On Target Newsletter
In this issue:
Changing attitudes to China
The Global Crisis – What Happens Next?
The lockdowns imposed by governments as their response to the Covid-19 pandemic have plunged the global economy into its sharpest downturn since the Thirties. What happens next?
Governments have started to face up to the reality that the scientists on whose terrifying predictions they understandably reacted were hopelessly wrong. You will remember the headlines about 2.2 million deaths in America, half-a-million in Britain. Now the same scientist who originated those figures says the death-toll in the UK isn’t likely to be more than 20,000, or hardly more than the number of people wiped out every year by ordinary influenza.
Those crazy forecasts triggered devastating clampdowns that have plunged the world into a particularly nasty recession, and in turn set off a massive response — an avalanche of easy money, credit and subsidies. In the US alone the central bank is “printing” $70 billion a day to buy government bonds, compared to $120 billion a month at the peak of earlier quantitative easing programmes. Never before have governments acted with such extreme panic.
It’s still too early to judge whether those phenomena were necessary and wise. It’s a problem that there’s a continuing avalanche of publicity about Covid-19 deaths when the reality is that the numbers are minimal compared to those who die from all other causes. So far this year Covid-19 accounts for less than 1 per cent of the world’s estimated deaths.
However, as the balance of priorities starts to shift from health to wealth, we see the first signs, in countries such as Austria, Denmark, Italy and the US, of governments beginning to put their own devastating policies into reverse. That’s a trend that will gather momentum.
As people develop doubts about the wisdom of the policies dumped on them, and as more facts about Covid-19 become known, they will begin reconciling to the prospect of living for a while, perhaps even permanently, with a reality that may be as inevitable as dying from some other equally nasty cause such as heart disease or cancer.
Hopefully the risk will become less inevitable as progress is made with development and mass production of a vaccine. Or perhaps not. But at least we’ll develop greater understanding of best ways to limit its impact. We may have to get used to living with the existence of a particularly nasty kind of flu.
More important soon will be the evolution of a backlash against the severity of governments’ anti-pandemic measures, whose damage to living standards will magnify astronomically if they continue to be enforced.
The equivocation of markets since they bounced back from their extreme plunge triggered by two Black Swan events, Covid-19 and the oil price war, suggests a continuing great uncertainty.
Investors are now divided into opposing camps…
► The bull case is that everything will open again within a few weeks. The unemployed can return to their old jobs. Within six months the economy will be back to normal. The avalanche of credit, money and subsidies — $2 trillion in the US — will drive price/earnings back to where they were. Low petrol prices and zero interest rates will pour fuel on to the economy. It’s going to be the Roaring Twenties again.
► The bear case is that unemployment rises to 20 per cent. Everything does NOT go back to normal before at least a year or several. There is a huge demand shock. The effects of lockdown on businesses and the oil shock deliver a depression.
My own opinion is that a concatenation of forces – unwinding of anti-pendemic measures, the avalanche of easy money, a surging desire to get things back to where they were before, and the inherent dynamism of infotech and social media – will drive recovery. But slowly.
Supply chains are largely located in Asia, the region least savaged by Covid-19 and blessed with the governments that proved best able to deal with it. The big problem for its factories is going to be sluggish demand for their products in their ultimate markets in North America and Europe.
As anti-pendemic policies relax, enabling people to return to offices and shopping malls, life will snap back to normal. But not quite as before. Some aspects of consumer demand such as dining out, sports and entertainment events may recover quickly. But for a while consumers just won’t have money to spend on anything but essentials after losses of jobs and income, the shutdown of small businesses. They’ll be keener on saving to restore family resources, unwilling to borrow to spend.
The key to strength in demand is confidence. After the nasty shock of the Covid-19 crisis it will be some time – perhaps two or three years – before enough confidence has been rebuilt to bring full recovery.
Do You Know These Things About the Virus?
The Covid-19 pandemic is being widely covered by all the media, but some interesting aspects of developments are being largely ignored. Here are several that I find particularly interesting…
► In Asia, where I live, Covid-19 isn’t much worse than ‘flu. The difference with Europe is extraordinary. As at mid-April, the numbers of deaths averaged only between one and five per million of population for Asian countries such as China, South Korea, Japan. Comparable figures for European nations on April 19 were 428 per million for Spain, 385 for Italy, 288 for France.
Why are the rates so low for countries whose populations are racially Mongoloid – are they blessed with a genetic resistance to the virus?
