A CONSEQUENTIAL MONTH


The month of November has marked a new beginning in many ways. Several announcements were made that have changed the landscape and we can now frame how we move forward.


A Medical Solution


The most consequential announcement during the month was, of course, the announcement of two vaccines (from two different US companies: Pfizer and Moderna) with 95% efficacy against COVID19. More vaccines with similar results are expected to follow. After eight months of lockdowns, shutdowns, cancelled holidays, changed lifestyles and endless obituary columns across the world, there is finally a light at the end of the tunnel. It will not be immediate as production and distribution logistics are never simple. Nevertheless, there is a solution and both individuals and corporations can once again start to make plans, even if these are for at least 6-9 months out.


A medical solution officially marks the beginning of when we can look towards the end of this medical nightmare that we have been living in. Whether you determine that the death rate is too high to be ignored or too low to be panicked about, hospital systems being overwhelmed by patients in ICU is never a good thing. Although the trickiest part of the vaccine may still be to come: distribution and logistics, the fact that there is something that works is all that the markets need to know. It will not be a straight line to normality as, for the most part, cases and hospitalizations are still climbing. Poor planning, particularly in the US, means the pain is likely to affect the economy for at least one more quarter, perhaps two. However, the end is in sight and markets discount 6-9 months out by which time things should have improved.


President-Elect Biden: A New Leader For The Free World


Joe Biden was unequivocally elected President of the United States. Given countless court challenges without evidence, the GOP has proven without a reasonable doubt, that there was in fact no election fraud of any type, despite having a record turnout for both candidates.


There was no blue wave as expected and it appears likely that it will be a divided government that is set to bring normalcy back to the country. This could be the most optimal result because there would be no ability for the Democrats to do anything dramatic to further exacerbate the debt problem. Perhaps we could even see the Republicans once again shift to concerns about the deficit and fiscal responsibility which they were quick to throw under the bus under Trump for their own personal gain. Stimulus bills will be more targeted, although sadly this probably also means there is not a lot of room for critical spending on infrastructure.


One can only hope that Biden will somehow manage to bring the country back from the brink of insane lies, conspiracy theories and divisiveness that have resulted in clear loss of life. As a centrist with a reputation for working with both parties, he is just what the country needs at this time to restore civility and hope for the future.


In the short term the worst of the economic crisis brought about by the pandemic can be solved with another stimulus bill. This is particularly required at the state level. State and local spending is around 10% of total GDP so the recession can end up being deeper and longer if they do not receive rescue funds within the next few weeks. To date, the workers in the service sector (often with lower wages) that have been most impacted by the pandemic have managed to pull through thanks to government subsidies. Since these have run out without Congress approving further assistance, the food lines have grown to levels not seen since the 1930s.


The US election has delivered a change in leadership that will also hopefully provide some normalcy to world order. Biden is most likely going to re-enter the US into the Paris Climate Accord Agreement, NATO, the World Health Organization and countless other organizations that Trump, with his America First policy, refused to abide by. American First has meant “America Alone” for the last four years and Biden’s choice of Secretary of State would indicate this will change on day one.


Importantly, Biden appears to view his mandate as bringing civility back to America and hopefully convincing all Americans, whether they vote red or blue, that they all belong to the same country and that they will always be stronger when they work together. Biden’s record as a Senator may not to be to everybody’s liking, but the one thing no one can disagree on is that he is a decent competent man who works with his opponents across the aisle to seek compromise. His job will not be easy as the country remains highly divided with one faction chasing endless conspiracy theories (such as rampant election fraud for which no evidence was ever provided), lies and outright fraudulent statements; while the other side promotes endless spending and refuses to listen to why the behaviour of the past four years would be appealing to anybody of sane mind.


Markets hate uncertainty more than anything. Two big uncertainties have now been removed. Whether we agree or disagree with who the new President of the US is, and/or what his policies are does not matter. The fact is there is a new President, with clear stated policies, and companies can now plan accordingly


The Largest Trade Agreement Ever Signed: RCEP


The third major event announced this month was something that received much less press but has huge implications for years to come. The Regional Comprehensive Economic Partnership (RCEP) was signed by 15 Asian-Pacific countries, uniting China, Japan, South Korea in a trade deal for the first time, that also includes 10 Southeast Asian countries plus Australia and New Zealand. By abandoning the Pacific Trade Agreement that would have provided for the US to remain as the most relevant trading partner in the region, the Asian countries have moved on with China at the helm instead.


