Sideways Shuffle as an Era Ends

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The death of Justice Ruth Bader Ginsburg marks the end of an era for the US Supreme Court. More importantly, it is a moment to pause and reflect on the enormous changes that a single person brought to the lives of so many, through her brilliance, determination and hard work. We all have much to be grateful for – men as well as women. And, as many have remarked this weekend, Justice Ginsburg dissented with civility, warmth and friendship – a model for us all to remember and aspire towards.

As we look ahead, the financial world seems on an uneasy pause. After six months of drama, markets moved sideways during the first three weeks of September. Again last week, equities in the US and elsewhere ended close to where they began, after jittery moves mid-week. The jitters continued Monday morning. Covid-19 continues its deadly climb, but at a steady pace of daily new infections in the 250,000 to 300,000 range, with a concerning late-summer surge in Europe threatening renewed lockdowns. On the economy, the world continues to pull out of the corona recession. But new data show – in the words of the Organization for Economic Cooperation and Development (OECD) – that “the pace of recovery lost momentum over the summer.” Looking ahead, risk-takers need to evaluate three big unknowns: the likely path of Covid-19 in the coming weeks, the response of governments and the uncertain US election.

The hit to 2020 global growth from Covid-19 is turning out to be less than was feared in the dark days of spring. As summer turns to fall, the question for investors and policymakers is not so much how deep the recession will be, but how long will it last. The OECD’s latest Economic Outlook report projects that global GDP at the end of 2021 will still be below its level of two years earlier.

Much of the better-than-expected performance this year was due to the swift and large-scale actions of governments and central banks to support jobs and incomes, which flooded markets with liquidity. But many of the emergency measures were temporary, in the face of a health crisis of unknown proportions or duration. In Europe, temporary job support for companies kept more individuals nominally employed – even if they were not actually working – and staved off bankruptcies. In the US, jobless figures soared – briefly hitting Great Depression levels – but emergency funding bolstered incomes and helped families to maintain spending. Around the world, from advanced to emerging economies, central banks cut rates and intervened to keep markets functioning, including with temporary loan facilities. As the temporary support fades, what comes next?

Observations and the takeaway for investors:
1. Central bank actions are still extraordinary, so why aren’t markets more enthusiastic?

Pronouncements last week from three major central banks – the Bank of England, the Bank of Japan, and the Fed – showed that extraordinary easing and historically low interest rates are here to stay. Even if inflation reignites, central banks stand ready to tolerate an overshoot – as the Fed has now made explicit. But markets did not seem impressed.

The Bank of Japan (BOJ) on September 16th left its monetary policy stance unchanged, as expected, while Governor Kuroda stressed how its “Abenomics” policy aimed at boosting inflation and growth would continue under new Prime Minister Suga Yoshihide. A nod to improving economic conditions, coupled with a near term outlook for negative CPI, pushed the Yen 0.6% stronger against the dollar after the announcement. Yields on Japanese government bonds were essentially unchanged.

Later that day, the Fed released its monetary policy statement. Despite a change in language – to reflect the FOMC’s commitment to keeping interest rates at their current levels until the central bank achieved its new targets for employment and inflation – the market was disappointed. Investors perhaps had hoped for more on asset purchases. Equities began to unwind their gains for the week immediately after the announcement, and the yield curve steepened only slightly.

Perhaps the most anticipated meeting of the week came on Thursday. The Bank of England (BOE) maintained its policy rate at 0.1%, but indicated in the minutes that it did not rule out moving to a negative policy rate if inflation and economic conditions warranted. Market participants increased bets on negative rates in the UK and the implied policy rate in June 2021 dropped from -0.06% to -0.12%.

As central bankers themselves are making it increasingly clear: in most regions, the economy needs more fiscal support to underpin jobs and growth. President Trump’s call last week for Republicans in Congress to be ready to “go big” might have led to a breakthrough in the standoff that has stalled US fiscal action since late March. But it came late. Since then, the furious partisan debate ignited by Justice Ginsberg’s death over the Supreme Court likely makes compromise on anything impossible. Democratic anger at the President and Republican colleagues is not the only obstacle to an economic agreement. At a time when economists across the political spectrum are calling for more emergency fiscal relief, some Senators have cited renewed concerns about deficit spending for their reluctance to compromise. Interestingly, despite the President’s sky-high ratings among Republican voters, they may not budge.

