The market has been obsessed with China’s coronavirus outbreak for weeks now.
Every little development, from another quarantine measure to a new isolated case found outside China, has sent stocks into a flurry of activity.
However, despite the News Media hyping up this outbreak like the end of the world, the data we had showed a different story.
The outbreak seemed mostly contained to its source in China’s central Hubei province. Most cases, and all but three deaths, occurred there. And the vast majority of cases outside of China were Chinese nationals who had recently left Hubei.
This was a Reality Gap where the market was reacting to its own fears, while the data suggested most of those fears were misplaced.
Many market participants were aligned with my analysis and we saw the market continually rebound after negative news pushed markets down temporarily.
This analysis allowed us to see rebounds coming after initial processing of the coronavirus data and handed subscribers to my premium services six 100% gains in the last two weeks.
But new uncertainty about the legitimacy and accuracy of the calming data that was coming out of China has changed all this.
To determine what the Reality Gap is, I always follow the data.
And over the weekend, it became very clear that the “data” China – and even the World Health Organization – has been putting out is in serious question.
And so, I have to updated my short and intermediate-term analysis of the impact of the outbreak on the financial markets.
And we need to adjust how we trade accordingly.
This Virus Is Not a Health Concern for You (If You’re Outside the Epicenter)
That’s not to say that the end of the world is coming.
Let’s be clear: it’s not.
Covid-19, as this strain of coronavirus is now officially called, is still not a threat to your health here in the U.S.
To this day, the largest cluster of cases outside of China is on the cruise ship Diamond Princess, currently docked and under quarantine in Japan. Chinese passengers aboard appear to have infected parts of the crew and other passengers, partly due to woefully inadequate quarantine measures taken by Japanese authorities.
And the number of new infections outside Hubei has been falling for almost two weeks now.
In other words, unless you’re on that cruise ship or are travelling to Hubei, you have almost no chance to contract the virus.
So there’s still no reason to worry about your health.
But Covid-19 has changed my medium-term outlook on the market and economy.
I’m now much more cautious.
Let me show you why.
Early Signs Suggested China Had Learned a Lesson from SARS
The last time China faced a major disease outbreak was the SARS epidemic in 2002-03.
The response to that outbreak was hampered by the Chinese government’s heavy-handed repression of so-called “rumors” that made the country look bad.
By denying the problem for several months, the disease was allowed to spread unchecked, and sick people couldn’t get the care they needed.
This time around, China appeared to act quicker.
It’s true that the physician that initially alerted the world that there was a new disease spreading, Dr. Li Wenliang, was warned by the authorities to stay quiet.
He had noticed an influx of cases while working at a hospital in Wuhan, the capital of Hubei province. He tragically died of Covid-19 earlier this month.
But unlike the several months it took China to admit that the SARS outbreak was real and dangerous, this time things seemed different.
The outbreak appears to have started in early December, and in January the World Health Organization (WHO) was invited to oversee the country’s response.
At the same time, Chinese New Year meant that almost 400 million people were travelling to celebrate with their families, increasing the risk that the virus would spread.
In response, China started imposing some downright draconian measures in Wuhan, a city of 11 million people. This involved closing down all train stations, airports, buses, and eventually all roads in and out of the city.
This was then extended to other cities in Hubei province, making it one of the largest quarantines in history.
Meanwhile, China’s data seemed to be showing that this quarantine was working. The number of new cases seemed to be slowing down, a sign that the outbreak was about to peak. And that the Chinese authorities were acting in a competent manner.
However, over the weekend it became clear to me that the Chinese government never learned the lessons from the SARS outbreak…
And that data from this Covid-19 outbreak continues to be more about political needs than scientific or medical ones…
It’s Become Clear China is Still Covering Up This Epidemic
There are a number of signs that we’re dealing with a cover up.
For one, China at first met only with the head of the WHO, but not with the organization’s experts in epidemics and medicine. The Director-General of the WHO, by the way, was chosen with China’s support and with their direct influence in the UN selection process.
And the WHO Director-General made the alarming statement on February 4 that there was no need for measures that “unnecessarily interfere with international travel and trade,” and he specifically said that stopping flights and restricting Chinese travel abroad was “counter-productive” to fighting the global spread of the virus.
This despite data that WHO sponsored doctors had publish in the prestigious medical journal The Lancet.