Where Do We Go From Here ?


Although the recession will likely continue at least until the second quarter of 2021, by the second half of next year the recovery should be well under way. It will not be back to January 2020 levels. It may not get there for years to come. Many businesses have closed. New ones will open but it will take time. Many lifestyles have changed as digitalization of the economy was accelerated, particularly in banking and insurance where working from home was an easy transition for most. There are indications that this is likely to continue for at least three days per week once the pandemic is over. Businesses and households will have to adapt to this new reality. That also takes time.


All of the events mentioned above are very important developments for all countries in the world but the most crucial one in the short term is the resolution of a virus that has ravaged economies and the health of nations alike. The markets, which never like uncertainty, have responded positively with a rotation, from the stay at home stocks and high growth high multiple technology stocks into the broader more cyclical sectors of the market, as the global economic recovery now has a more definite timeline. Still we must keep an eye on credit markets as the medical crisis remains in full swing. With people hiding in their homes, whether lockdowns are enforced or not, business will continue to fail. For many, recovery will be a bridge too far. With default rates on junk bonds running around 8% according to Moody’s, it is hard to see how an investor is compensated for this risk with junk bond yields running at under 5%. There is always the threat that investors at some point may demand higher yields for the level of risk they are taking on, particularly when governments themselves are such big issuers of debt. As the President of the ECB, Christine Lagarde has recently mentioned in a speech: “monetary policy has to minimize any “crowding-out” effects that might create negative spillovers for households and firms” as “otherwise increasing fiscal interventions could up upward pressure on market interest rates”.


We remain of the view that the new world order will be somewhat different when we come out of this. Commercial real estate demand will be different. Housing (location and size to accommodate WFH) demand will be different. Human interaction overall is likely to be different and business models will need to adapt. None of this is insurmountable but it will take time and the recovery is likely to be slower than some would like to see. Central banks have done a great job of keeping the train on the tracks because they are the masters at providing liquidity when required to do so. The only problem is if insolvency becomes an issue, which is a problem they are not equipped to resolve. Regardless, at least for now, there are plenty of funds available to invest in business ventures, even if those investments might become highly questionable if rates were to go higher.


The bottom line is that as soon as the vaccine was announced markets could suddenly forecast again. The economic recovery now has a timeline that is a lot less uncertain than it was a month ago. People will be able to go out to restaurants and travel again towards the second half of 2021 or beginning of 2022. Although it was expected that it would be the case, it is now irrefutable. Given markets generally are priced for 6-9 months ahead it is not inappropriate for prices to reflect the new reality. The expectation of a broader recovery from a global cyclical rebound increased yields almost immediately, further steepening the yield curve, which is good for the financial sector but not so good for the stay at home (technology) stocks that have been outperforming during the last six months. Industrials and consumer services are now the new favourites. The problem in the US is that large cap growth stocks (technology, communication services plus Amazon) comprise over 40% of the market, while cyclical value stocks are only 20%. It is hard to see how the market goes up in a scenario where the top 40% gets rotated into the bottom 20%, so caution remains warranted. Stock picking will remain key.


Once the economy stabilizes, the next chapter will be about how the government will deal with all the debt incurred, which was already a problem before the pandemic. Ultimately all this debt will have to be either restructured or inflated away. Sustained low interest rates could become a source of concern for the future, as free money always leads to financial speculation and higher long term risk from new questionable financial structures and rampant debt accumulation. The central banks promising to keep interest rates at very low levels for the next two to three years has led to an insatiable desire for risk assets. For example, 2020 ushered a boom in special purpose acquisition companies (SPACS) promising long term equity market upside plus a warrant with a yield that is only slightly superior to treasury bills. All this is great until interest rates edge up and suddenly a lot of investments no longer can make the adequate returns as promised, in order to cover the cost of that debt. Nevertheless, until the music stops, market participants will keep dancing.


The Summerhill Team

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