Covid-19 in the Oval Office

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President Trump spent the weekend in the hospital with Covid-19.  Markets remain steady, with positive statements from the President’s doctors and some still hoping for fiscal action. But the jarring news of the President’s diagnosis  — along with that of First Lady Melania Trump, senior aides and three Republican Senators — is a new and ominous signal of how vulnerable we remain to this lethal disease, which could soon surge again as cold weather drives more people inside. Going into the week, there remains more confusion and uncertainty than clarity on the President’s condition.

This recession has not been like any other. Manufacturing and construction usually lead the way into a downturn. The service sector provides a buffer. Not this time. Services — from restaurants to air travel to hotels and gyms — were hardest hit in the Spring. They also are likely to be the slowest to recover. The question going forward is whether the short, sharp, shock to the economy delivered by the pandemic and lockdown will give way to a slow cycle of layoffs and bankruptcies that will prolong the recession pain. Or can governments bolster recovery whether through better public health measures — maybe even effective vaccine delivery — or, more likely, through further short-term stimulus?

Observations and the takeaway for investors:
1. Jobs — more than before, but still not enough

Investors weighing up the cost of yet more uncertainty in the outlook moved again to take risk off last week. Optimists hope that renewed Covid-19 fears could solidify agreement on another round of US fiscal stimulus. Friday’s September unemployment data show that the economy needs it. The jobless rate dropped below 8%. But with millions of Americans still out of work, the reports confirmed that the US recovery is losing pace. Payrolls rose by 661,000 in September, less than half the monthly increases in July and August. So-called discouraged workers dropped out of the labor force, perhaps because unemployment benefits ended and labor participation (the proportion of the working-age population who are employed or seeking a job) was a depressed 61.4%.

As the official data have become less cheerful, so too has the news. Last week brought the announcement from Disney of 28,000 planned layoffs. Other companies have also announced job cuts, from 3,800 by auto insurance provider All State to the much smaller — but still significant — 400 at Goldman Sachs. Meanwhile, major airlines added to the significant cuts already made — of 150,000 at the four big carriers — with American and United pleading for more government aid to forestall furloughs of 19,000 and 12,000 respectively. So far, the government has not delivered.

As we noted last week, there is a growing debate about how best to support employment and economic activity through what is now clearly more than a temporary downturn. Initially, the focus was on saving jobs and businesses that were especially hurt by the pandemic lockdown. The idea was that with sufficient cash flow support and judicious grants once-thriving businesses could survive until “normal times” returned.

As the prospect of normalcy has receded into the future, its likely shape has also changed. Propping up existing companies may reduce the scope for new and different ones to spring up or expand, argue some. This need not concern governments just yet. We are still in the phase of battlefield medicine. Patching up the damaged and minimizing further losses remains worthwhile. Workers and cheap credit are plentiful, so new entrepreneurs need not be squeezed out. Indeed, the burgeoning private markets, discussed more below, suggest as much.

2. Lopsided spending, lopsided recovery

During the worst days of the pandemic shutdown, consumption in the US slumped. But the drop was concentrated on spending by the better-off, as they could not go out to restaurants or fly to desirable vacation spots or to perhaps less desirable business conferences and appointments. Less well-off families broadly maintained their (much lower) spending levels. How did they do this? Government support that boosted incomes, in some cases above pre-pandemic levels. In August, by contrast, personal incomes slipped by around 3% as temporary benefits were phased out. Spending kept up — but the 1% August increase was well below that recorded earlier in the spring and summer when the economy was rebounding. Pent-up demand for dinners out, vacations and — perhaps not as enjoyable — medical care, including dentistry, accounted for much of the additional August spending, while purchases of food for home-cooking dropped.

Stepping back, demand and production during the pandemic have favored durable goods, construction and manufacturing over services. The US, as well as the UK, is a service-oriented economy. Many employees in these industries are low-paid and dependent now on government support, including for the small businesses that have been important employers. A less obvious example: medical personnel. The halt to elective surgeries cut incomes for both hospitals and doctors in the US.

Looking around the world, no surprise that China has recovered better than any other major economy. An impressive control over Covid-19 that has allowed the economy to reopen is a big part of the story. But the concentration on industrial production rather than services also helps.

3. This is where we need the federal government

One bright spot for the global economy has been the ability of governments and central banks to stop — and begin to reverse — the crash caused by the pandemic and resulting lockdown. It seems obvious now, but it was not clear in March and April, that concerted — if not coordinated — public action could support incomes and spending to such an extent that the economy bounced back swiftly from a terrible blow. Of course, the stimulus from central banks also boosted stock markets, particularly helping those with above-average incomes and savings, including in 401Ks.

Looking ahead, what is most needed to bolster recovery is more of the fiscal support that helps individuals at the lower end of the income scale either directly or through essential federal support for states and local governments. Unless that happens, cuts in state and local employment and services will be a drag on the economy. And families with reduced incomes — whether from wage cuts or cuts in unemployment benefits — will be pushed into cutting spending on essentials including rent and utilities as well on the credit card and other debts that they may owe.

Hardship hurts both the families it hits directly and American society more broadly. It will also have a cascading effect on the economy if utilities, commercial landlords — many of whom have their own mortgages to pay — and other businesses that have survived the pandemic so far are forced to close. As one central banker remarked privately to me last week “central banks were the rescue rockstars of the 2008/09 crisis; treasuries and finance ministries must be the rock stars this time around.”