2. What should governments do?

The most important actions for the well-being of society and the economy is to contain and control the pandemic. Six months in, scientific advances have been tremendous. In addition to the rapid progress towards a vaccine – broad distribution in 2021 would be astonishingly rapid by historical standards, even if disappointing for some – treatments have improved. At least in richer countries and regions, mortality rates have come down significantly. This only partly reflects the different demographics of those infected (more younger people, with fewer comorbidities).

In contrast to these huge steps in medical science, public health responses have remained surprisingly weak and ineffectual across much of the world. This is especially notable in the US, where politics has intruded into public health. Wearing a face mask is disdained by millions and trumpeted by others as a political signal, rather than recognized and adopted as a simple intervention proven to be effective at containing and curbing disease. Many governments have also fallen short on promises to adopt the mantra of test, trace, isolate and support. In the absence of easy, swift and widespread testing, we have to behave as if everyone is infectious – unnecessarily impeding a return to a more normal life for the millions who are not. There is a clear lesson for almost all nations from the pandemic: health systems must be improved for the sake of broad economic prosperity as well as improved lives for those who become ill.

Beyond public health, there are three key aspects that governments should take into account in spending and tax plans.

First is to continue to support incomes and basic livelihoods as long as the economy is weak. It is now widely recognized that fiscal policy was tightened prematurely after the global financial crisis. An early switch to deficit reduction slowed recovery in the US and contributed to further crisis and recession in much of Europe in the decade after Lehman’s collapse. This time around, governments should resist pulling back until labor markets and businesses have fully recovered – provided inflation remains subdued. This is, perhaps, especially important given the uneven impact of the pandemic. This has particularly hurt low-income families – with inadequate access to health services, a greater need to commute for work, and less likelihood of high-speed broadband internet needed for virtual learning and working from home.

Secondly, and this is not simple, governments should emphasize preparing workers and businesses for the future rather than propping up the companies of the past. Again, supporting workers who need to transition and build new skills is all the more important in today’s divided society.

Finally, as severe weather and wildfires have reminded Americans this month, action to mitigate and adapt to climate change is needed urgently. There is an opportunity for governments and investors to face this challenge now, with investments in green technology and bold actions to phase out fossil fuels, As IMF Managing Director Kristalina Georgieva noted last week, “if you don’t like the pandemic, you are not going to like climate crisis one iota.”

3. Look out for housing and small business rentals

The pandemic lockdown has had a differential impact on real estate, as individual homeowners, renters and businesses adjust to lockdown life. So far, much has been frozen in place, with some federally mandated rent and mortgage deferral programs and special funding for small businesses. The next steps should be carefully considered. Homelessness and evictions worsened the social costs of the last crisis, rooted as it was in the collapse of subprime mortgages. Record low interest rates have been supporting homebuilding and will help many homeowners this time around. But already more than a million mortgage holders – apparently unaware of the special federal forbearance program – are behind on payments and could face foreclosure and eviction according to the Wall Street Journal. Continued high unemployment and a squeeze on small businesses whose rent payments are a big part of costs is likely to add to pressures in coming months.

At the other end of the spectrum, wealthier homeowners shut out of offices for weeks have new appreciation for ample living – and working – space at home. Proximity to parks, beaches, and other outdoor space is also attractive when it does not come with the cost of a lengthy commute. The jury is out on whether dense, expensive cities – think New York and San Francisco – can retain their allure post-pandemic. With restaurants, stores and theaters closed, they have certainly felt like ghost towns, without appeal for those who enjoy city-life. Revival will also depend on what happens to offices and working life in the future.

4. Investor Takeaways

As the behavior of people changes due to Covid-19, so do investment opportunities and markets. Underneath a seemingly complacent market are political fluctuations and shifts by companies that will have lasting effects for investors and portfolios.