► Another extraordinary difference is that between hot tropical countries in Asia, Africa and Latin America with very low rates of infection and the rest, which are largely in temperate or cold regions. Chinese scientists say their research shows that high temperatures and high relative humidity “significantly reduce the transmission of Covid-19.”
► Risk of dying is almost exclusively for the elderly, which suggests that the virus is usually only dangerous for those whose bodies are weakened by other illnesses, particularly those of the heart and lungs, diabetes and cancer. In Britain the average age of those dying of Covid-19 is 80. Italy’s figure is about the same.
There is minimal and conflicting information about to what deaths can be attributed — to Covid-19, or pre-existing illnesses, or both. Perhaps the virus worsens pre-existing illnesses and accelerates death. The Italian National Health Institute says that more than four-fifhs of those listed as dying from Coronavirus had two or more pre-existing illnesses. Fewer than one per cent had no prior medical conditions.
► It’s extraordinary to see how wrong the experts seem to be with their estimates of how many of us are likely to die. America got a shock wake-up when the team at Imperial College London said the virus could kill as many as 2.2 million of them. Now, only a couple of months later, the US’s most respected forecaster says he expects the death-toll to be no more than 60,000. Even allowing for many caveats such as differences of opinion and assumptions, more up-to-date information, and a tendency to headline the scariest forecasts, it does seem that the scientists are too often giving policymakers a lot of very bad advice.
Millions are infected but without symptoms
► Mortality rates range widely and, says John Iannodis, professor of epidemiology at Stanford university, the data we have so far is “utterly unreliable.” The proportion of confirmed cases that die currently ranges from 2.2 per cent in Germany to 12.8 per cent in Italy. However Britain’s chief scientific adviser reckons that because so many people aren’t tested but are infected or have been without showing symptoms, headline death rates are ten to 20 times greater than the true rate. If the headline rate is, say, 5 per cent, the true mortality rate is 0.25 to 0.5 per cent.
The death rate is around 0.1 per cent for seasonal flu and 0.2 per cent for pneumonia in high-income countries. Each year around the world about 56 million people die… an average of around 153,000 a day.
► If you think governments are being too tough forcing you to stay at home, perhaps allowing you out to walk the dog, consider what it’s been like for the Chinese, with Beijing’s harsh but ultimately highly successful policy. Lockdown, applied to almost all the country, required residents to report their temperatures several times a day, and needing a certificate of being symptom-free (only one person from each household) to go outside twice a day.
► Taiwan was the first country to alert the World Health Organization, in December, to the danger posed by Covid-19 – a warning that the WHO failed to pass on to member-nations because of China’s hostility towards anything that could be perceived as recognition that Taiwan is an independent state.
Taiwan has turned out to be a model for governments to fight Covid-19. The model grew out of its battle against an earlier viral disease, SARS, which killed 73 of its people in 2003. Taiwan identified Wuhan as the source of the new disease a month before the Beijing government recognized it, and began testing arrivals to the island from Wuhan. It acted promptly to open a command centre to fight the disease, and has been a pioneer is using mobile phones and big data to manage it.
To date there have been only six Covid-19 deaths in Taiwan.
Where to Look for Investment Profits
Investment bank Morgan Stanley says that with the shock of last month’s forced share-market liquidation now behind us, unprecedented monetary and fiscal support, and elevated equity risk premia (the extent to which returns from shares can be expected to outperform “risk-free” bonds), “the worst is behind us and current [price] levels are buying points” on a six- to 12-month horizon.
However my own view is that we can expect stock markets to weaken again soon and fall back, perhaps even to test the lows of early March, before resuming their recovery.
There is definitely reason to start buying, argues Merryn Somerset Webb, editor-in-chief of MoneyWeek, and one of the advisers for whom I have greatest respect.
One reason is that shares are no longer expensive. Shiller price-to-earnings ratios, one of the better indicators of long-term value, particularly outside the US, are at 20-year lows.
It’s also hard to see any attractive alternatives to equities. The bond market is hardly a long-term safe alternative. Neither is cash.
“There is a good argument that in a time of unbounded quantitative easing [money printing], it doesn’t matter what you buy. All equities, all assets even, will move in tandem.”
