February 2020
The coronavirus outbreak in China has generated economic waves that are disrupting global supply networks that act as the backbone of the global economy and comes as the global economy was already cooling off. Profit warnings from companies with significant operations in China and abroad have begun. We are monitoring these developments and have concluded that our Stagnation outlook for the U.S. economy will shift to Recession beginning in the back half of the twelve-month time horizon.
China is likely heading into a consumer recession, as auto sales there plunged 18% year over year in January to their lowest level in eight years.1 China accounts for 16% of global GDP on a US dollar basis, compared to 4% in 2003.2 In 2019, China accounted for 75% of total world oil demand.3 Commodities markets have tumbled as factories are idled. Iron ore demand is down more than 10% this year. Copper and nickel are down about 8%, while zinc and aluminum are both down more than 5% in 2020.4
In Japan, the world’s third-largest economy declined 1.6% in the fourth quarter of 2019 as the country absorbed the effects of a sales tax hike and a powerful typhoon. It was Japan’s largest contraction compared to the previous quarter since 2014.5
The U.K. and Germany managed to escape a technical recession while France and Italy contracted. Switzerland’s core CPI declined 0.5% sequentially in January. Italy, Germany, and France experienced a 2.7% decline in December industrial production. EU auto sales also declined 7.4% YoY in January.6 The UK’s future trade relationship with the EU remains unanswered. Brexit has already cost the UK economy between 2.5-3.0% of lost output.7 The final economic bill will depend on the extent to which EU trade is disrupted as the UK pursues greater autonomy over regulation, migration, and state aid.
In the U.S. the budget deficit to GDP ratio stands at 4.9%, up from 4.3% a year ago. The last time we saw this level was in May 2013 when the unemployment rate was 400 basis points higher than it is today at 7.5%.8 January nonfarm employment growth was 225,000 jobs. While the unemployment rate ticked up to 3.6%, this increase was driven by a jump in labor force participation.9 The coronavirus impact will be felt in the U.S., resulting in weaker exports, imports, and inventories. Canada’s economy has stalled as transportation activity has been disrupted by blockades set up by anti-pipeline protestors. Real manufacturing shipments fell 0.4% in December and real retail sales were flat. A recent rise in insolvencies comes amid a relatively robust job market.10
U.S. equities started the year strongly, but gains were erased towards the end of the month as a result of coronavirus fears. The S&P 500 was flat in January while the S&P MidCap 400 and the S&P SmallCap 600 were down 2.6% and 4.0%, respectively. Canadian equities were positive, with the S&P/TSX Composite up 1.7%. The S&P Europe 350 finished January with a loss of 1.3%, ending a four-month streak of gains. The S&P United Kingdom lagged its European counterparts in January, with the index declining 3.3% in pound sterling terms. U.S. fixed income performance was positive across the board, with treasuries and corporates leading the way. The decline in the U.S. long bond’s yield reflects a confluence of factors including easy Federal Reserve monetary policy, concerns about the COVID-19 epidemic’s impact on economic growth, and an absence of inflationary pressures. Gold is continuing its advance, after breaking out from a six-year base formation, rising as the US dollar rises, not the usual correlation.
In February, we reduced exposure to U.S. equities across all models and reintroduced the U.S. long-term Treasury Bond. This reflects our view on deflationary influences that dominate the global economy. Allocation to equities was reduced to 12% in Tactical Conservative, 17% in Tactical Moderate Growth, 26% in Tactical Growth, and 34% in Tactical Aggressive Growth. Within the Fixed Income allocation, we added the 20+ year Treasury Bond as long rates are expected to decline further. Gold continues to be present in all models as it performs well in high risk, low yield environments as a risk-free asset class.
The trend towards populism and protectionist policy remains a risk to the stability of global financial markets and the COVID-19 outbreak is likely to delay recovery and intensify disinflation. We will continue to monitor the data for growth, inflation, and recession signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.
Deborah Frame, President and CIO
1 Trading Economics, China Vehicle Sales. February 13, 2020.
2 Visual Capitalist. 70 Years of China Economic Growth. October 12, 2019.
3 Trading Economics, China Imports of Fuel Oil. February 2020.
4 Trading Economics, Commodity Prices. February 2020.
5 Trading Economics, Japan Q4 2019 GDP. February 2020.
6 Trading Economics, E.U. Economic Data. February 2020.
7 Oxford Economics. Brexit. February 2020.
8 Trading Economics, U.S. Debt to GDP. February 2020.
9 Trading Economics, U.S. Non-Farm Payrolls. February 2020.
10 Trading Economics, Canada Insolvencies. February 2020.
Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. January 31, 2020. Index performance is based on total returns and expressed in the local currency of the index.
