Catapult Insights – Global Macro Perspectives – August 2020

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Where are we now?

With the NASDAQ surpassing pre-COVID highs at beginning of June and now trading more than 10% higher still… The S&P, the DOW and RoW indices all within spitting distances of pre-COVID levels, the question is: Where are we now?

If one looked only at the financial markets one could be forgiven for thinking that the worst of the COVID storm has passed but I for one am not so sure that is the case.

In fact, I think we are at the beginning of a 6-9 month period in which the dust from the COVID shock in combination with the already anemic state of the global economy pre-COVID and the impact of the fiscal and monetary response thereto will finally start to settle.

So let’s look at some data and statistics…

• In China industrial production has picked up sharply but it is still 5-10% lower than pre-COVID levels. Shanghai containerized freight index is also not showing any signs of “catch-up” demand or positive bull-whip effect.
• Hong Kong and Singapore have rolled over on sharp/swift initial snap-back to normality with new outbreaks and rising new case counts.
• Mainland Europe appears to have broken the back of the virus spread through draconian lock-down policies which are now being eased.
  • Activity (retail, mobility etc.) levels in July although varied appear also to be stuck around 15-20% below pre-COVID levels and recovering further but case numbers are again growing with travel restrictions relaxed for the Summer (although flight cancellations is still at an eye watering 70%).
• Emerging markets around the world are among the worst hit by COVID and most trail the developed markets in their ability to combat the issues and fallout.
• In the US new case numbers have been rising steadily since mid June and average new daily confirmed case counts are now around the 70k mark… And NO that is NOT because we are doing more tests, as evidenced by deaths also rising in lockstep surpassing the 1000 mark on a daily basis again in the most recent week.
• Q2 GDP numbers are trickling in for the developed markets and whilst the US annualized number of 32,9% decline (which is actually only a 9,5% decline relative to Q2 2019) was better than earlier projections by the Atlanta FED and market expectations they are still the worst in history and now a fact for all to ponder.
• In the words of FED Chair Powel: “On balance, it looks like the data are pointing to a slowing in the pace of the recovery,” Powell said — adding that consumer surveys appear to be “softening again,” while labor market indicators pointed to a slowing of job growth, particularly among small businesses.
• Let’s focus a little on the latter point, the US jobs market:

• Most recent “continued unemployment claims” number remain stubbornly high at around 17m with more than 50m people estimated to have “left” the workforce since March. The prospect ending fiscal support programs is therefore amounting to a “fiscal cliff” for the US.
• It is clear that fiscal programs will need to be extended, likely at a lower clip thus cementing my view that recovery will take a lot longer and will be more painful than is currently discounted by the markets.
• All in all, the sharp US recovery from Q2 lows appears to be “stalling” at 90% of pre-COVID output with a negative outlook… i.e. not recovering back to 100% but remaining below 90%!
• In Europe, although differently measured quarter on quarter declines in Q2 GDP amounted to -12,2% for the whole with Germany (-10,1%), France (-13,8%), Italy (-12,4%) & Spain (-18,5%) all showing larger declines than the US.
• Unemployment numbers/issues in Europe are also no better, they are just camouflaged by better/pre-existing program’s/benefits to deal with them so that we avoid the political debates currently ongoing in the US.
• We will need a lot more that a little “EU solidarity” and/or a mandate to issue a (limited) amount of Eurobonds to to “fix” Europe’s ails, but for now the fact that we have taken a turn in the right direction (according to markets) seems to be more important that the details and the magnitude of the required reforms required, or whether they are actually feasible.

