A Case For the Best Case

A Case for the Best Case

*In an act of hubris I have written this before companies have begun releasing their earnings reports. I can only assume I will be punished by the animal spirits for such reckless predictions!

The news has been grim. The number of people seeking EI has spiked so much, so quickly that it reduces the previous unemployment numbers to a flat line (this is true in both Canada and the United States, US EI graph below). Countries remain in lockdown and some of the worst hit countries like Italy and Spain are starting to plateau, adding ONLY between 500 to 1000 deaths a day. In Canada the numbers continue to climb and the economy has been largely shut down, with governments rolling out unprecedented quantities of money to stem the worst of this. Talk of a deep economic depression has been making rounds, while the Prime Minister has reluctantly suggested that we may be in a restricted environment until July.

Us Jobless Claims - Q3 2017 - Feb Q1 2020
These two charts show the unemployment rate in the US just before the coronavirus, and after. From Refinitiv
US Jobless Claims Including April 2020
These two charts show the unemployment rate in the US just before the coronavirus, and after. From Refinitiv

And yet.

And yet.

And yet, I suspect we may be too negative in our outlook.

First, just how restricted is the economy? Despite the wide-ranging efforts to restrict the social interaction that daily economic activity produces, much of the economy continues to function. Office and white-collar jobs have quickly adapted to remote working. Few have been laid off in that respect. Industrial production is down, unless they are deemed essential, but the essential label has applied to a lot of businesses. Until the recent additional restrictions applied on Sunday April 5, 2020 in Ontario, Best Buy, Canadian Tire, Home Depot and a number of other stores remained open to the public. Those businesses have had to restrict access to their stores, but remain functioning through curb pick and online delivery.

Even the service economy is still largely functioning. Most restaurants remain open providing take out and delivery. Coffee shops, gas stations, grocery stores, convenience stores are all open, as are local grocery providers like butchers and bakers (and candle stick makers). Its’ true that large retail spaces like Yorkdale or the Eaton Centre are closed but this too tells us something.

The government has helped make it easier to get money since people have been laid off, and many of the people who have been let go will only be out of work for a short time. They are the waiters, union employees and airline pilots who will be rehired when the society begins to reopen. Even in the period I began writing this, Air Canada rehired 16,500 employees, West Jet will be rehiring 6,500 employees, and Canadians applying for the new CERB (Covid-19 Emergency Response Benefit) have reportedly already begun receiving it.

You might be reading this and thinking that I’m being callous or simply ignoring the scope of the problem that we are facing, but I want to stress that I am not. I recognize just how many people have found themselves out of work, how disruptive this has been, how scared people are and how this pandemic and its response has hit the lower income earners disproportionately more. But just as few people correctly saw the scale of the impact of the coronavirus, we should remain cautious about being too certain that we can now anticipate how long the economic malaise may last, or how permanent it will likely be, and what its lasting impacts will look like.

Labour work

The sectors of the economy worst hit will likely be those already suffering a negative trend line. The auto sector, for instance, is one that has been hemorrhaging money for a while, with global car sales in a serious slump. Some retail businesses, already on the ropes from Amazon’s “retail apocalypse” may find they no longer can hold on, though government aid may give them a limited second life. Hotels and travel will likely also suffer for a period as they carry a high overhead and have been entirely shut down through this process (sort of).

Longer term economic problems may come about from mortgage holders who have struggled to fulfill their financial obligations to banks, and it may take several months to see the full economic fallout from the efforts to fight the pandemic, so some of the effects may be staggered over the year.

Economist image

But even if that’s the case, the current thinking is that the market must retest lows for a considerable period, with few people calling for a rapid recovery and many more calling for a “W” shape (initial recovery then a second testing of previous market lows) and in the Economist this week “one pessimistic Wall Street banker talks of a future neither v-shaped, u-shaped or even w-shaped, but ‘more like a bathtub’”.

