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Steep Drop in Trade Flows Shows Pitfalls of Cross-Border Supply Chains

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Global trade flows tumbled in the first quarter, a preview of what could be the largest contraction in international commerce in decades, as the coronavirus pandemic causes policy makers and multinationals to reconsider globe-spanning supply chains that have become a defining feature of the world economy.
The World Trade Organization’s economists estimate that flows will fall by between 13% and 32% during 2020 as a whole. A decline of a third would be equivalent to the collapse associated with the Great Depression—but concentrated in one year rather than spread over three.
Trade flows are likely to rebound next year if economic activity returns to normal and the virus is contained.

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But the sudden halt in trade has exposed how interdependent countries are in sourcing and manufacturing everything from cars to ventilators to smartphones. Individual countries have become nodes in vast supply chains whose vulnerability became clear when the pandemic sliced them apart.
As a result, the coronavirus—along with previous tensions between China and the U.S. over trade and technology—is forcing multinationals and policy makers to consider ways to bring production closer to home, safeguard the production of essential goods and reduce their reliance on China as a manufacturing base.

Europe Is Opening for Business But Isn’t on Sale

European companies are cheap relative to U.S. rivals, which have strong dollars and higher-valued shares to spend. But new hurdles are also forming that will make it harder for outsiders to pursue acquisitions in the region.Even as Europe gradually reopens for business following the coronavirus shutdowns, the Stoxx Europe 600 remains down 7% in dollar terms since the start of March, while the S&P 500 is broadly flat. That leaves European stocks trading near their widest discount to the S&P 500 relative to forecast earnings since the global financial crisis.

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For deal makers, though, taking any advantage will be challenging. European authorities are busy sharpening their tools to stop foreigners snapping up family jewels on the cheap.
Margrethe Vestager, the European Union’s competition chief, said the EU needs to be “vigilant” and “assertive about what is in our strategic interest” in an interview with Bloomberg TV last week. The Dane is the one who decides whether to approve or block tie-ups. She insisted that while Europe is open to foreign direct investment, Brussels doesn’t want takeovers by state-subsidized businesses, nor foreigners buying a company just to take its technology—nods to China and the U.S. respectively.
The EU, which has strict rules against state subsidies for its members, has long worried that state-backed Chinese companies have an unfair competitive advantage over homegrown rivals. Since the crisis, its concerns have broadened. Officials are now on high alert after Berlin accused Washington of seeking control of CureVac, a German biotech company with promising Covid-19 vaccine technology. Last week, the German government expanded its power to block the acquisition of a more than 10% share in any of its health-care companies.Brussels has been busy building hurdles too. From October, the EU will have new powers to screen major foreign direct investment in key sectors. Its opinion will be influential but nonbinding: EU member states will make the final decisions.

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Over half of member states already have an equivalent of the Committee on Foreign Investment in the U.S., which scrutinizes overseas takeovers of U.S. companies. The EU wants the rest of its members to create their own FDI screening process urgently and to use their other powers to the full, including the option to buy a stake in important companies to prevent foreign buyers snapping them up.
Once through that screening, all big deals need EU antitrust approval, an intense process that the crisis has made less predictable. Officials’ primary consideration is how any tie-up might affect competition, but right now that’s nearly impossible to determine: Most sectors aren’t operating and no one quite knows what they will look like when the economy restarts. The forecasts that frame antitrust decisions were always a mix of art and science. Now they also involve a lot of guesswork.Special rules can clear the way for anticompetitive deals if they are buying so-called “failing firms,” which some targets after today’s shutdowns are likely to be. But there are high legal requirements to qualify. It isn’t enough for the target to have run out of cash in the current crunch.

U.S. Moves to Audit Chinese Firms. Market Frets Over What Comes Next.

