes me approach the stock market more carefully. However, investors should not panic-sell either, as the virus could fade away as well. I believe investors should wait out US economic indicators over the coming weeks. If the market drops by another 10%, it would get more interesting to buy stocks carefully. However, I advise to only buy high-quality stocks which can withstand a recession and generate strong cash flows, as it is possible that the virus will be followed by a worldwide recession. I am talking about stocks like JNJ (JNJ), Accenture (ACN), Intuit (INTU), ASML (ASML), Ulta Beauty (ULTA) etc. I also wrote an article about how initiating a position in Gilead could be an interesting hedge for your portfolio. For now, that's the only stock I would approach. Investors should keep a close eye on the exponential worldwide increase and the flare up in China over the coming week. If things get much worse, a recession could be around the corner.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
This article was written by
Analyst’s Disclosure: I am/we are long GILD, ULTA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (16)
I'm very curious about the USA the coming weeks. When eventually more people get tested, how many will be infected?
For now, the exponential increase ex-China extends. We must keep an eye on these developments for sure.
I do like your Flow Traders pick, as it is a great hedge against a crash.
Good luck!
But paying more than 20x earnings for a company growing in the low single digits is just too much. The market needed a cooldown & I believe it could tank more given the horrible PMI numbers from China.