FT China Cinema

That pessimism is well warranted, and I count myself among those expecting markets to have a second dip. But I admit to having my doubts about the full scale of the impact to the real economy. There will no doubt be some fairly scary charts, like thre were from China, showing the drop off in cinema goers and people eating out. But the more certain, the more gloomy, the more despairing the outlooks get, the more I wonder if this is an over compensation for having overlooked the severity of the virus, or if it is the prevailing mood biasing these predictions? Only time will tell, but I am taking some comfort in knowing that there is still a case for the best possible case.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

All Eyes Are On China

People in China

China, the first hit by the coronavirus and the first to emerge from its enforced hibernation, is the global centre of attention as people watch to see how fast its economy can recover from the from the pandemic chaos unleashed in January. If China is able to bounce back quickly it will be good news for other countries and should raise spirits of investors, businesses, and governments that a global shut down may not lead to the worst of all worlds.

Early economic data is both more and less reassuring than one might expect. The impact of the lockdown in China took a sizeable bite out of the economy. The one year change in the value of exports is -15.9% (down already since the trade war began), industrial production was -13.5%, the fastest contraction in 30 years, while retail sales in China were down -20.5%.

China Data

But as things return to normal in the shadow of the pandemic, numbers may also be improving faster than we thought. Reported in the Financial Times on March 20, of the 80% of restaurants that had been closed in February, less than 40% are closed now. That’s good news for small businesses watching from across the Pacific. There is good news in manufacturing as well. The Purchasing Manager’s Index (PMI) has been officially reported at 52.0, which indicates that manufacturing is growing and not contracting. In February the PMI for China was 35.7, a record low for the country. That positive PMI result is helping extend gains today (March 31st) and giving hope to governments and markets that the worst of this pandemic may be shaken off faster than economists have predicted.

PMI China March

But economic activity is still well below 2019 levels and have a way to recover. In addition, China is one nation, the Western economy is made up of many, and the countries worst hit by the COVID-19 outbreaks have yet to peek and plateau. Italy, Spain and the United States are all fairing poorly, with Italy and Spain perhaps just finally reaching peak of cases now. The United States on the other hand now has more officially recorded cases than any other country, while New York, Catalonia, and Madrid are on track to pass Lombardia as the worst affected cities both in infections and mortalities.

Ft Capture Countries

The coronavirus remains the central unknown in this story. If tamed, can it be permanently subdued? If not, can new cases be dealt with on a case by case basis, or will we have to revert to aggressive forms of social distancing? Concerns remain about whether there will be a second wave of infections in Asia, while China has maintained that all new cases are being imported and can be dealt with proactive screening and testing.

FT Corona City Mortality

In Europe and North America the best news has been to see production of ventilators, masks and the deployment of field hospitals ramp up to deal with the threat. In the wider Asian region, wide testing and a willingness to follow government dictates and a focus on personal protection through the adoption of wide mask usage has had a direct impact on taming the virus in Taiwan, South Korea and Japan (the exception here might be Japan, which seems to have relaxed prematurely and now is considering shutting down Tokyo). But the best news may still be from China and a sudden and rapid improvement in their economy as restrictions are lifted. If prolonged the early rally than began last week, and has continued yesterday and through overnight trading may become the foundation for a more sustained recovery. If not markets may be thrown back into turmoil.*(Please note, markets seem to be in turmoil again.)

Covid-19 CHina Economy

Today, at the end of March, I think the potential for a slower recovery remains possible. Huge stimulus packages have been put in place by governments to help ease the worst of the economic fallout. Governments and their citizens seem to be facing the challenge head on, even if they have been late to the game. America’s enormous manufacturing capacity is being used usefully to deal with the pandemic (better late than never) and early economic news from China is encouraging, but should be treated with caution.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

If I Tell You This is Just a Correction, Will You Feel Better?

19_6_origA correction is typically defined as a drop of roughly 10% in the markets over a very short period of time. It’s often “welcomed” by investment professionals because it creates opportunities for new investments into liked companies that were previously trading above valuations considered appealing. Corrections are talked about as being necessary, beneficial and part of a normal and healthy market cycle, which all makes it sound somewhat medical. But in medical terms it falls under the category of being told your are about to receive 5 injections in short order and they are all going to hurt.