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For more than a decade, Chinese companies raised billions by listing their shares on American stock exchanges while avoiding the accounting-quality checks that other public firms endure.
But economic tension between the two global superpowers, amplified by political outrage in the U.S. over China’s role in the spread of the new coronavirus, has pushed a financial-markets issue into the political mainstream. Legislation passed by the Senate—and now introduced in the House—would kick Chinese companies off U.S. stock exchanges unless their audits are inspected by U.S. regulators.
No firms would immediately lose their listing under the proposed legislation, but investors worry it will further inflame tensions between Beijing and Washington at a particularly bad time. Shares in major Chinese companies listed in the U.S. dropped sharply in the days after the Senate passage. With the global economy reeling from the coronavirus, a worsening of the relationship could create more skepticism about the resumption of trade talks and send both U.S. and Chinese shares lower.
Unlike other countries, China has never given U.S. regulators routine access to audit records needed to review the quality of financial accounting, according to U.S. officials, who have sought a deal for years. That covers about 200 companies with a total market value exceeding $1.4 trillion, according to S&P Global Market Intelligence.
Investors have often been willing to overlook the regulatory gap as they snapped up shares of Chinese companies, including Alibaba Group Holding Ltd., that made their debuts on U.S. exchanges. Wall Street banks, which underwrote the stock sales and are supposed to conduct due diligence on the companies, have been rewarded with more than $1.4 billion in fees, according to data from Dealogic. The major stock exchanges also benefited from lucrative, attention-getting global listings.
The Senate legislation requires the Chinese companies with shares traded here to disclose to the Securities and Exchange Commission whether they are owned or controlled by state authorities.
While many of the Chinese companies traded in the U.S. aren’t state-owned, such as Alibaba and e-commerce rival JD.com Inc., others are fully or partially under Chinese government control. China is less likely to allow audit work papers for state-owned firms to ever be shared with overseas regulators, according to securities lawyers.
China says sharing audit work papers would violate its sovereignty and risk leaking state secrets. This year, it outlawed complying with overseas securities regulators without the permission of its own market supervisor and various components of the Chinese government.
The SEC has stepped up its warnings about the regulatory blind spot in recent months, including after the disclosure of accounting fraud at Luckin Coffee, a once-highflying Chinese startup and competitor to Starbucks Corp.
Luckin, which went public on the Nasdaq Stock Market and is being investigated by the SEC, said some employees fabricated $310 million in revenue. It has since fired its chief executive and chief operating officer, and its shares have fallen to a recent $1.39 from $50 in January. The SEC said last month that the agency’s ability to promote and enforce standards in China and other emerging markets is severely limited.
Before Luckin, there was a string of Chinese frauds in the U.S. stock market. The SEC sued Deloitte Touche Tohmatsu CPA Ltd. in 2011, seeking records it needed to conduct a fraud investigation of the audit firm’s former client, China-based Longtop Financial Technologies Ltd. In 2016, the SEC sued Longwei Petroleum Investment Holding Ltd., a fuel company based in China that had been listed on the New York Stock Exchange’s market for smaller companies, over claims that it fabricated aspects of its business. The SEC prevailed in the case in 2019.
Backers of the proposed U.S. crackdown say what had been a low-profile issue in financial markets took on greater political meaning after this year’s economic crash.

The Stock Market and Consumer Sentiment Are Telling Different Stories

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Stocks have rebounded dramatically off their March lows, while consumer sentiment is hovering near the lowest level in nearly a decade. The divergence is one of many realities investors are struggling to reconcile.
The spread between the monthly percentage change of the S&P 500 and the University of Michigan’s consumer sentiment survey climbed to 32 percentage points last month, the widest-ever gulf in data going back to 1978, according to Dow Jones Market Data.
The drop in sentiment reflects the wave of challenges unleashed by the coronavirus pandemic. Almost overnight, the economy swung from an expansion into a deep contraction. Unemployment rose to record highs from record lows. Personal incomes in March suffered the steepest drop since 2013, and consumer spending fell at the fastest rate since 1959. The numbers for April, due Friday, are expected to be worse.
Yet stocks have continued to rise. The S&P 500 has surged 34% since bottoming March 23, cutting its losses for the year to 7.4%.
The stock market and sentiment both ultimately reflect conditions in the economy, he said. But sentiment surveys tend to closely track economic trends, while stocks can also be influenced by other factors, including Federal Reserve policy.
The S&P 500’s 13% rally in April marked its best month since January 1987, a rise most market observers attribute to the unprecedented level of stimulus provided by the Fed. The pace of the rebound suggests many investors are betting on a V-shaped recovery—a sharp drop in economic activity, followed by an equally rapid rebound.

