Dark Winter Before Dawn

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Public health experts agree with President-elect Biden: we face a dark winter. With over 250,000 Americans now dead from Covid-19, a third surge of the pandemic is raging across the US, reaching into the lives of millions. There are two big differences between now and the spring when the novel coronavirus really was new. The first is deeply concerning. Americans are fed up with restricted lives and Zoom get-togethers and as many as 50 million plan to travel this week for Thanksgiving. According to a recent Axios/Generation Lab poll, this includes 59 percent of college students, whom the CDC last week urged — belatedly — to avoid seeing families because of the risk they pose to their parents and older relatives. The second difference is truly one to be thankful for and to remember around smaller, less festive Thanksgiving tables this week. We now have real, fact-based prospects of more than one effective vaccine becoming available within weeks. According to Bill Gates, these scientific advances could return life in the US to near pre-pandemic normal within the next three quarters.
Observations and the takeaway for investors:
1. Not a moment too soon

Last week’s data on both Covid-19 and the economy showed how much the US and Europe needed that vaccine news.

First — on Covid-19. In contrast to the successful containment of the virus in China and Asia more generally, countries in Europe and the Americas — with the exception of Canada — went headlong into the feared “second wave” (third in the US) of infections just as winter arrived. The data in the US is particularly horrific — and tragically unnecessary. Analysis shows that infections, hospitalizations and deaths are higher in the areas where people have shunned mask-wearing and social distancing and resisted restrictions. Small towns in rural areas and states that had not seen many infections earlier are now facing overflowing hospitals — and morgues. Urban areas are not spared, with the burden falling particularly heavily on the young, and their parents, as public schools are shut down in major cities, now including New York City.

In Europe, governments have taken a different tack. Economic restrictions were imposed as the virus took off again, but schools were largely kept open. Economic prospects are gloomy, with a contraction of output in the current quarter now likely for the EU as a whole. Germany’s strong manufacturing sector and leading role in vaccine development — the Pfizer vaccine was invented in Germany — may help Europe’s largest economy. But even there, economy minister and close colleague to Chancellor Merkel, Peter Altmaier, recently revised down his forecast for fourth-quarter growth to just 0.4 percent.

The choice in much of the US may help some businesses in the short-term. But it comes at a price. Education experts point to long-term costs of online schooling, especially for younger children and lower-income families. Public health data suggests that schools have lower infection rates than in the community at-large, and certainly are less likely to spread infection than bars and restaurants which remain open — at least partially — in much of the US. No wonder the nation’s top public health expert, Dr. Anthony Fauci, is warning that the virus will continue to spread in coming weeks unless behavior changes and the CDC has begged people not to travel for Thanksgiving. This came too late to stop the bulk of college students who, according to Generation Lab, plan to go home this week, with only 25 percent saying they will remain on campus.

No bad economic news can compare with that on virus infections and deaths. And the likelihood remains that this quarter will see some positive growth, at least in the US. But last week’s data on sales and jobs was sobering nonetheless. Retail sales climbed by just 0.3 percent in October, and are unlikely to bounce back again while consumers remain worried about mixing with others and concerned about their incomes and jobs. A rise in jobless claims in November — to 724,000 — confirms that the labor market improvement over the summer that sparked hopes of strong recovery has petered out. The number of Americans out of work is much lower than in the early stages of the Coronavirus Recession. But it remains high.

2. Global power play

President-elect Biden is now focusing on how to plan for the public health crisis and its resolution with vaccine distribution and is expected to announce some Cabinet nominations shortly. These are expected to include Anthony Blinken, long-time Biden aide and former Deputy Secretary of State, as Secretary of State; Linda Thomas-Greenfield, a career diplomat and former Assistant Secretary of State for Africa, as UN Ambassador; and Jake Sullivan as National Security Adviser. None of these is expected to be controversial. Next up: the choice of people to head up key domestic areas.

Meanwhile, the President continues to mount legal and media challenges to the election results. The Trump administration has also been taking action overseas. Although the incoming president’s top priority will be domestic policy — notably, attacking the virus and boosting jobs and the economy — the long-term challenge from China will have to be addressed at some point. The situation is much tougher than it was four years ago, when the US was on the cusp of agreeing to a broad trade agreement with major Asian and Pacific countries that would lock in US leadership on standards and rules. Now, the other 11 countries negotiating the Trans-Pacific Partnership (TPP) have come together without the US and — in a major win, at least in PR terms, China has pulled together the largest trade pact: RCEP, analyzed nicely in this piece by Wendy Cutler, a former senior negotiator at USTR. India dropped out of the negotiations, but US allies from Japan to Australia have signed up — in a meeting of Asian countries that President Trump did not attend.

3. Tug of war: Treasury versus the Fed?

Swift and effective collaboration between the Treasury and the Federal Reserve earlier this year helped to calm markets and provide needed cash to businesses. That made it all the more surprising last week when Treasury Secretary Steven Mnuchin announced the pull back of unused funds in the special loan facilities established in the spring. The Fed responded with an unusual rebuke, saying it “would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue,” before announcing its intention to comply with the request on Friday. This spat came on top of Secretary Mnuchin walking away from earlier talks with House Speaker Nancy Pelosi on a new stimulus. This will further delay help to the lowest income families and small businesses.