Screen Shot 2014-10-02 at 7.22.55 AM
S&P TSX From Bloomberg – October 2, 2014

For investors the past couple of weeks in the market has felt like many such injections. The US markets have had a significant sell off, as have the global, emerging, and Canadian markets. All of it very quickly. The sudden drop has erased many of the gains in an already slow year and eaten dramatically into the TSX’s return which had been one of the best.

From Bloomberg - October 2, 2014
Dow Jones Industrial From Bloomberg – October 2, 2014

For many investors any sudden change in the direction of the markets can immediately give the sense that we are heading into another 2008. As Canadian (and American) investors are now 6 years older and closer to retirement the stakes also seem much higher. So here are some reasons why you shouldn’t be concerned about the most recent market volatility, and what you can do to make them work to your advantage.

1. Everyone is nervous.

For several months people have been calling for a correction. Investor sentiment is neutral and consumer confidence has dipped, meaning that overall atmosphere is somewhat negative for the markets. But that can be a good thing. Market crashes and bust cycles typically show up when people are exuberant and feel euphoric about markets. Bad news is swept aside and the four most dangerous words in investing “This time it’s different” become the hallmark of the new bubble. It’s rare that negativity breeds an over exuberant market.

2. The Economy isn’t running on all cylinders.

There certainly have been encouraging numbers in the United States, and even recently Canada has had some improved economic numbers, but by and large there hasn’t been a big expansion yet in the economy. Unemployment is still high, especially in Europe and the labour force has shrunk (which can skew the unemployment numbers) while corporations continue to sit on enormous piles of cash, to their detriment. A market crash usually follows an overheated economy that begins to over-produce based on faulty views about future growth potential. That isn’t where we are yet.

3.  Corporations are really healthy, and so are investors.

Canadians may still have bundles of debt, but the US is a different story. American corporations and households have been heavily deleveraging since 2008. In fact corporations in the US look to be some of the healthiest in decades, showing better earnings to debt ratios than previously thought. Crashes have as much to do with over-production as they do with out-of-control borrowing. The two go hand in hand and both factors are currently missing from the existing economic landscape.

4. Energy is cheap. Like, really cheap. 

Remember when oil was more than $100 a barrel? High energy prices, and the expectation of future high energy prices can really put the kibosh on future returns and throw cold water all over the market. As we’ve previously said, energy is the lifeblood of civilizations and a steady supply of affordable energy is what separates great economies from poor ones. (Look, we tweeted this earlier! See, twitter is useful. Follow us @Walker_Report)

https://twitter.com/Walker_Report/status/517604263493894145

West Texas Crude Oil Price over the last 3 months - from NASDAQ - October 2, 2014
West Texas Crude Oil Price over the last 3 months – from NASDAQ – October 2, 2014

The arrival and growth of American gas production combined with changing technologies and increasing efficiencies on existing energy use means that global demand is slowing, while global supply is increasing. In fact in March of last year, the head analyst for energy at Citigroup published a paper describing exactly this trend of improved efficiency with new sources as a mix for lower energy prices in the long term. Whether this proves true over the next two decades is hard to say, but what is true is that cheap energy helps economies while expensive energy hinders it. Since economies have already adjusted to the higher price over the last few years, a declining price is a tailwind for growth.

Does this mean that there aren’t any risks in the market? Absolutely not. Europe is having a terrible year as a result of persistent economic problems and Russian intransience, and many Emerging Markets are showing the strain of continued growth, either through corruption or exceeding optimism about the future. Those pose real risks, but taken in the grand scheme of things our outlook remains positive for the markets.

How can I make this all work for me?

So what can you do as an investor to make a correction benefit you? The first piece of advice is always the same. Sit tight. Dramatic changes to your investments when they are down tends to lead to permanent losses. Secondly, rebalance your account periodically as the market declines. On the whole equity funds will lose a greater proportion of their value than fixed income, leaving a balanced portfolio heavier in conservative than growth investments. Rebalancing gives you a chance to buy more units of growth funds at a lower price while adding greater potential for upside as the market recovers. Lastly, if you have money sitting on the sidelines, down markets are great opportunities to begin Dollar-Cost-Averaging. For nervous investors this is a great way to ease into the markets even as markets look unstable. You can read about it here, but I recommend watching the movie below for a nice visual explanation. Now, take your medicine.