We could be about to witness one of the major drawbacks of global market interdependence, which increases the probability of economic and financial contagion taking hold in a crisis.
With Asian battling to prevent the highly contagious COV-19 from spreading to neighboring countries, the timely keyword in this piece is contagion.
Moreover, how economic and financial contagion has the potential to create pitfalls and opportunities in an investment portfolio going forward.
“Asian battling to prevent the highly contagious COV-19 from spreading to neighboring countries”
Contagion is spreading to global supply chains as the world’s factory China is in lockdown in the wake of COVID-19
Contagion to the pharma supply chain is a silent threat of COVID-19.
China is the largest and sometimes only global supplier for the active ingredient of some vital medications.
Today, 80% of pharmaceuticals sold in the US are made in China, which also happens to be the largest manufacturer of medical equipment.
Contagion to the pharma supply chain, in the short term, will cause a shortage of medical supplies
India’s largest drugmakers, Cipla, said there could be “huge unavailability across the chain” if the shutdown extended beyond February.
But that also means that disruption to the global pharma supply chain will boost demand for pharma companies and medical equipment makers who can supply China’s shortfall.
So those manufacturers of medical equipment and pharmaceuticals made outside China who can supply on demand will see an unexpected boost in their revenue and profits.
US trade adviser, Navarro said COVID-19 is “a wake-up call” to create the American pharmaceutical supply chain.
In other words, COVID-19 is a wake-up call for investors to invest in domestic medical suppliers and disinvest in China
“If we have learned anything from the coronavirus and swine flu H1N1 epidemic of 2009, it is that we cannot necessarily depend on other countries, even close allies, to supply us with needed items, from face masks to vaccines,” said Navarro.
The big picture of contagion could also mean the acceleration of US dollar repatriation, which is an early macro trend that could also support the US dollar double top view.
Contagion in the global supply chains could accelerate capital flows into strategic industries.
Perhaps the financial crisis of 2008 will be remembered as a turning point for globalism, where China industrialized on the back of a US debt binge. China bought the US’s greatest export US treasuries, it made a few elites on Wall Street rich by recycling the debt in the form of cheap household loans to borrowers who were increasingly losing their jobs due to the deindustrialization of the US industry. That was the origins of the 2008 US mortgage subprime crisis.
“If the motive behind the US-China trade war is to fortify US strategic industries, then COVID-19 has now strengthened the national security case for this” – Win Investing
While China was rising, US hegemony was circling the drain, US living standards were falling and it provided a winning political platform for Trump’s America first mantra.
Where capital flows prosperity follows. If the American electorate is better off under a Trump administration, which is credible to believe, then Trump is likely to win the 2020 November presidential elections. Put another way, the repatriation of US capital could be a macro trend going forward.
So contagion in the global supply chains is likely to benefit US strategic industries the most
This could represent a buying opportunity in the event of a stock market correction.
If the motive behind the US-China trade war is to fortify US strategic industries, then COVID-19 has now strengthened the national security case for this.
A strategic industry is defined as one that a country considers vital for its economic development. Strategic industries cover a wide spectrum, they include the steel industry, important commodities and the techno-driven sector, particularly those active in next-generation technology.
Chipmakers play a central role in the strategic industries of the 21 century.
Computer chips were a feature of the battleground in the trade war between the US and China.
Investing in strategic industries is likely to provide investors with high returns and even more so with contagion to the global supply chains playing out
As explained above, the reasoning is based on the fact that when China’s supplies are choked off due to a trade war and now also with COVID-19 being an obstruction to Chinese supplies that is going to give a boost to US suppliers, particularly strategic industry suppliers.
“COVID-19, a significant black swan event, is expected to lower China’s real GDP growth rate in 2020 to approximately 5.4%” – Win Investing
Financial contagion could also play out with global banks having the largest exposure to loans in China and Asia
COVID-19, a significant black swan event, is expected to lower China’s real GDP growth rate in 2020 to approximately 5.4%
“The impact of COVID-19 outbreak on the global economy could be more severe than the impacts of the other major outbreaks in recent history,” wrote IHS Markit.
Moreover, a 1% fall in China’s GDP, a best-case scenario, would be significant enough to send shockwaves around the global economy. So it is China’s $796 billion in offshore loans which could cause financial contagion.
British banks have the largest exposure in China
The British bank HSBC Holdings PLC has the most exposure to China’s offshore loans, so it would be most vulnerable to a steep economic downturn.
HSBC’s outstanding loans in China grew 12% in the year ended June 30, to $36.2 billion, according to its latest financial report.
Standard Chartered PLC’s overall exposure to Chinese loans also rose 30% to $58.3 billion.
Financial contagion was already moving on the radar with Chinese steelmaker sparking debt contagion fears.
A Chinese bond default was causing market concerns back in October 2019 and bond investors feared that it might spread to other firms in the province. This was playing out before COVID-19 was reported in mainstream.
So COVID-19, the global economy’s kiss of death, is likely to accelerate a global economic depression, thereby making financial contagion inevitable.
Throw into the equation the rising credit risk for a few major banks with deep exposure to China’s loans and we could have the making of a contagious global credit squeeze that would make the 2008 financial crisis look benign by comparison.