Rabobank: “Coronavirus Is The Kind Of Risk That Doesn’t Just Put You Out Of Your Portfolio, But Out Of The Game”

Submitted by Rabobank’s Michael Green

China returned from a longer-than-usual lunar New Year holiday today. Not the swathe of businesses that have been forced to close temporarily; and not the now tens of millions under quarantine at home; and not the villages that have barricaded themselves in from the outside world; just the financial markets. And, despite the promise from the PBOC of CNY150bn (USD21.7bn) in extra liquidity, lower rates, and whatever it takes to get through this ahead of market open, the initial response was a complete collapse: at one point the Shanghai stock exchange was -8.7% on the day – and recall that under the terms of the Phase One US-China trade deal, US financial firms are supposed to be diving in to this kind of market aggressively; the Chinese currency, both off and onshore, has crashed through the psychological 7 level once again; and trading in Chinese commodity markets has been suspended after iron ore, copper, crude oil, palm oil, and eggs all closed limit down on the day.

Of course, there is going to be a spill-over into other markets. You wanted to know what a real decoupling from China might look like, and/or what a “What if everyone just stayed at home and didn’t buy anything?” economic thought-experiment looks like? Well here you are, folks.

In terms of trade, Australia and New Zealand are at the front of the queue, as well as time zone-wise. Add plunging iron ore to a cessation in Chinese tourist arrivals, and to the news that high-value agri imports like lobsters are allegedly not allowed into China anymore, and you have all the ingredients for AUD to give up the 67c level and NZD to give up 65c. Yet other global commodity exporters are likely to feel the pain. For just one example, China’s oil consumption is now down 20% according to sources quoted on Bloomberg. That is the equivalent of an economic depression, not a recession, landing overnight. Expect prices, and global inflation expectations, to follow suite. Indeed, there is already talk of an emergency OPEC meeting. Yet even ordinary exporters (and more so net exporters) of goods and services are going to get hit. In fact, you’d need to be a continent-sized, inward-focused, commodity importer to be able to ride this out comfortably. Perhaps the US and India fit that bill to some degree, but less than one might think, perhaps.

Naturally, this kind of market sell-off imparts a natural tendency on the part of our not-so-natural markets for aggressive dip-buying. However, as opposed to the headline of “World War Three!” which triggered a bout of risk-off action at the start of the year, this sell-off appears far more justified. The same op-ed writers who did not understand the real-politick of the Soleimani assassination and were wrongly screaming “Sell!” after that event are today trying the argument that “More people die from slipping in the shower, etc., than this Coronavirus.”

This overlooks the fact that this virus has the potential to go exponential and become a global pandemic. It’s a small risk, yes – but it’s a FAAAAAAAT tail risk, that tens of millions of people simultaneously slipping in the shower really isn’t. Indeed, it’s the kind of huge risk that doesn’t just put you out of your portfolio position, or out of business, but out of the game, full-stop. Markets are quite right to react in a strongly negative, preventative fashion to this risk until we see evidence that it is being brought under control and the threat has truly passed. And we are not there yet, very regrettably. When we are, we see the real bounce. In short, “panic measures” are not always a sign of panic – they can be rational.

The global establishment of the WHO are, by contrast, remarkably cavalier in their market-friendly approach that there should be no restrictions on free movement or free trade as a safety-first measure, and we should all aim to find a vaccine. All very IMF. It’s not a surprise, perhaps, that once again nation-states are thumbing their noses at that particular economic policy prescription from a famous acronym and imposing travel bans and, in China’s case, import bans too (if the no seafood report is true).

On which note, today is the first trading day of the bold new world of BoJo Brexit. Headlines in that regard are that the UK is going to play hardball and is aiming to keep all its own fish, and for an EU trade deal somewhere between those of Canada and Australia rather than the far closer relationship that had been initially promised. Indeed, BoJo is talking about preparations for full customs/border checks in 2021 once the transition period ends. That also suggests a healthy dose of risk-off is required. However, for whom? Some of the impacts of this kind of scenario could arguably prove more positive than the Brexit naysayers have long warned. Nissan, which runs a huge car plant in Sunderland that has long been flagged as at risk under hard Brexit, is today claimed to have a contingency plan to pull out of European production and double down on the UK market instead, where it would then have a competitive edge vs. tariffed European imports. So less EU exports, more UK local production, and more UK jobs – in that one industry.