However, although everything falls in value in most bear markets, not everything rebounds thereafter. “So buy the things that probably will – market leaders with little or no debt, experienced management, operating in sectors that offer some relief in lockdowns…
“Think about the Fangs: Facebook, Amazon, Netflix and Google. The giant tech stocks that led the US bull market for the last decade had become stupidly expensive that many thought they would trigger its end. Instead they are the companies providing the few services that we really need. You can’t put a price on that.”
An additional point is that these data giants have huge cash balances: a massive positive in what risks being a deflationary bust.
The devastation wrought by Covid-19 has been very clear in a handful of industries such as airlines and hospitality, but much less publicity has been given to those that have benefited.
Thematic investment managers Iain Little and Bruce Albrecht identify these behavioural social and economic changes that have been under way for some time, but have been accelerated by the pandemic in the form of greater…
Use of internet, computer hardware/software at home and “on the go.”
- Use of e-commerce and e-retailing.
- Desire for personal care and hygiene at home.
- Demand for healthcare provision.
- Demand for security and risk control.
- Acceptance of remote working and need for business software that permits it.
- Entertainment software for use at home.
- Need for data management, infotech and so on.
- Faith in and use of branded consumer staples.
- E-learning and self-education.
- Use of modern financial businesses (“fin- and insure-tech”).
- Use of cashless, informal and internet-based payments services.
For investors the immediate knock-on effects of the Coronavirus crisis will be at least a halving of stock buybacks and dividends in the US, says Eoin Treacy of FullerTreacyMoney. However, these will be short-term headwinds. The figures will get better as corporate fortunes improve.
Big data is the basis of money and power
The fragility of the system of global supply chains “has been clearly exposed during the virus scare.” Countries and companies are now having significant discussions about what components whose manufacturing they need to control and what can be outsourced. “At the very minimum, diversifying geographic risk away from China seems to be an obvious conclusion.”
That alone means there is going to be significant investment in infrastructure in alternative supply sources. We can also expect major investment in public projects undertaken by governments as stimuli to repair the damage to economic growth brought about by the Covid-19 crisis.
This is now “a stock-pickers’ market,” Eoin says.
In a period of uncertainty, cash is a prized asset. “Companies that can avoid cutting dividends deserve to trade at a premium” – for example those that survive the oil market purge and are able to sustain their dividends.”
Although the mega-cap technology shares were not immune from the sell-off the ten shares in the FANG+ index are still trading above their 200-day moving average. The relative strength of the sector is clear proof that big data is now the basis of money and power.
The tech giants are betting heavily on the evolution of virtual reality systems. The roll-out of 5G will allow for seamless connectivity. That will mean real-time remote access to supercomputer computing power at our fingertips.
We can expect “automated diagnostic tools built into our devices within the next few years. My Garmin smartwatch is a crude version of that today; the body battery feature tells me when to take a rest and when is a good time to work out.”
It has been a good time for shares benefiting from fear and boredom, reports Investor Chronicle’s Bryce Elder. Stocks likely to benefit from enforced isolation make up the bulk of the best performers so far this year, with the likes of Netflix and the video game makers keeping pace with traditional defensives such as gold miners and arms dealers.
“Yet tobacco, the default product of anxious idleness for nearly a hundred years, has been left sidelined.” Since 2017 sales have been falling, with e-cigarettes threatening to disrupt main manufacturers’ oligopoly, endangering dividends and their role as a bond proxy.
However the tobacco companies have a formidable reputation for defending their interests in a sector where political enmity (the powerful anti-smoking lobby) has the ironical virtue of providing a firewall against any new competition. Jefferies’ Owen Bennett says: “We are firm believers in the oligopoly persisting.”
David Klein of Cantor Fitzgerald tips luxury stocks like LVMH and Kering. Both have been rallying well from recent lows. In times of stress, demand for luxuries holds up, as they did during the Great Depression. “I would put money to work in these wonderfully managed businesses.”
The Changing Basis of International Trade
The pandemic will change the way the world does business says Beata Javorcik, chief economist at the European Bank for Reconstruction and Development.
Globalization promoted a system of supply chains based on doing bits of manufacturing wherever it can be done most efficiently and cheapest, largely in China.
In the Covid-19 crisis many countries were shocked to discover how dependent they are on China for essential supplies. Three-quarters of blood thinners imported into Italy, for example; 60 per cent of antibiotics needed in Japan. America found it had to import 80 to 90 per cent of its medical supplies, mainly from China.
“Businesses will be forced to re-think their global value chains… shaped to maximize efficiency and profits,” Javorcik says. “While just-in-time manufacturing may be the optimal way of producing a highly complex item such as a car, the disadvantages of a system that requires all of its elements to work like clockwork have now been exposed.”
