Investors pay close attention to how their individual stocks are doing. While it is important to scrutinize your individual investments, it is also crucial to pay attention to global economic conditions. Globalization is a boon and bane at the same time. Globalization is the development of an increasingly integrated global economy marked especially by free trade, free flow of capital, and the tapping of cheaper foreign labor markets. In other words, it is because of globalization that you see so many products that are “Made in China” when you go shopping at your local mall. Now what’s the bane? Due to globalization, something like corona-virus in China can cause an unbalance in supply and demand, which leads to fluctuations in various asset prices. So, in this week’s blog post I will talk about the different events that are transpiring across the world and their economic consequences. Let’s dive in.
We can start off by talking about Corona-virus as it shook the world by surprise. The US Department of State issued a Level 4 Travel Advisory on February 2, 2020, which essentially means “Do Not Travel” to China. In order to contain the virus, China has closed many cities, transportation has been halted, and businesses have been affected due to this. Since this lockdown prevents business-related travel and the movement of goods and workers, we know that companies will soon face cash flow problems – even though the production is halted, companies still need to pay bills. Many Chinese companies are key players in the supply chain of large companies across the world. So, this government lockdown will negatively affect the larger companies, who depend of Chinese manufacturing. This was one of the biggest reasons why there a selloff in the stock markets all across the world after the virus outbreak. In fact, when the Chinese stock market opened after its New Year, Shanghai stock exchange fell 10% in one day. It appears that all the liquidity generated after the sell-off was then pushed into the US stock market. This is one of the reasons why a company like Tesla, with ugly fundamentals, just shot up 80% in a month. It is times like these when an investor needs to sit on the sidelines and observe the irrational behavior of other “investors”.
Due to the outbreak, in addition to the expected drop in global economic growth, we are also seeing price fluctuations in certain commodities such as crude oil. China, the second largest economy in the world, is a big importer of oil. With many Chinese cities under lockdown, the demand for oil has dropped considerably. As price and demand are directly related (given that supply remains the same), the global prices of crude oil fell as the demand dropped. Similarly, metals such as copper fell because copper is deemed to be an important material for the manufacturing industry. I suspect these price fluctuations in commodities are temporary because once the virus outbreak is behind us and the factories open up, the demand will pick up and drive the prices to their original levels.
Now let’s look at what is happening in Europe. The British exit (“Brexit”) from the European Union (EU) would lead to a new trade deal which would impose tariffs and cause inflation. Since Britain’s tariff free status with other EU members would end, the costs of imports and exports would increase, which means British citizens will have less money left over at the end of the day. As consumer spending drops, company’s profits diminish, and the economy slows down. Germany, Europe’s largest economy, is also facing a possible recession. On February 7, 2020, Germany posted the worst industrial production figures since January 2009. Moreover, both France and Spain posted a similar decline in industrial production. On February 6, 2020, the European Central Bank’s (ECB) president, Christine Lagarde, said, “This low interest rate and low inflation environment has significantly reduced the scope for the ECB and other central banks worldwide to ease monetary policy in the face of an economic downturn.” What she is trying to say is that the central banks are going to be helpless when the next economic downturn rolls around. With ECB’s interest rates reaching the negative territory, it is extremely difficult for other other central banks (such as the US Federal Reserve) to raise its interest rates without pushing the domestic economy into a recession.
Moving onto the US stock market, which just appears to be unstoppable. It looks like nothing can stop and reverse this decade long bull market. I suspect that this aging bull market has been driven by liquidity injected by international investors. In 2019, the Federal Reserve lowered interest rates multiple times. In September 2019, the US repo market ran out of cash, which caused a spike in repo rates. The Federal Reserve injected cash into the banking sector and brought those repo rates down. In 2019, we also saw the US 2 year and 10 year bond yield curve inversion, which is a warning for an upcoming recession. Lastly, if we compare the 10 year US Treasury (safe investment) yield to that of the 12-month US dividend yield, we notice that US stocks, given the risks, do not look very attractive. The 10 year US Treasury note yield is 1.62%, and the 12 month dividend yield of US stock market is 1.8%. Now, all of this does not mean that the United States is at a brink of recession. The market can stay irrational for a long time. Berkshire Hathaway, a company run by Warren Buffett, holds $214 billion in publicly traded stocks and $128 billion in cash and cash equivalents. While it might not be the right time to nosedive into the current US stock market, it is probably a good idea to set aside some cash so that you have liquidity to buy cheap mispriced assets during the next downturn. As we inch closer to the November 2020 election date, we might see more volatility in the US stock market.
Hope you learned a little and found this blog post helpful. We talked current events associated with corona virus, Chinese economy, commodities, European economy, and the US stock market. As always, you can sign up for our free mailing list here. You can sign up for our paid subscription services here. Like us on our Facebook page here. Thank you!
Superior North LLC’s content is for educational purposes only. The calculators, videos, recommendations, and general investment ideas are not to be actioned with real money. Vyom Joshi is not a professional money manager or a financial advisor. Contact a professional and certified financial advisor before making any financial decisions. Please review the Disclaimer and Terms and Conditions.