Looking Ahead?

Pity the world’s central banks, who are trying to make sense of the global economy as they ponder their next policy move. Covid-19 is rearing up again, just when many had thrown masks and caution to the winds. Can its economic impact be contained? We learned last week that the pandemic recession lasted a mere two months last year — from February to April 2020. Enormous policy action halted the recession and powered recovery, even while Covid-19 raged. Fiscal infusions, notably in the US, kept incomes up even when jobs disappeared. Coupled with extraordinary monetary ease, stimulus encouraged investors to buy up equities — but also bonds. Bottom line: policy overwhelmed the pandemic. 

Now, with the US recovery just 14 months old, its future is hard to predict. For the longer term, as recent weather has reminded us, the main challenge — and opportunity — remains climate change. At the RockCreek Climate Summit last week, policy and finance leaders agreed on the urgency of action and the role for private investment in climate smart assets — an area where the RockCreek team has long experience. More on that below, and online.

In the near term, uncertainty springs mainly from the same two sources that shaped the recession and recovery: policy and the pandemic. As first one and then the other capture investor attention, markets have alternately wobbled and then regained strength. China’s newly aggressive moves against some of its successful companies are also a concern for global investors. Taking the long view remains critical. Central banks are worried about inflation but — at least in the major developed markets — they are still more worried about tapping the brakes too soon. So monetary ease will continue, at least for a while longer. Fiscal stimulus on the other hand is getting pulled back in the US. Future bold spending plans are hanging in the balance in Congress, as legislators press for a breakthrough this week. 

As to Covid-19, more than six months after the widespread distribution of effective vaccines began in the US, UK and parts of Europe, we are in the midst of a troubling fourth wave. The “delta variant” has proved devastatingly capable of transmission. It has spread rapidly even when vaccination rates are quite high, as in the UK, as well as in emerging markets such as Indonesia, where vaccinations are scarce. In the US, as RockCreek had foreshadowed six months ago, there is now talk of booster shots for the fall, and a possible return to mask advisories for indoor meetings. No wonder that the “BEACH” stocks that roared ahead after the discovery of the vaccine, have returned to earth more recently.
Observations and takeaways for investors:
What next, and why?

Investors will get important clues this week to how the world’s most important central bank sees the outlook when Federal Reserve Chairman Jerome Powell wraps up the FOMC meeting on Wednesday. Last time the FOMC met, the news was of faster than expected growth and higher inflation. Since then, inflation data have worsened and consumer surveys show more concerns, although market expectations of inflation remain muted. At the same time, unemployment has budged very little, hovering close to 6 percent since the Spring. The latest insurance claims data showed an unexpected rise in new jobless claims in early July, back over 400,000, after three weeks of drifting down to 368,000 at the end of June. The labor market is almost always a lagging indicator. But a pickup in unemployment would be surprising after a quarter of what is likely to have been peak growth — we will see the advance GDP numbers on Thursday, July 29.

So far, equity investors have repeatedly returned to being bullish. Despite negative price action early last week, second quarter earnings — together with the cash continuing to slosh around in the system — quickly dissolved initial fears of a resurging pandemic. Even among BEACH stocks, American Airlines, United Airlines and Delta Air Lines all reported strong second quarter earnings, beating expectations. Carnival announced 75 percent of its fleet capacity will return this year as it resumes cruises across eight of its nine brands. 

What is unusual is that bonds have also mostly maintained strength during the recovery. The dip in yields early last week made sense when investors had a general attack of nerves about growth and Covid-19. It is less easy to explain why yields remain low when stocks have regained momentum. Some believe that foreign investors in Treasuries are helping to flatten the curve — as one analyst commented privately last week “have you taken a look at Japan?” Another possibility is that as equity markets have risen to new record heights, more pension funds are fully funded, reducing the pressure on them to hunt for returns and allowing a build up of safe assets to de-risk portfolios.