Japan. Last week in developed markets, Japan came into the spotlight. The election of Yoshihide Suga as the new Prime Minister of Japan caused a temporary jolt to Japanese equities and the Topix (TPX) saw some strength before settling back. Mr. Suga is widely expected to continue the trajectory of Abenomics while also seeking to make his own stamp. Although not a watershed event like the introduction of Abenomics, the change in leadership has appeared to slightly increase investor expectations for Japanese markets. Major banks raised targets slightly, with one increasing its 3/6 month TPX targets to 1600/1650 (NKY 23,000/23,500) from 1550/1625. Foreign flows into Japan were positive in August for the first time in eight months and positive signals on the structural reform front could help turn that into a longer lasting trend. Japanese markets will be helped in the near term if Mr. Suga were to call a snap election to form a more robust administration. During the five election periods since 2005, the TOPIX has held its value or risen from the day before parliament was dissolved to five trading days after the election, with an average return of 7.6 percent. Investors may be looking at least at shorter term gains in Japanese equity markets.

Strained US-China Relations. Tensions between China and the US continue to mount. The US administration’s decision to ban US tech companies from offering Chinese apps – TikTok and WeChat – on their platforms introduced further market volatility. It added to the tally of points of dissension between the world’s two biggest economies, from unrest in Hong Kong, to the SEC’s crackdown on Chinese ADR’s, to a stalled trade deal, and to the White House encouraging college endowments to divest from Chinese companies. The rhetoric will only ratchet up in the coming weeks – at least on the US side. President Xi’s administration may bide its time until after the US elections. While outwardly defiant – see recent military exercises in the straits of Taiwan – Xi’s focus is very much on shoring up the domestic economy. There, things are looking good.

China is the only major country expected to avoid a drop in GDP this year – quite an achievement. Covid-19 may have begun in China, but it has also been curbed more successfully there than in most nations. And that has helped the economy to recover. Both retail sales and industrial production have made impressive comebacks and are once again showing positive growth rates month on month, of 1% and 5% respectively. Travel and leisure stocks have surged more than 80% since the lows in March, significantly outperforming their peers in the US. And of course China benefited, at least in the short-term, from the jump in trade in medical necessities for which it is often the main or only supplier.
The OECD latest estimates project China’s economy will grow this year by 1.8%, and by 8% in 2021 – far better than it foresaw back in June. Our portfolios that have already tilted emerging markets exposure towards North Asia seem well placed.

Private Markets. Although public markets overall in the US have not done much in recent days, there has been excitement for private companies. Last week saw another example of the high-flying IPO market for US tech stocks, with the extraordinary pop for Snowflake. What does such a strong IPO market signify for investors and longer-term prospects for technology investments? Most importantly how do we determine when the party will end? The IPO of Snowflake, as well as other previous SAS focused companies, may well be a harbinger for the future of tech IPOs. The cloud-based data warehousing company, founded in 2012 with revenues of $265 million in its last fiscal year, made history last week. With an IPO price of $120 a share and debuting at $254 a share, Snowflake’s IPO became the largest software IPO and the largest IPO to double on its first day of trading. At its debut the $70 billion company is already the same valuation as Alibaba’s cloud computing business. Snowflake joins the list of previous tech IPOs including Zoom, Cloudflare, Ping, Datadog and others that are delivering strong returns for private market investors. Our private investments biased towards early- and late-stage venture and growth opportunities are continuing to profit from trends in technology – amplified over the last six months.

Generally, across any stage of private investing, the market for enterprise software is “smoking hot” while fintech, telehealth, and biotech are also hot. This contrasts with the waning interest in more traditional consumer companies which are increasingly out of favor. Globally private investment opportunities also continue to grow with China a dominant play. Chinese private investors are seeing a very strong rebound in luxury businesses and basic needs businesses that are tracking at 90-95% of pre-Covid-19 levels. Home-living is becoming a major theme as the Chinese already embraced e-commerce and delivery. A trend spreading fast across the globe.
RockCreek Update
As we head into the last few months of 2020 the RockCreek team is focused on our investors, colleagues, and communities. We continue to benefit from the numerous relationships, partnerships and global network that inspire, educate, and inform our investments. Our notable advisory board members have been a constant source of thought leadership across a number of timely areas. DeAnne Julius, a RockCreek advisory board member, former member of the Bank of England’s monetary policy committee and a distinguished Fellow and former Chairman at Chatham House, published an op-ed in the Financial Times Wednesday entitled “Ditch the Zombies and Embrace the Entrepreneurs.” She stresses the need to acknowledge that Covid-19 has permanently changed our economy and for economies to embrace adaptation and innovation. Read more here.

Team RockCreek

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