China Partially Shuts Down

According to The New York Times, at least 760 million Chinese currently face limits to their travel – or more than twice the population of the United States. The ultimate impact of partially shutting down the world’s second-largest economy falls under the predictive category of known unknown.

Current Activity Measure in China Suggests Sharp First Quarter Decline

Figure 1 from Goldman Sachs research provides some sense of current economic activity in China since the eruption of the 2019 Novel Coronavirus (COVID-19). The chart shows declining coal consumption by the major utilities, indicating reduced demand for electricity. Both indicators likely translate into slowing economic activity. Using that as a guide, China’s economy will likely show a significant slowdown, at best, in the first quarter. Of course, whatever economic results the Chinese government reports will receive more than the usual skepticism.

Figure 1

Daily Coal Consumption – China’s Major Electric Utilities

Source: Goldman Sachs, Wind

China Economic Recovery Likely In Stages

The Chinese economy will likely recover in stages as critical sectors resume their activities first. The highest priorities will likely fall on transportation, health services, and food. For the Lunar New Year, many Chinese traveled away from home. Figure 2 from Bank of America global research shows the sharp decline in inter-city traffic volume resulting from the government’s clampdown on travel. Returning economic activity to past levels will require normalizing transportation services to bring workers back to their places of employment.

Figure 2

China — Inter-City Travel Volume

Source: BofA Global Research, Baidu

Korea Could Be One of the Hardest Hit Economies

The extent to which COVID-19 interrupts the efficient flow of global supply chains will determine its impact on global and U.S. economies. The first impact will likely fall on East Asian economies. For example, China is South Korea’s biggest trading partner, with one-quarter of Korea’s exports going to China. At the same time, Korea depends on component imports from China to feed its automotive production lines (see Figure 3). For example, South Korea imports 80% of automotive wiring harnesses from China. In response to a shortage of components from China, Hyundai suspended production earlier this month. If the recovery of the Chinese economy lingers, Korea could be one of the hardest-hit economies – with Korea being a key leading indicator of global economic growth.

Figure 3

South Korean Auto Parts Imports from China

Source: Korea International Trade Association, Reuters Graphics

China’s Healthcare System Does Not Measure Up to Its Economic Growth

In the last twelve months, China experienced not only the COVID-19 epidemic but also the African Swine Fever (ASF). This overall experience brings into question whether the rapid growth of the economy outpaced its ability to prevent such outbreaks. According to an article in Asia Times, “massive urbanization over the past three decades has further exposed weak links in the sanitation system and a deteriorating state of overall healthcare.” Figure 4 shows China’s health expenditures as a percent of gross domestic product (GDP) compares poorly to many nations. China will need to step up its health care spending to avoid another epidemic.

Figure 4

Public Healthcare Expenditures — by Country — As a Percent of GDP

Source: BCA Research, WSJ/Daily Shot

Long March for China to Become a Developed Country

Despite its rapid industrial development, issues raised this year point out — to borrow from Chairman Mao — “the long march” China must travel before reaching developed country status. With that, combining public health issues revealed by COVID-19 with the Sino/American trade war gives businesses even more reasons to move their global supply chains away from China. Easy conclusion, but it will take time and capital to make that move.

Investment Conclusions

Unexpected events, such as COVID-19, confirms the value of a diversified portfolio asset mix for many investors. In the current investment and economic environment, our recommended asset mix remains 40% equities, 35% alternatives, and 25% fixed income. With the shortage of U.S. economic growth, stocks of quality companies that show steady profit growth should benefit. As a plus, such companies usually reward investors with regular dividend increases. With historically low interest rates, alternative investments make sense, as long-term bonds will not likely play their traditional role of moderating equity risk. Finally, use shorter duration credits for their role in preserving capital.