U.S. Government-Bond Yields Rise as Economies Reopen

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U.S. government-bond yields climbed Tuesday, lifted by investors’ optimism over resumed economic activity around the world.
The yield on the benchmark 10-year U.S. Treasury note rose toward the high end of its recent range and recently traded at 0.698%, according to Tradeweb. That compares with 0.659% at Friday’s close.
Yields, which rise when bond prices fall, climbed with global stocks amid signs of a pickup in spending on hotels, restaurants, and airlines in the U.S., as well as a decline in the daily number of new coronavirus infections.
The Federal Reserve’s plans to slow its purchasing of Treasurys could also help drive yields higher, said Mr. Milstein. The Fed plans to purchase around $20 billion in Treasury securities this week, down from $30 billion last week and $35 billion two weeks ago.
The yield on the 10-year note, which tends to move along with expectations for economic growth and inflation, has remained stalled around two-thirds of a percentage point recently, a sign of investors’ fears about the pandemic’s long-term hit to the economy.
U.S. corporate bonds gained on Tuesday. BlackRock’s iShares U.S. investment-grade corporate bond exchange-traded fund climbed 0.2%, according to FactSet, while its high-yield ETF jumped 1.1%.

Investment in U.S. Shale Projects to Halve in 2020, IEA Says

Investment in the U.S. shale sector will drop by half this year, the International Energy Agency said Wednesday, predicting a period of pain for producers, even as oil prices rally.
The forecast body-blow to the availability of capital for U.S. producers comes as part of an expected world-wide decline in broader energy investment during 2020. The Paris-based organization expects global investment in oil and gas to decrease by a third and the financing of all energy projects to decline by 20%.

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Production cuts from oil-producing nations have in recent weeks combined with a bounce in demand after the lifting of lockdowns to help oil prices begin their recovery from their April collapse. U.S. companies spent on average $35.90 to produce a barrel of oil in 2019.. U.S. oil prices haven’t traded that high since early March.
With oil prices long-trading below the cost of production for shale producers, several companies have been forced to file for bankruptcy in recent months, while U.S. major oil companies have slashed capital spending. Exxon Mobil, for example, said in April it would cut its 2020 capital spending by 30% this year in response to the coronavirus.
The drop in spending has already reduced U.S. output as shale companies drill less and shut in existing wells. The EIA said Wednesday that average daily crude production during the week ended May 15 was 11.5 million barrels. That’s down 12% from a record 13.1 million in March.

 

Global Business Activity Starts to Steady but Recovery Looks Far Off

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Business activity in the U.S., Europe and Japan continued to decline in May but at a slower rate, data showed Thursday, suggesting any recovery will be exceedingly slow.Surveys of purchasing managers indicate that private-sector activity fell for the third straight month in May, according to IHS Markit, the group that compiles the data.

The surveys pointed to continued job cuts and a rise in unemployment dragging on any recovery as affected households cut back on spending.
The surveys suggest the three months through June could see even larger contractions in many economies.
“Demand is likely to remain extremely weak for a prolonged period, putting further pressure on companies to make more aggressive job cuts,” said Chris Williamson, IHS Markit’s chief business economist. “We therefore expect...a full recovery to take several years.”
In the U.S., the world’s largest economy, business activity continued to fall but at a less steep pace than before. IHS Markit said its index of manufacturing activity stood at 39.8 in May, up from 36.1 in April. A reading below 50.0 indicates that activity has fallen and the lower the figure, the larger the fall.
A measure of activity in the U.S. services sector—representing the broadest segment of the economy—rose to 36.9 from 26.7.
IHS Markit’s composite Purchasing Managers Index for the eurozone—a measure of activity in the private sector—rose to 30.5 in May from 13.6 in April.

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