Worse yet, the WHO medical team still hasn’t arrived in China (they are scheduled to arrive this weekend). And, of course, no other outside infectious disease or epidemiology experts have been allowed to come into the country to help, let alone provide independent information about conditions there.
Meanwhile, the numbers China was putting out became less and less plausible as time went by.
See, epidemics have been recorded and studied for centuries, and epidemiologists have very accurate models.
I won’t bore you with the details, but the short of it is that we know what pattern an outbreak like this one should take.
And as more and more numbers were released out of China, the picture they painted did not fit those models.
To the extent that the data appears altered to fit a less steep, less concerning curve.
Statisticians who modelled the numbers even predicted the numbers that China would publish for the following week – and were exceptionally close.
The few reports from within quarantined Hubei province that have made it past China’s censors suggest the situation there is much worse than Chinese officials claim.
And if the numbers are close to correct in The Lancet research piece I mentioned above, there are many more people (perhaps by an order of magnitude more) infected than the official numbers state.
And last week, we got a first inclination that official numbers were off when China jacked up the number of new cases and deaths by 35% and 23%, respectively, in just one day.
Things are still in a very dire state. Not reporting that you have symptoms of infection is now a criminal offence in Hubei. On the other hand, so is spreading “rumors” about the disease, leaving people afraid no matter what they do.
Meanwhile, the equipment used to quickly detect the signs of the Covid-19 virus in blood appears to either be missing, misused, or broken, leading up to 50%-70% of infected people being marked as virus-free in China.
The massive quarantine imposed on more than 11 million people seems to have backfired heavily. By telling people to stay at home, China’s authorities ensured that the virus spread to otherwise healthy family members.
It also delayed people from receiving care early on while they could still be helped. And by imposing the curfew, it reduced access to food. This weakened sick people, putting them at more danger from the Covid-19 virus.
This may have created an appearance of fewer cases at first, but once whole households were infected, it quickly swamped the province’s hospitals. There is now a shortage of hospital beds in Wuhan, despite several 1,000+ bed hospitals having been built in record time to handle the influx.
Some of these quarantine measures have now been instituted in other parts of China. The Chinese New Year holiday was extended to prevent people from returning to their offices and factories, where the virus could spread.
Many factories are still closed, or operating below full capacity.
And the Chinese government is tight-lipped on exactly what the risk is in different areas, and how long these measures will be in place.
And from a data perspective, it’s become clear that we’re almost operating in the dark here.
And as Apple Inc. (AAPL) and other companies have made clear, this is now trickling through to the global economy…
The Global Economy is About to Take a Hit
On Monday, Apple announced they would probably miss their sales guidance for this quarter.
This is because the company’s Chinese suppliers and manufacturers are either closed or operating below capacity because of the outbreak.
Apple isn’t alone. And the company’s rivals and suppliers are just the beginning.
China is a much larger economy now than it was in 2002-03 during the SARS outbreak, and is much more tightly linked with Western companies and economies.
Already, companies as diverse as soft-drink giant Coca-Cola Co. (KO), travel company Expedia Group Inc. (EXPE), food manufacturer General Mills Inc. (GIS), and medical-device maker Medtronic plc (MDT) have warned shareholders that the Covid-19 outbreak will affect them negatively.
Expect many more warnings like these in the weeks to come.
That’s not only going to put a damper on traders with every report…
It’s also a significant new headwind for the global economy.
Experts now estimate that as many as 4.5 million Chinese workers could be laid off if the outbreak isn’t contained by the end of March.
And major signs of economic activity like property sales, coal consumption, and transport congestion have all cratered in China.
Every company that either sells its products in China, or has Chinese factories as part of their supply chain, will feel the pain.
And in today’s global economy, that includes a great many companies.
That’s why I recommend you stay away from new positions in companies that have big supply chain connections to China or get a large amount of revenue from sales there. And in certain cases, I’d even suggest shorting them as I’ve done this week with put recommendations in QCOM and QRVO for my premium subscribers.
Meanwhile, focus your bullish trades on companies with little exposure to China. These companies will be stronger going forward, as traders move their investments over from those affected by the outbreak.
Be sure to stay cautious, with a tighter time horizon on your trades. The effects of this Covid-19 outbreak on the global economy have yet to be clear, though my current analysis says we have yet to see the worst news about this outbreak.
Great trading and God bless you,
D.R. Barton, Jr.
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