Catapult Insights - Global Macro Perspectives - July 2020

05-07-2020

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Where are we now?

With the NASDAQ hitting all time highs and S&P & DOW having recovered most of their losses it is tempting to think that the FED has succeeded in staving off economic disaster in the US, but I fear that would be too hasty a conclusion.

Not withstanding the underlying differentiation between businesses, sectors & geographies affected by COVID it appears (for now) that FED stimulus has succeeded in “backfilling” the negative short term impact of the demand/income shock in markets through its various programs and succeeded in sparking increased retail investor participation in markets.

It is the latter that is attributed to be the marginal factor responsible for breaking through classic bear market rally (Fibonacci) retracement levels to new highs, post COVID correction.

Meanwhile in the real economy…

  • China data post reopening is sparse but July data for mobility in Beijing and airline cancellations suggest activity levels still 10-20% below pre-COVID levels, more than two quarters after outbreak and a quarter after re-opening (before recent flare-up in infections).
  • 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 20% below pre-COVID levels but are likely to recover further in coming months if no further outbreak emerges.
  • Japan, South Korea and Singapore that had the swiftest response to COVID are doing a bit better at around 10% below pre-COVID levels, whilst the rest of the Emerging Market space is largely still in the middle of dealing with the health crises with activity levels down 50% or more.
  • The US is attempting to bring its economy back online post lock-down but increasing virus infections and R0 values in more than half of the states in the US will inevitably result in prolonged/increased overall economic drag.
  • News of weekly/monthly jobless claims decreasing in the US has been positively interpreted by markets but the total unemployment numbers (U6) are remain stubbornly stable at around 20m or 21% down from the high of around 23% showing no signs of V-shaped “snap-back”.
  • There is of course no knowing how quickly this labor-market oversupply can be “re-absorbed” in the economy but with every passing week the chances of quick recovery decreases as more and more SMEs get to the end of their tether and throw in the towel. Without them, historic organic job creation rates suggest recovery will take a lot longer than is currently discounted by markets.
  • As the impact of COVID on the US and other economies drags on longer than initially foreseen and morphs from a necessary/temporary economic “pause” to more protracted and/or lasting impact on consumer spending and business behavior it is increasingly clear that the “transitional cost” and lost output will surpass current monetary and fiscal stimulus.
  • With stimulus programs rolling off in Q3, markets at all time highs and the US elections in less than 5 months, it will be increasingly hard to argue for and/or agree on further stimulus whilst the realization that more will be necessary is growing buy the day.
  • That said I believe that monetary authorities (central banks) will do everything within and beyond their mandates to keep markets buoyant and policy makers will prefer the “easy way out” of prolonging stimulus to the taking of long overdue “bitter medicine” of necessary restructuring.
  • Interestingly IMF estimates of Global GDP declines are slowly catching up with my own more somber predictions, with the US now estimated to be down 8% and Europe down 10% over 2020 (vs. earlier predictions of 7% and 8%), my take is that these numbers will increase to 10% and 12% respectively as we progress
  • These forecasts would align with my views that all other things being equal the US Dollar should outperform the Euro, but the US’s inability to effectively curtail infections is instead causing Dollar weakness. These losses should be reversed when/if the US gets its act together with respect to curtailing COVID, else the above mentioned GDP decline differential is at risk of being reversed.
  • I believe the “hope” phase of the post COVID recovery, where positive sentiment and news flow from “lifting” of lockdowns outpaces negatives from credit & solvency issues is coming to an end. Having driven markets to new highs and sucked in retail investors in the process we are now poised for a period heightened market volatility.
  • With price discovery, valuation concerns and efficient capital allocation through market forces thrown to the wind by central bank intervention, absolute market levels and/or a correction are driven more by policy than market forces. Without Stimulus prolongation I would expect a correction in Q3 (as stimulus rolls off and COVID earnings impact becomes visible). That said I think the odds of stimulus prolongation are high, which could postpone such correction for some time to come.
  • Bank stocks and bond yields continue to be good indicators of abysmal (growth) outlook and although banks are better capitalized than before the size of the necessary debt restructuring/write-offs could still pose systemic concern as highlighted by recent FED bank stress test.
  • Expect sovereign rates/curves to remain close to or below zero and corporate and high yield spreads to remain elevated.
  • As inflation (CPI) goes negative / deflation picks up, rates in the US too may be forced to go negative to keep real rates close to zero and avoid unnecessary monetary tightening.

What does all that mean for (Dutch) SME’s?

  • 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 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).
  • Use scenario’s specific to your line of business to determine necessary strategic and financial actions to be implemented and to keep financiers “on board”.
  • The improvement of the Macro environment and 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.

Other points of interest, risks and asset allocation perspectives

  • Digital fiat and crypto currency developments are gathering momentum and crypto’s have weathered the COVID storm relatively well.
  • 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.
  • My preferred current asset allocation is 1/3 USD cash, 1/3 EUR cash, 1/3 Gold and a bitcoin for every family member, just in case.
  • Intend to slowly plow EUR cash position into commodities, utilities and staples on market weakness over next quarter in anticipation of reflation and use USD cash position to build commodities, EM & tech equities position if/when correction comes.

 


 

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Catapult Insights - Global Macro Perspectives - 2020.07