Quotidian Investments Monthly Commentary – February 2020
Within days of issuing our January report we became increasingly concerned as we noted the inconsistencies emanating from official sources in China in relation to the current outbreak of coronavirus. Further information they continued to present as updated ‘factual’ news we quickly interpreted as simply propaganda (intended only to disguise the impact of Covid-19).
As ever, it is always revealing to observe what people do rather than what they say. ‘Actions speak louder than words’ is a long-held cliché for very good reasons. Sadly, the Chinese leadership going back all the way to Chairman Mao (and perhaps much further) has a long history of being parsimonious with the truth and this trait, combined with their cultural imperative never to ‘lose face’, allows a cynical outsider to see through the manipulation of so-called facts and less than accurate figures (designed purely, of course, to mislead).
As the Covid-19 started to spread, the Chinese government have given every sign of being panic-stricken; factories and schools were closed, travel restrictions were put in place (originally in the city of Wuhan, its province of Hubai and then internationally) and these restrictions were severely enforced. Flowing from this official reaction, industrial production slowed to a halt and consumer activity was hobbled.
When the Sars outbreak began in 2003, China represented just 5% of the world economy. Today it accounts for 20% and in the past 20 years or so the onward march of globalisation has created an interlinkage and inter-dependence that didn’t exist when the Sars issue was at its height.
China’s factories are a significant element of global supply chains and China’s newly-wealthy consumers comprise a sizeable percentage of the global demand for goods and services. In today’s world, therefore, the knock-on effects of poor risk mismanagement are palpable, severe and financially punishing.
For example, Apple issued an earnings warning (which amounts to a profits warning) on 17th February saying that their iphone sales would not meet quarterly revenue expectations due to the impact of the coronavirus. That statement is a proxy for large swathes of industry and commerce and will significantly affect business revenue worldwide. This adverse effect may well be short-lived but it will have an unwelcome impact on corporate valuations.
On 29th February 2020 the FTSE100 index closed the month at 6580.61, a fall of -9.68% in the month of February and it now stands at -12.75% for the 2020 calendar year to date. By comparison (despite the sell-off which began in earnest in mid-February) the Quotidian Fund’s valuation at the 29th February shows an uplift of +2.87% for the month of February and the Fund is up +5.30% for the 2020 year thus far.
Our concerns about China’s official reactions to Covid-19 reached a peak at the end of the first week of February and so, on 7th February, we took the decision to exit equity markets. To ensure that we did not move prices against us, we slowly and methodically sold our equity holdings on that day (and the following Monday) in order to consolidate our profits, protect our investors from investment risk and keep our powder dry until this economic crisis passes.
To repeat our January comment: this outperformance as measured against the FTSE100 and other global markets is simply a function of our oft-stated aim of trying to be in the right sectors of the right global markets at the right time. In that regard, none of the world’s equity markets are now in positive territory for the 2020 year to date and so it follows that the only place to be invested for the time being is in cash. When the facts change, we will change our minds and adapt accordingly.
As an exercise in turning a containable, manageable drama into a full-blown economic crisis, the actions of President Xi (arguably the most powerful man in the world; more-so than either Putin or Trump) and his merry men have provided a textbook example of how not to act in the face of adversity. Suppress, lie and deny swiftly followed by panic has been a masterclass in creating the worst possible economic outcome. History provides a cornucopia of examples of absolute power disguising extreme cunning combined with profound stupidity and, on the face of it, the current Chinese leadership have qualified for an honours degree (summa cum laude) in incompetence.
Actually, however, the hyper-myopia on display here is of such an epic, not to say herculean, scale that one must question whether it was a quite deliberately engineered response designed to further weaken Western economies (many already under serious financial and political pressure) and Western asset values as a means of creating the financial conditions that could allow China to buy large tracts of valuable Western assets at vastly reduced prices. Indeed, that has already been one of the effects whether by design or not.
Real evidence has now emerged to indicate that we are now beyond the point where Covid-19 can be regarded simply as a containable health issue and a temporary economic inconvenience. The current mark-down in equity valuations has already reached the level regarded as a correction. Prices may well continue to decline and there will no doubt be a false dawn or two until a degree of modest confidence and perspective returns.
Having seen enough to extract ourselves from equity markets before this downturn began, our challenge now is to identify a positive and potentially lucrative re-entry point. There will certainly be a huge buying opportunity once all the emotional noise dampens down and the Chinese smoke and mirrors clears away.
The next realistic indication of both the speed and extent of stock-market direction will come when the 1st quarter 2020 reporting season begins early in April. From corporate commentaries since the coronavirus took centre stage, we expect these numbers to be largely disappointing. They could kick-start a modest recovery in equity pricing but it is more likely that the prevailing market gloom will persist.
There is little doubt that the second quarter reporting season during July will be dismal as they will more fully reflect the economic damage caused by the Chinese authorities mishandling of this crisis. However, stock-markets are forward looking and price up on future expectations as opposed to historical data. Global markets are well into ‘correction’ territory (10% down from recent highs) and may even fall further towards a ‘crash’ of 20%.
On the final afternoon of February’s trading the US Federal Reserve (its Central Bank) announced that it would “use all the tools available to us” to support the econonmy. That suggests that they will cut interest rates and/or inject a further round of stimulus by way of quantitative easing (printing money). In the short-term that will inflate asset values again but in the longer term this simply kicks the underlying problem (future inflation) further down the road.
With unerring certainty there will be a point where the risk of further falls is balanced by ‘fire-sale’ prices that offer the potential of great gains. Until then we will keep the sound of trumpets muted on the basis that hubris is inevitably followed by nemesis. In the meantime, we are in the relative safety of cash and unaffected by this severe stock-market correction.