Firms will now need to diversify their supplier base to hedge against disruptions to a particular producer, geographic region or changes to trade policy, building in redundancy, even moving away from the practice of holding near-zero inventories. Costs will rise.
Moving Towards a Weightless World
The pandemic, in forcing businesses to substitute electronic communication for physical presence, has accelerated the shift from transport to teleport, says the FT’s John Thornhill.
“Investors have been anticipating the future. At $42 billion the market capitalization of Zoom, the nine-year-old videoconferencing company currently used by thousands of businesses and schools, now exceeds that of any US airline. A form of teleportation… may be usurping transportation.”
Traditional businesses are going more fully on-line while digital businesses such as Amazon and Alibaba are pursuing opportunities in sectors such as food retailing and logistics.
Healthcare is also becoming a big-data business. Taiwan, Singapore and South Korea have responded most effectively to the pandemic, partly through the extensive use of digital technologies to trace those most likely to be infected.
The pandemic, by forcing millions to stay at home and preventing their going to shops, is also giving a big boost to an important trend under way before the virus arrived – e-commerce.
Logistics analyst Marc Wulfraat says stores that would normally experience 4/5 per cent of revenue through on-line sales are now getting rates as high as 20/30 per cent; in some cases as high as 50 per cent.
Changing Attitudes to China
The biggest shift in the UK’s foreign policy arising out of the Covid-19 crisis will be in its attitude to China, James Forsyth reports in The Spectator. The British government was shocked by China’s efforts first to cover up the existence of the virus, then to spread misinformation about its origins. It expects public pressure to take a tougher line on China.
The desire for supply chain security, particularly for medical goods, will favour more domestic manufacturing. There’s going to be a lot less trade with China.
The compromise decision to allow the Chinese telecoms giant Hua Wei to build part of Britain’s 5G network will be replaced by an urgent search for an alternative non-Chinese supplier (presumably either European or American).
China’s keys to strong economic growth are its One Belt One Road initiative, 5G smart city construction, a focus on battery energy minerals and stockpiling natural resources, “while maintaining a massive low-wage/high-output work force,” says Andrew O’Donnell of Supercharged Stocks.
The Covid-19 epidemic shocked Americans to discover that they depend on China for most of their medicines, but that’s only a fraction of their dependence. It makes “just about everything.” It controls the supply chains for technology, infrastructure, pharmaceuticals. How much of a trade war can America fight when its opponent controls all the critical resources?
Seeking Jewels in the Wreckage
Corporate leverage has increased substantially over the last decade because low interest rates made balance sheet optimization strategies a no-brainer. Eoin Treacy asks: What board would refuse the prospect of reducing the interest on existing debt by refinancing, and using the difference to reduce the share count?
That was the logic in the early part of the cycle. But refinancing was quickly exhausted. Companies then migrated to “maximizing shareholder value” by inflating the share price with debt-fuelled buybacks. Some companies are obviously much more guilty of this practice than others, and have been among the biggest decliners.
The most exposed companies are those with debt-to-equity ratios of more than 100 per cent and intangible asset values higher than their market caps.
The value of brands can help a business to recover once debt issues have been dealt with, but they do not help with debt servicing in the short term. That suggests there will be ample scope for better-capitalized companies like Berkshire Hathaway and/or private equity firms to feast on the overleveraged sector in the event of bankruptcies.
Social Change and the Future of Oil
What no one knows, and can only speculate about, is how economic and social patterns will change in the post-Covid-19 world from their pre-virus patterns, says the well-known American commentator Allen Brooks.
For example, will people return to flying as they did before to attend to business or to vacation? Has the idea of a cruise vacation been universally damaged? How many people will be willing to cram into commuter trains and buses, or stadiums and rock concerts? Will employees be more desirous of working from home, especially once schools reopen?
All of these changes, and a myriad of other possible shifts in how we live and work, will impact on energy consumption. It is difficult to see changes being favourable for oil demand long-term, although cheap oil initially may offset demand-depressing forces.
Global demand shifts are happening in a world where global oil supplies are increasing.
Gold Miners to Consider
The renewed strength in the yellow metal has triggered upside breakouts in several stocks and strong rebounds in others.