It is also possible that fears of a stalled global recovery have not entirely dissipated. This explains the comeback defensive technology stocks have been making in developed markets. Microsoft, Apple, Adobe, Autodesk, ServiceNow, Alphabet and Facebook are all up between 6 percent and 9 percent month-to-date. Twitter and Snap far exceeded analysts’ second quarter estimates, due in large part to companies pouring money into digital advertising. Their shares were up 8 percent and 31 percent, respectively, in the last week. This bodes well for Facebook and Alphabet, which are also heavily dependent on digital advertising and report this week.

Improved vaccination rates, cheap valuations and ongoing economic recoveries were not enough to lift emerging markets assets last week. Both China and EM ex-China sold off, giving up a good portion of second quarter gains. Much of the pressure outside of China was a reaction to the spread of the delta variant. In China, the news coming out of Beijing weighed heavily on markets, as the government made clear the investigations into the country’s technology giants were far from over. Most worrying were the edicts around after-school tutoring companies (ASTs) which, in an effort by the government to provide equal opportunity to wealthy urban and poorer countryside students, will be subject to price controls, prohibited from providing tutoring services on weekends and holidays, barred from pursuing public listings and may have to become non-profits. As might be predicted, the news triggered sharp declines in online education stocks.
RockCreek continues to believe that the fundamental strengths of Chinese tech should not be underestimated, even as regulatory attacks have followed on one company after another. But the powerful move against education stocks last week should make investors take note. 

Covid-19: pandemic of the unvaccinated?

For months, public health experts have worried about the uneven distribution of vaccines around the world. As we have learned, Covid-19 can spread quietly and quickly across borders. As long as there are deep pockets of the unvaccinated anywhere, there is a risk to everyone. Infections allow the virus to mutate. As we have seen, Covid-19 has done this efficiently, swiftly producing more transmissible and dangerous versions as it has circulated widely.

The bad news now is that we need to worry not just about the undervaccinated in poorer countries, where vaccines supplies are far too low, but also about the unvaccinated in rich countries, including the US, where there are plenty of doses. 

The Center for Disease Control (CDC) director Rochelle Walensky warned, we face a “pandemic of the unvaccinated” in the United States, with new cases up by 170 percent in the last two weeks. It is true that the vaccines are highly effective at stopping infection, and that the risk of serious disease and death is low among the vaccinated. But the more the virus is around, the more likely it is that even those who have followed the guidance to be vaccinated will become infected. And, even more worryingly, the more we face the risk of further, more dangerous, mutations. Vaccinations of highly infectious diseases matter not just to protect individuals, but also to protect communities. Only when overall infections are driven down, will the risk of Covid-19 be reduced to the level where we can safely abandon caution and return to life that is close to what was normal. This is why vaccination policy is a public health issue, and not just something for individual consideration. Increasingly, businesses, hospitals, schools and government offices — including Congress — will be faced with the question of whether to insist that employees become vaccinated. That will be easier to do if and when the Food and Drug Administration moves the vaccines from emergency authorization to approval. Broader political support would also help. The data — from both France and the US — suggest that many who have been waiting will decide to get a shot if it affects their ability to go ahead with normal life.
Climate — the other tail risk.

For anyone who wasn’t convinced that climate risk is real and pressing, recent weather events may have been a wake-up call. Floods in Germany and other parts of Northern Europe shocked policymakers and the public alike. German Chancellor Angela Merkel said that there was no word in the German language to describe the horror. Another commenter noted that in Germany, no one thinks that the weather can kill. In China, there may be more awareness of natural dangers. But flooded subway trains in a major city were not on anyone’s list. At the same time as Europe and China saw historic rainfall and floods, the Middle East, Northern Africa, Western USA and Canada suffered historic heatwaves and drought, leading to dangerous wildfires in North America, much earlier than usual in the fire season. As these burn, smoke has spread across the North American continent to cause deteriorating air quality from Toronto to Washington DC.

