Henry James International Management February 2020 Market Commentary

Market Overview

 Since last month’s entry, coronavirus – or for the more technical among us, COVID-19 – has gone from theoretically worrying to officially scary, life-changing and economically devastating. A short time ago coronavirus was mostly China’s problem and was a situation that we in the West looked at with genuine worry and sympathy. Now, no country is immune from the devastating impact of this virus on virtually every aspect of life. The effect of the coronavirus on China can be seen as a harbinger of the impacts of the virus on other societies and economies. Initially the West was seemingly mostly concerned about the economic effects of a disruption to supply chains and was reluctant to take precautions.  That has all changed as virtually every country in the world is taking extraordinary steps to abate the spread of this pandemic.

Until the last week of February most investors were all braced for a significant, but not necessarily ruinous, coronavirus impact. That all changed on February 21, 2020 when Italy’s very manageable and seemingly stable total of 3 coronavirus infections jumped to 20. The next day the number became 70 and a week later 1,128, including some fatalities. Markets took note of coronavirus making itself at home comfortably within a Western nation and investor panic ensued to deliver the worst week for stocks since the 2008 financial crisis, which saw the MSCI EAFE index tumble by -8.00% in February, the MSCI Emerging Markets index by -4.17% and the MSCI World ex USA Small Cap index plunge by  -8.74%. There has been little improvement since the final week of February; the current situation is far worse and several nations are seeing the virus run rampant through their populations. Moreover, economies are paralyzed and markets have been in veritable free fall.

Without minimizing how dangerous coronavirus is for both the elderly, infirm and possibly others – the death rate is generally believed to be less than 1%. Indeed, for the vast majority of people it is even less than that. What the virus lacks in deadliness to people, it more than makes up for in its lethalness the global economy. COVID-19 has the power to freeze the capitalism that drives global growth: slowing both production and consumption. As we have seen in China, Italy and now across the rest of the world, to prevent the spread of the virus, places of work shut down and whole cities and provinces are quarantined. While plenty of jobs in the modern economy allow for employees to work remotely at home, not only are many businesses not equipped for this kind of work, factories and the manufacturing sector cannot do so by their very nature. As was the case in China, factory closures suspend both product and component manufacturing, which not only stifles the quantities of items for consumers to purchase locally (and affects business cash flow), all global businesses whose supply chains run through China (and elsewhere) are starved for the items or parts required to sell and/or complete their finished products, respectively. Car manufacturing in South Korea, Europe, United States and beyond, for example, have been massively impacted by the supply chain disruption in China; many have already suspended their own production or are poised to do so.

On the consumer side, people staying indoors due to quarantine, self-isolation or fear of contracting coronavirus have seen the amount they spend in the economy plummet; indeed, in recent days consumer spending is at unprecedented lows. Simply put, we have not been spending in the retail sector, on entertainment, at restaurants or travel, etc. Moreover, doing so is scarcely possible since many countries have coerced such businesses to close. These sectors are huge parts of the global economy and not only does it mean that big businesses are suffering and small businesses risk bankruptcy, it also threatens millions upon millions of jobs that supply people with cash to afford their lives and to spend in the local economy. In short, people are not only refraining from buying because coronavirus is keeping them away from shops, restaurants, movie theatres; etc. – they also are cash deprived or soon will be.

The knock on effect is massive, and when production and consumption have been suffocated, it is down to banks and governments to step up to the plate, but the question is what can they really do when coronavirus has literally taken off the wheels of capitalism? Banks can give loans to businesses struggling to pay their bills; they can also let mortgage holders miss a couple of payments, amongst other items. However, as we witnessed in 2008, even the biggest banks are mere mortals and have limits to what they can do. Indeed, even governments and central banks have limits, not just because their pockets are not infinitely deep but also because policy changes – dramatic though they may be – cannot always have the desired effect. For example, on March 3, 2020 when the Federal Reserve slashed interest rates by 50 basis points – not to mention March 15th’s slashing of an entire percentage point – markets were left unsatisfied and continued in their volatile downward trend. Indeed, the face value for this seems quite obvious in hindsight: the reasons consumers are not spending money in shops is not because of expensive loans or debts, but the fact that they are afraid of contracting coronavirus. Ultimately, economies must pay their own way, and while government policy can help banks loosen their purse strings, delay or abolish tax payments and help to lubricate the wheels of capitalism through financial packages, it is down to whether production and consumption can persist through this pandemic and out-muscle and outlast the virus.

Investment Outlook

James O’Leary, CFA, Chief Investment Officer and Senior Portfolio Manager at Henry James International Management, believes that the impact of the coronavirus pandemic will catapult us into a global recession. ‘The major global sell off that began at the end of February indicates that as coronavirus spreads throughout the planet that markets will continue to panic and result in a global recession.’ He continued: ‘Hopefully everything will slow down through a coordinated global effort and prevent – or limit the impact of – this near inevitability.’ O’Leary suggests reasonable expectations include a 1% reduction in global economic output (from 3% to 2%) citing that the world’s second largest economy China has already been devastated by coronavirus and the reality that the pandemic is poised to smite the rest of the world’s economies in no time at all.