Looking at markets is there anything we can glean…

• Given the FED is controlling most asset prices and yields in the US through its various programs it appears that the US-Dollar is the relief valve that is equalizing the pressure differentials building up by differing success in combating COVID in the short term.
• This in turn makes for an interesting dynamic as dollar weakness is positive for most emerging markets, Europe and to some extent even the US… I believe this is why the FED is quite happy to let it run as long as treasury yields remain controlled/controllable and I for one actually don’t see it as a telltale for runaway inflation and instead remain focused on longer maturity treasury yields for such signaling.
• I am of the view that current Euro euphoria on the back of recent “landmark” agreement on the issuance of Eurobonds will dissipate as it does not offer any real solutions to the problems at hand…just a slightly bigger band-aid! Given however the US failure to get its act together on COVID and the markets preference for lip service over action, it may be some time before this view manifests its self.
• I believe the “hope” phase of the post COVID recovery, where positive sentiment and news flow from “lifting” of lockdowns and beating of overly pessimistic COVID impact estimates outpaces the negatives ended last week with the beating of earnings expectations by the big tech names.
• From now on there will be a 6-9 month undercurrent of second order effects of COVID, the global shutdown and the response thereto grinding away towards the “new normal”. All of which is still overshadowed by the possibility of a second wave which may or may not be alleviated by success on the vaccine/drug front (which I choose to ignore for now).
• The FED’s ability to “prop-up” markets with monetary intervention is diminishing as evidenced by the plight of the dollar and surging interest in precious metals and other commodities. Having driven markets to new highs and sucked in retail investors in the process we are now poised for a period heightened market volatility/vulnerability in which the ultimate outcome will be determined more by fiscal policy than monetary.
• The surge in interest in non-yielding assets such as precious metal assets and Bitcoin suggests increasing investor worries about monetary debasement (read inflation), especially of the USD whilst valuations of bank stocks and bond yields actually show no real change to growth/inflation outlook. If anything, they signal further deflationary pressure. As said I don’t mind the run up in gold for my portfolio but am more focused on the latter as an indicator of inflation.
• And while banks are better capitalized than before, the size of the necessary debt restructuring/write-offs necessary still poses systemic concern especially in places like Italy and HongKong. The fact that the most effected banks are trading at vast discounts to (tangible) book value means that the ability to autonomously bolster reserves through equity market issuance is severely impaired.
• Given the above situation for banks combined the limited ability of sovereigns to withstand higher rates, expect sovereign rates/curves to remain controlled (”Yield Curve Control”) close to or below the zero bound. And inflation to be limited to precious metals, commodities, staples whilst for other assets (real estate, stocks, used cars, boats etc.) deflationary pressure is more likely.
• Central bank and other governmental support measures have supported companies & markets to counteract COVID impact, but given the increasing time to recovery and rolling global nature of the pandemic, the impact will be greater than currently discounted in markets/estimates.
• As governmental support is dialed back globally and the tide of central bank liquidity slowly goes out, the true impact of the COVID shock will become visible but it will feel like a slow motion movie and take 2-3 quarters to materialize.
• As turnaround professionals, we know that an ounce of prevention is better than a ton of cure. Entrepreneurs should prepare proactively for more severe impact, changing consumer behavior and preferences and a future less dependent on leverage and with higher required resilience (lower costs, higher capital adequacy and more inventory and working capital).
• Expect asset prices (real estate) to come under increasing pressure, providing room for cost reduction or balance sheet lightening. Whilst commodity and input costs are likely to continue to rise, especially in USD terms.
• Use scenarios specific to your line of business and pro-active financial modeling to determine necessary strategic and financial actions to be implemented and to keep your business afloat and financiers “on board”.
• The eventual improvement of the Macro environment through the “purge” of non-viable companies and business practices will take a lot longer than people think/hope, and thus people should prepare for a longer period of economic weakness/low growth during which only the fittest will survive. Cash conservation and buying time will be key to survival.
• Think pro-actively about how to take advantage of the technological and behavioral changes that are being accelerated by the COVID shock and how to turn these into business opportunities going forward.

Other points of interest, risks and asset allocation perspectives

• Digital fiat and crypto currency developments are gathering momentum and cryptos have weathered the COVID storm relatively well. Bitcoin and Etherium have staged a break-out of a longstanding wedge pattern in the past week and seem to be poised for higher ground along with precious metals.
• Equity markets remain difficult with volatility (VIX) still double normal levels, elevated valuations due to central bank liquidity intervention and the risk reward skewed to the downside. Banks are still difficult to fathom but utilities, infrastructure, commodities and staples are area’s that will outperform if stagflation is the near term outlook.
• My preferred current asset allocation is still 25% USD cash/treasury, 25% EUR cash, 30% Precious metals (mostly physical and some ETF), 20% commodity, staples and infra-linked equities and a bitcoin for every family member, just in case.
• I am slowly plowing EUR cash position into commodities, utilities and staples on market weakness as long/hold positions and will use USD cash position to build EM & US tech equities position if/when correction comes.

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Catapult Insights – Global Macro Perspectives – 2020.08