Ones that caught my attention are US-listed Newmont, the world’s largest gold mining company; Great Bear Resources of Canada, one of the highest-grade new mines in recent years; Evolution Mining, the Sydney-listed firm with five wholly-owned mines in Australia and New Zealand; and Polymetal International, the London- and Moscow-listed group with gold and silver mines in Russia, Kazakhstan and Armenia.
Californian broker B Riley FDR reckons that the extreme monetary and fiscal stimulus will drive higher the gold price towards $2,500 an ounce. That will draw investors into mining companies.
Past experience suggests they will gravitate to large-cap producers, those with the largest output. Almost all have all-in-sustaining costs significantly below prevailing gold prices.
Investment Trusts Deliver Safe Income Flows
Securing a regular income from investments with low risk has long been a problem because of central banks’ crazy policies of “printing” money and easy-credit to drive down interest rates. It’s a problem that has now got much worse with governments’ financial antidotes to the severely disruptive consequences of their own war against Covid-19.
One answer is to put together a handful of UK-registered investment trusts (closed-end retail funds). Some have long records of increasing the dividends they pay, or at least never cutting them, year after year.
Eoin Treacy has researched all 145 of such trusts with histories of dividend growth over 31 years. The five with the best records are: Scottish American (which has a dividend yield of 3.35 per cent); Merchants Trust (7.41 per cent); City of London Investment (5.86 per cent); Murray International (6.13 per cent); and TR Property Investment (4.44 per cent).
A New World for Bonds
The way governments have resorted to enormous spending programmes to counter the devastating impact of the pandemic, scrapping all traditional measures of responsibility in public finance, is going to have huge ramifications for the future, says Jim McCormick of NatWest Markets:
► Greater reliance on fiscal rather than monetary policy should mean higher bond yields and higher risk premia.
► A big step has been taken towards policy based on modern monetary theory, which argues that debt mountains or giant budget deficits don’t matter for nations borrowing in their own currencies. Huge fiscal deficits will be funded, at least in part, by central banks “printing” money.
► There is likely to be more inflation.
► Shares “look much more attractive compared with bonds.”
The wokerati: It’s a new word to describe the politically-correct (“woke”) classes that infect and largely dominate academia, mainstream media, the world of entertainment and now publishing in America and Europe.
Latest example is the decision of book publisher Hachette, under pressure from its own woke staff, to scrap its plan to publish the memoirs of comedian Woody Allen, who has been accused of being a sexual abuser many years ago… although no charges have ever been brought against him. In the age of #MeToo, those accused are automatically always assumed to be guilty.
Ones to consider: Here are the companies that RBC Capital Markets selects as its 30 best global ideas for this year…
Alimentation Couche-Tard, Americold Realty, Barrick Gold, Brookfield, Canadian Natural Resources, Canadian Pacific Railway, Cigna, Crowdstrike, Diageo, Duke Energy, GDS, Genmab A/S, Gilead Sciences, ING Groep, LVMH, Market Corp., McDonald’s, Microsoft, Ollie’s Bargain Outlet, Orsted A/S, Pepsico, Pfizer, Roper Technologies, Siemens, Stericycle, Thomson Reuters, Trust Financial, Uber, Visa, Xero.
Mobile phones in the war against Covid-19: If South Korea and Singapore are a guide, medical and electronic privacy are about to be set aside. Hong Kong uses apps on phones that show where you are; China has a passporting system to record who is safe to be out; South Korea says that automatically tracing the contacts of fresh infections using mobile technology gets results in just ten minutes instead of 24 hours.
American savings: They’re now a much higher share of their taxed incomes than they’ve been during most of the past decades. Why? One explanation could be that the rich have been doing particularly well. Wealthy people save more, because they can. Another reason could be that it’s become harder for those who want to, to borrow (going into debt offsets saving).
Japanese companies: They’ve survived two decades of the kind of grinding deflation that the rest of the world is now experiencing. And they’re ready for it with strong profits and big cash reserves. They have the healthiest balance sheets and have tripled their dividends over the past six years.
Oil: Expect US shale production to respond sluggishly to low prices. They can discourage new output because of the relatively high initial costs, but have little effect on existing facilities as stopping their production only yields marginal savings.
Strategies of the ultra-rich: Professor Philip Golub of the American University of Paris points out that even before the pandemic some of them prepared against the risk of an apocalypse “by purchasing luxury underground condominiums in repurposed nuclear missiles sites in the US, replete with five years of food and medical supplies, or buying vast tracts of land in sparsely-populated parts of New Zealand.”
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