As readers will recall, as we transitioned from 2019 to 2020, despite being bullish, we were particularly aware of the full range of snags and snares desperate to trip up a roaring global economy (of course, who would have predicted a virus would have been the inevitable tripwire?). 2019 stiff-armed Brexit and President Trump’s tariff wars, including the US-China trade dispute, along with plenty of other headwinds. According to O’Leary, in a world without coronavirus the 2020 economy may have simply ploughed through these items to deliver returns for investors, as it did in 2019; however, in our current situation he believes that they will only add to the pain. He said, ‘Brexit and the US trade disputes with China will continue to have an effect on the global economy and coronavirus will only magnify their effects and make them more painful.’ According to O’Leary, a silver lining is that he believes that coronavirus has taken Trump weaponizing tariffs off the menu until at least after the November General Election, saying, ‘Trump needs a strong economy to be re-elected.’

While O’Leary does value globalism, he believes the coronavirus has exposed the fatal flaw of the status quo; i.e. a lack of diversified import sources. ‘It has negatively effected global supply chains as China is a major provider of parts that go into many finished products that are manufactured elsewhere, like in the automobile industry for example.’ He continued: ‘Since these parts are not available, manufacturers in other countries, like in South Korea, for instance, have to stop production lines altogether.’ In short, the undiversified supply chains that were arguably put in place to turbo boost capitalism, have become its undoing.

Of course, the implications are far more significant than negatively impacting the economic cycle: how does an undiversified supply chain threaten the supply of the drugs and medical equipment needed to maintain and manage our national health in normal times? In 2018, 88% of active pharmaceutical ingredients came from overseas, with around 14% of that sum produced in China. In short, from a pharmaceutical perspective, the US is not self-sufficient and relies on its supply chains, so what happens when there is a pandemic and our trading partners are either unable to continue supplying us with the necessary drug ingredients, or they simply become unwilling to part with their stash to instead look after their own populations? ‘Evidentially the USA is dependent upon China for some of the component ingredients that are needed to make drugs that are used to fight the coronavirus,’ O’Leary said. Of course, one hopes and expects that the experts will figure out how to overcome these present difficulties; however, it is clear that coronavirus has revealed that undiversified supply chains are not the best way forward on any front.

This brings us to the faint silver lining of the dark cloud that is coronavirus: will this hasten the creation of diversified supply chains? We think so. ‘We think that a decoupling of the US and Chinese economies will be a good thing for both countries and will mean US relying less on China for rare metals, pharmaceuticals and a range of other items.’ Of course, one may say that the US-China trade war was rather inadvertently a blessing in disguise in so far that it got businesses expanding their supply chains outside of China to avoid tariffs. Despite this, the US and Chinese economies are still deeply interconnected; indeed, the trade deal Trump has been working on presumably would strengthen, if rebalance, the relationship between these two economic juggernauts. O’Leary doubts that any business will want to continue with the existing supply chain status quo when coronavirus calms down; on the contrary, he believes that companies will be proactively diversifying their production and parts sourcing throughout the world. O’Leary said, ‘The impact of a diversified supply chain will make business production more complicated and likely more expensive, but it will protect it.’

In conclusion, we think it is likely that markets will be forced to endure more pain in the coming months and that coronavirus will have ruined any hope of 2020 being a bull year. However, we believe that it is reasonable to expect markets to find a bottom and begin to recover. This is not the time to panic, financially speaking – history has shown that even the most violent negative market spirals are often followed by significant gains. We believe in maintaining a portfolio of high quality stocks to weather the storm and remain in position to take full advantage of the inevitable recovery. Despite sucker punching international markets and creating a global health emergency, we believe the coronavirus will lose much of its sting by the end of 2020’s second quarter. Hopefully, by the middle of 2021 the economic wounds wrought by the coronavirus pandemic will be nearly or completely healed.


This material is prepared by Henry James International Management and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are obtained from proprietary and nonproprietary sources believed by Henry James International Management, to be reliable, are not necessarily comprehensive and are not guaranteed as to accuracy. No warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions is accepted by Henry James International Management, its officers, employees or agents. This material is based on information as of the specified date and may be stale thereafter. We have no obligation to tell you when information herein may change. Reliance upon information in this material is at the sole discretion of the reader. Certain information contained herein may constitute forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Any indices chosen by Henry James International Management to measure performance are representative of broad asset classes. Henry James International Management retains the right to change representative indices at any time.

Henry James International Management and its representatives do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation.