Hedge Clippings | Friday 28 February, 2020

If reading this edition of Hedge Clippings has an element of déjà vu about it, it's probably because we wrote about the "unknown unknowns" of the coronavirus in Hedge Clippings just three weeks ago. At that stage we mentioned that the "outcome was unknown, not only from the medical perspective, but also an economic one".

As with everything to do with the coronavirus, the situation is constantly and rapidly changing  (so much so that they have even changed its name to COVID-19), although as we said at the time, the speed of progression is a known unknown.

What is becoming clear is that the economic effect is significant, and depending on how things unfold from here, it seems unlikely that China will record any growth, not only this quarter, but potentially the one beyond. Given Australia's economic dependence on China there is a strong possibility that our economy will follow suit.

Having seen markets power ahead over the past year or two based on FOMO (Fear Of Missing Out) or TINA (There Is No Alternative), the markets are now gripped simply by the "F" word - FEAR.

Fear that has driven the yield on Australian government 10-year bonds to just 0.859%, down from an already low 1.37% at the beginning of the year.

Fear that has wiped out six months of All Ordinaries' gains.

Fear that is likely to keep consumers subdued, with their hands in their pockets (or out depending on your perspective) and retailers having difficulty in keeping their heads above water.

Fear that has people wearing facemasks in the streets of Melbourne and Sydney, in spite of the fact that as yet no one has actually contracted the virus within Australia, with all known cases here resulting from returning travellers.

In reality the fear is potentially more contagious than the virus that is spreading it.

However, there are some worrying realities. Chinese car sales fell 92% in the first two weeks of February. Australia is highly leveraged to China not only from tourism and education, but also for our exports of the raw materials that feed China's now stationary mills and factories.

As yet the US seems less affected, however there is a significant caveat on that given (as previously mentioned in Hedge Clippings) the significant number of so called "Zombie" companies in the US which, having been bloated by cheap and easily available debt, use their entire free cash flow paying the interest bill. That works whilst interest rates remain low (which we expect to continue) but it won't do so if there is any slowdown in economic activity or sales.

In the short term it's highly likely that there will be a further interest rate cut when the RBA next meets, although at current levels there's a limit to how much further rates can fall. Looking further forward a couple of months, and the chances of the much vaunted budget surplus evaporating would seem inevitable.

One might even say both are highly likely to be "known knowns".