4. Investor Takeaways

Weakening Dollar: will the President’s health change the trend? All bets are off with President Trump contracting coronavirus and being hospitalized just over one month before the election. If the President’s condition worsens, or uncertainty and concern builds, we may see the usual flight to safety pushing up the dollar this week. Markets had not shifted that way as last week closed out. The DXY closed the week down just under 1%, continuing the Dollar’s downward trend which began in March and the yield curve continued to steepen. The Dollar may continue to weaken in the absence of a market sell-off particularly against the Euro (EUR) and Chinese Yuan (CNY). Short-term real rates in the US are lower than in Japan, Europe, China, and the UK given the relatively higher inflation expectations in the United States. This makes the Dollar unattractive, especially from a carry perspective. In China the 3-month nominal rate is particularly high, delivering the highest real return across all five economies. The People’s Bank of China (PBOC) has also adopted a neutral policy stance, which will likely leave rates at these elevated levels for some time to come.

This contrasts with the US which is currently running a twin current account and fiscal deficit as opposed to Europe, Japan and China which have stable current account surpluses at the moment. All five of these economies are running fiscal deficits in response to Covid-19 induced recessions, but the United States is forecasted to have the largest deficit as a percent of GDP for each year through 2022. The unprecedented boost in spending we have seen requires a large issuance by the US Treasury. The Fed’s commitment to keeping long rates at current low levels may necessitate a move lower in the exchange rate, in order to attract the foreign buyers necessary to support the country’s continued borrowing.

Many investors have been discussing alternatives to the dollar such as cryptocurrencies, precious metals, CAD, EUR, JPY, CNY, and GBP. However, most of the possible alternatives are lacking in liquidity to be a true dollar substitute in the near-term if global investors decide to diversify away from USD holdings. Cryptocurrencies, metals, and even the CAD are less liquid compared to the Dollar.

Despite relatively high growth prospects for the UK in the upcoming years, uncertainty around those prospects, and the level of real rates, are particularly elevated given the current state of Brexit negotiations. Japan continues to face the prospect of anemic growth. Europe offers sounder fiscal footing, higher forecasted growth, and better carry given its low inflation environment. In addition, the Euro is a widely circulated currency offering a variety of investment opportunities for international investors. China has the highest growth, best carry, and only idiosyncratic tailwinds from recent index inclusion for its government bonds, although susceptible to greater government market manipulation and possibly other risks.

US equity markets fell, but not by much, in the face of the news of Covid-19 hitting the White House and the negative headlines on employment. Cyclical segments of the market continued to recover from weakness exhibited earlier in September with the Russell 1000 Growth Index gaining 1.40% versus 2.15% for the Russell 1000 Value and the tech-heavy NASDAQ outperforming the broader S&P 500. Nevertheless, the NASDAQ remained down 5.16% for September.

With the news of larger company layoffs, markets may begin to get nervous in the weeks coming into the US elections. Even further layoff announcements are expected and we are watching closely Q3 earnings announcements from the larger bellwether companies across industrials, service, and manufacturing sectors. While the cost-cutting measures announced by major companies will alleviate pressure on bottom lines in the short-term, there could be serious ramifications on consumer spending as a whole, potentially reaching industries that have thus far been more immune and showing up in future earnings results.

In Asia, Japan began this past week on a solid footing, reflecting the rally in the US, however investor outflows followed the US presidential debates, a large-scale shutdown of the TSE due to a technical malfunction, and news of President Trump’s Covid-19 results. Japan’s TOPIX ended down 1.5% week over week. Following closely was European market sentiment that tracked similarly with the US and Japan. Highlighting the continuing pain felt in the hardest-hit sectors, Rolls-Royce announced it was raising up to $6.5 billion to bolster its balance sheet following the collapse of revenues from its civil aerospace business.

Last week also finished off a negative month for emerging market equities, with the MSCI EM Index falling 1.8%. While EM equities outperformed developed markets (the MSCI World index fell 3.6%), larger EM countries like Brazil and Russia fared worse. Fears tied to a resurgence in global Covid-19 cases, pessimistic comments from central bankers, and political noise, drove commodities lower affecting these larger emerging market countries. Brent and WTI crude fell by 7.7% and 5.6%, respectively, while the S&P Industrial metals index was down 2.0%.

Chinese equities also experienced a difficult month, lagging peers in Korea and Taiwan. Given the lack of fundamental or major political noise, these downward moves may have been more profit-taking after a very strong 12-month run in Chinese equities. The difficult week in Chinese markets may also be overhang worries from the escalating US-China tensions, as the US added an additional 38 Huawei-affiliated companies to the Entity List and tightened the financial scrutiny over ADRs.

While investor attention has been fixated on the US and China for the most part over the last several months, smaller emerging market countries are also experiencing tensions. Turkey remains a country to watch. While Turkish assets did not meaningfully react to the worsening fighting in the contested region between Azerbaijan and Armenia last week, the country remains one of the worst-performing markets for the year, down more than 30% through September. On a five-year basis, dollar-based investors have lost 10% per annum investing in Turkish equities and with an economy flirting with fiscal and monetary policy disaster there seems no end in sight. We should keep a watchful eye on ongoing Turkey-EU negotiations to extend relief aid to the tune of 750 million Euros a year that would keep economic and political refugees in Turkey from entering the union.
RockCreek Update
The RockCreek team, which continues to work seamlessly remotely, gathered for a socially distant outdoor reunion last week, where best practices, as outlined by the CDC, were followed.

here to watch a fireside chat between Afsaneh Beschloss and Oscar Munoz, Executive Chairman, United Airlines Holdings, Inc., as they discuss the economy, the future of travel, and the importance of diversity in the workplace.

Team RockCreek

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