But maybe, just maybe the calculus on Capitol Hill could change — a shift hinted at last week by Minority Leader Charles Schumer. There are two reasons why that could be: the two run-off elections in Georgia on January 5, which will determine control of the Senate. Neither party can be sure of winning. That could perhaps make taking half a loaf now seem attractive to both Republicans and Democrats. For Majority Leader Mitch McConnell, a bill with some Republican “must-haves” could please pharma companies that are keen to lock in liability protection as they rush to produce vaccines and therapies for Covid-19. For the Democrats, giving the economy some help now would only be good for President-elect Biden. In this view, if the Senate flips to Democrats, more can be done later. If not, then at least some measures would be in place to support incomes and jobs in 2021, when unemployment benefits expire for an estimated 12 million Americans, rent obligations that have been suspended for months come due, and states and local governments are forced to cut spending further as tax revenues fall short. The continued pleas by large and small business leaders, including last week’s appeal to Congress from Jamie Dimon — to split the difference, but do something — makes a lot of economic sense. Of course, that economic logic has been failing for months to produce congressional compromise.

4. Investor Takeaways

Emerging Markets. Emerging markets equities rallied once again last week amidst global investor optimism following the vaccine news. Chinese equities continued to underperform much of the rest of emerging markets. The gap between Chinese equities and EM ex-China now stands at over ten percent in November. Brazilian, Russian, Thai and Turkish equities, in particular, continued their strong rally and are all up over 20 percent month to date. From a sector perspective, energy and financials stocks largely outperformed, lending credence to the idea of cyclical rotation.
Weekly flows point to continued interest in EM assets. Latin American saw the largest inflows in nearly three years, with Brazil receiving over $2 billion of foreign capital. EMEA equity flows turned positive for the first time in over three months and foreign investors were net buyers of Indian equities for the 7th consecutive week. In the ASEAN region, Thai and Indonesian markets also benefited from renewed foreign interest. As a percentage of global assets, emerging markets are now back to 2019 levels, although still a far cry from the highs reached earlier this decade.
Given relatively low levels of foreign ownership and attractive yields, we believe there is significant upside left to capture in EM assets. The prospects of several viable vaccine options, relatively stable currencies, and low rates in developed markets make a compelling case. While we remain strong believers in the secular growth story tied to technology-related opportunities in North Asia, we also think there is a strong case for less technology-focused markets such as Latin America in the medium term. When compared to the S&P 500, Latin American equities are at levels not seen since the crises of the early naughts.
FX markets also piqued investor interest last week, especially those investing in emerging markets currencies. Standout performers in the FX markets came from a handful of high beta currencies that posted strong returns. Specifically, the Russian Ruble (RUB), Peruvian Nuevo Sol (PEN), Brazilian Real (BRL), and Mexican Peso (MXN) all strengthened by more than 1.25 percent. These currencies, much like their respective country equity markets, are benefitting from the risk-on sentiment globally. MXN was the best performer, rising 1.5 percent. Mexico stands to benefit not only from a domestic rebound, but also a rebound in the US. While US and Mexican economies are already tightly linked, the Mexican economy also stands to benefit from trends in supply chain diversification.

It is no coincidence that the Chinese issued one of their largest Euro Bonds last week — the first time in over a year. The 4 billion-euro three-part offering was more than 4x oversubscribed. This is yet another sign that China would like to compete with the US as a player and reference point in financial markets.

Globally, investors are digesting mixed signals. Economic data including retail sales and jobless claims are a worry for US investors as a slowing consumer may spook equity markets. Canadian equity markets continue to be focused on the spike in virus cases and being overweight in Europe is an increasingly contrarian view by investors.

Japanese markets also experienced a strong week with the Topix returning 2.17 percent versus 0.62 percent for the MSCI ACWI. The Japanese economy is primed to benefit from a firm global recovery given its export prowess. As Japan’s number one trading partner, China will play a critical role in this recovery, especially in the areas of high-value finished goods. To ensure the country capitalizes on the global economic recovery, Prime Minister Suga’s government is expected to maintain accommodative economic policies. In addition, we expect the government to promote digital transformation initiatives which will introduce badly needed efficiencies in parts of the Japanese economy.

Sustainable Investing Trends. Recent Bloomberg data highlighted that assets surged past $145 billion as of September into ETFs focused on ESG themes. Climate change themes should have a natural tailwind. The proliferation of ETFs globally focused on ESG also signals an interesting change in the market. The iShares ESG MSCI Mexico ETF has seen more than $400 million in capital from institutional investors. Increasingly pensions in Europe and Canada have been seeding such ETFs as they look for options in the public markets.

Interestingly, a gap still exists in the desire on the part of some investors to increase equality in their portfolio and the acceptance of gender-based equity funds. While there had been at one time a proliferation of gender-based mutual funds and ETFs the amount of inflows into any one fund is lacking. Most were seeded by only one or two large institutional investors and have not attracted capital despite solid performance. Across public equities, fixed income, private credit, and private equity, RockCreek is researching and creating investments that are focused on diversity and gender equality at a global scale — demonstrating the return benefits of a strategy that will hopefully become more mainstream in the future. Research by the IFC and RockCreek on private equity and venture showed there are more women general partners in emerging markets than in the US.
RockCreek Update
The RockCreek team continues to work effectively from home and from our offices. We are grateful to our team, our clients, and our partners for their outstanding work and commitment. We are particularly grateful to the extraordinary healthcare staff, essential workers, and first responders who continue to work tirelessly in the fight against Covid-19.

This Thanksgiving, RockCreek has made a donation to support CARE, a non-profit that works around the globe to save lives, defeat poverty, and achieve social justice.

Best wishes to all for a safe and joyous Thanksgiving holiday.

Team RockCreek

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