First Quarter Modest Coronavirus Impact — Later In the Year Could Reduce U.S. Capital Spending
First Quarter GDP — 737 Production Shutdown and Coronavirus
Boeing’s cutoff of 737 max production and the 2019 Novel Coronavirus epidemic in China will likely modestly effect U.S. first quarter gross domestic product (GDP) growth. The Atlanta Fed’s survey Blue-Chip Financial Forecasts shows a broad forecast range of about 1-2% growth for first quarter GDP — admittedly not yet reflecting the coronavirus impact.
Seasonal Adjustments May Prove Even More Important to First Quarter GDP Comparisons
In the first quarter each year, investors can usually expect the government’s seasonal adjustments will distort preliminary GDP growth estimates — more often negatively. That distortion could prove more of a drag to GDP growth than Boeing’s production cutoff or the coronavirus epidemic.
Business Optimism Picking Up—But Coronavirus Could Lead to Further Cuts in Energy Drilling Investments
In our view, continued high levels of consumer optimism could lead to an uptick in second half business investment spending. Also contributing to that view, the Sino/American and USMCA trade agreements should lift last year’s shadow over business investment spending. However, a new shadow arises as the coronavirus pulls down both Chinese oil demand and prices. The resulting damper on capital spending for drilling would bring a repeat of last year’s weakness in drilling investments. Before the shadow from the coronavirus outbreak, supporting our view for a likely uptick in business optimism, the Fed’s manufacturing indices sharply increased in January (see Figure 1). If the epidemic impact proves short-term, business optimism will likely sustain itself.
Regional Fed Manufacturing Indices—January 2020
Source: Factset, Chart: Naeema Ahmed/Axios
East Asian Economies First Affected by Coronavirus
The extent the virus creates friction in complex global supply chains will determine the ultimate impact on global and U.S. economies. The initial impact will likely fall on East Asian economies. Deutsche Bank’s economics research recently outlined the interdependence of regional supply chains among primarily East Asian countries. For example, China mainly imports intermediate products from South Korea, Japan, and Taiwan. At the same time, it primarily exports intermediate products to Taiwan, South Korea, India, and Vietnam.
Longevity of Epidemic Will Determine Impact on the U.S.
These intermediate supply chains ultimately wind up exporting components to the final link in the supply chain — manufacturers in North America and other developed countries. If the coronavirus delays delivery of components late into the spring, then auto manufacturers might need to shut some of their plants. Finally, combining the Sino/American trade war with the broader questions on China that arise from the coronavirus epidemic further leads to likely shifts of production away from that country.
Accommodative Fed Policies and Absence of Trade War Headlines Should Be Positive for U.S. Economy by Second Half of 2020
Recognizing the many ifs facing the U.S. economy, nonetheless, more accommodative monetary policies and less trade war overhang should enable the economy to recover from any near-term impact from coronavirus by late spring. With that likely bounce back, the U.S. economy should reach its potential growth rate of 2% by year-end. However, the futures market shows a more cautious view. That market expects a rate cut at the Fed’s July meeting. Nonetheless, if our expectation that the U.S. economy can avoid real hurt from the coronavirus, then there seems less reason for further Fed funds rate cuts at that time. In addition, the closer to the presidential election, the less likely the Fed will alter its policies.
Unexpected events, such as the coronavirus epidemic, confirm the value of a diversified investment approach to a portfolio’s asset mix. We continue to recommend an asset mix of 40% equities, 35% alternatives, and 25% fixed income. In the case of equities look to quality companies that show steady profit growth and reward investors with regular dividend increases. The current environment also points out the value of alternatives for diversified portfolios. Finally, employ shorter duration credits for their role in preserving capital.
Andrew J. Melnick, CFA
Chief Investment Strategist
First Capital Investment Partners