Investors are interested in putting their money to work to mitigate climate change — and take advantage of the opportunities in the enormous economic changes that reality, backed by policy changes, will provoke. This sentiment was repeated again and again during the RockCreek Climate Summit last Wednesday. “Follow the money,” said Gina McCarthy, White House Climate Czar, in a session moderated by RockCreek Founder and CEO Afsaneh Beschloss. “The reason to encourage big investment now is not just because the infrastructure is deteriorating…We need to have a solid signal sent to the private sector that clean energy is going to be the winner here,” she continued. 
“Everyone is looking at climate as something that matters now,” said Britt Harris, President, CEO and CIO of UTIMCO. “That last era was about hydrocarbons. The era we are going to have now… is going to be about moving away from hydrocarbons to moving toward more renewable, sustainable sources,” he said. 

There was widespread recognition that one driver of this change was young people. “Young people on campuses, in high schools, all across the country, have risen up. And the intense interest in climate change is now at a historic high,” said Senator Ed Markey of Massachusetts, Chair of the Senate Climate Change Task Force. Young people are also driving change with their wallets. “95 percent of millennial investors worldwide say they want to invest in more sustainable companies,” said Afsaneh Beschloss. 

As we know, it is not just young people pushing companies toward climate action, but also institutional investors. There is an increasing likelihood that activist investors like Engine No 1 may become the new norm. “Climate is not the only metric or issue that we look at, but climate has become an increasingly important one. And, if we think companies have been resistant, we’ll vote against their directors,” New York State Comptroller Tom DiNapoli noted. The UN Climate Champions at the summit, Nigel Topping and Gonzalo Muñoz, both of whom come from industrial backgrounds, noted the opportunities for business growth and profitability if companies take a serious and fact-based approach to adapting operations to climate and ESG more broadly. RockCreek, along with many, have adopted the UN Principles for Responsible Investment as well as committed to net-zero by 2030. 

“The empirical evidence is that if you…pick companies across the entire economy that actually understand ESG and actually have goals, turns out the returns are higher,” said Andrew Steer, President and CEO of the Bezos Earth Fund. Jean Case, chairman of National Geographic Society and CEO of the Case Impact Network and Case Foundation agreed, saying, “The real opportunity that I see is a new generation of entrepreneurs and a new generation of investors that are really building great new companies where climate and sustainability is in the DNA at the founding.” 

One such company was on display on Wednesday. James Rogers, Founder and CEO of Apeel Sciences, a company whose product reduces food waste, spoke with RockCreek Managing Director Alifia Doriwala about the role of private companies in addressing climate-related issues. “If you want to have sustainable innovation, it needs to create economic benefits for everyone in that particular supply chain,” he said

Ultimately, it remained clear that addressing climate change was a top priority for policymakers, academics, business leaders and investors alike. Gina McCarthy echoed this, saying “Climate shouldn’t just be considered a challenge. It should be looked at as an opportunity for the United States to recapture our clean energy economy and win the 21st century.” 

Politics versus economics?

Six months in, the Biden Administration’s determination to counter what it sees as China’s aggression is clear. Last week’s decision to stop opposing Nordstream 2 — the pipeline that will take Russian gas directly to Germany without going through Eastern Europe and Ukraine — was driven not by any love for the project, but by a desire to win German support for moves against China. Similarly, a concerted push against Chinese cyber attacks does not mean that the US is unaware of Russia’s malign actions in cyberspace. But China is the more important threat in the eyes of the White House.
RockCreek Update
The RockCreek Climate Summit last Wednesday brought together policymakers, investors and leaders from the finance, academic and climate justice communities to discuss how tackling climate change can go hand in hand with garnering returns. “The summit I hope will be one step in ratcheting up our global ambition to build a 21st century climate smart, inclusive economy that works for all people and our planet,” said Afsaneh Beschloss. 

Full replays of the RockCreek Climate Summit are available here on our YouTube channel. 

Team RockCreek

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