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Tug-of-War

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The past week has made it clear: coronavirus is surging again in the US. Equities lost some ground last week, but markets have mostly held their nerve so far. Even before the feared “second wave” that many expect in the fall, daily Covid-19 infections have climbed back above peak April levels. But – mainly thanks to the Fed markets are flush with liquidity, interest rates are low, and no one expects a tightening. Not surprising then that markets are shifting almost daily between “risk on” and “risk off.” Covid-19, and the enormous job losses and business closures from the Great Lockdown, are on one side of the tug of war. On the other side, bolstering markets and hopes of economic recovery, is the expansionary policy response of unprecedented size and scope in the US and globally. Expect the battle to go on for some time.
China is the only major economy likely to see (marginally) positive growth this year. But will tense relations with the US limit any positive spill-over for American firms and investors? Watch David Dollar, China expert and former US Treasury rep in Beijing, share his views with RockCreek.

Last week, Covid-19 fears just won out, as the US bucked the trend of other advanced economies with a marked uptick in disease.The S&P dropped 2.9%, after the dismal US numbers on infections led to reports that the EU will still exclude most US travelers when it lifts travel bans imposed earlier this year. US cases are spiking in the South and South West – notably Florida, Texas and Arizona – which had not seen much infection before May. Reluctant state Governors pulled back and even reversed some reopening measures, casting doubt on the resilience of recovery. The bounce back in spending and hiring that surprised many in May seems likely to have continued through June, but at a less robust pace. All eyes are on the June labor market report, due out on Thursday.

Three observations and the take-away for investors
1. Instead of clarifying with time, the contours of recovery from this health-induced recession are getting fuzzier.

Economic data always lags. Turning points are always hard to pin-point. But the twists and turns of the virus make this time even harder. Add to that the market switch-back, as panic in March gave way to exuberance in April amid the flood of fiscal and monetary support. The IMF reported last week that an astonishing $10.7 trillion is being added to demand by fiscal authorities around the world. They estimate that central banks have put in a further $6 trillion so far. The balance sheets of the four major central banks – the Fed, ECB, Bank of England and Bank of Japan – will likely reach well above $20 trillion by the end of this year, says Tim Adams, President and CEO of the Institute of International Finance. Unwinding that will be a long and tricky task.

Forecasters are even more uncertain than usual, with growth revisions going in both directions. The economic impact in March and April of the lockdown across Europe and the US was greater than many expected. This was one reason for the IMF’s sharp downward revision last week to its forecast for the global economy. But their new projection – that global GDP will shrink by nearly 5% this year, with a drop of 8% in the US – may seem too gloomy in light of the strong May pickup in output and spending, which has made other analysts more optimistic.

The bottom line? As we have said before, that depends more on the course of disease, and psychology, than on purely economic factors. Importantly, how will consumers and businesses react to the stop-start pattern that we are likely to see. Perhaps Larry Summers had it right last week when, in discussion with Glen Hubbard, he framed predictions not in terms of months from today, but from when a vaccine would be widely available. Bill Gates agrees with Anthony Fauci that a safe and effective vaccine may be discovered by the end-2020 or early 2021. Companies are already preparing to manufacture the most promising vaccines, likely allowing for swift deployment in the US. It will still take time to manufacture the billions of doses needed globally and deliver them around the world.

2. Deflation risk in the short-term, although some worry about inflation longer-term

The latest inflation data show that prices are being held down by the global plunge into recession in March-April.  Higher savings, continued job losses and the uncertain outlook for demand will keep inflation low for at least some time to come.  But the supply shock to the global economy from Covid-19 will continue as long as the disease is still around, curtailing access to many services – with restaurants, bars and movie theaters, for example, unable to provide the same service as before – and increasing expenses for some businesses. Coupled with the extraordinary liquidity being pumped into the global economy – estimated by IMF head Kristalina Georgieva at $10 trillion by fiscal authorities and $6 trillion by central banks – it is possible to imagine inflation expectations slipping their moorings.  Markets do not yet price in anything of the sort, making it cheap to hedge as some have noted.

3. European unity – Angela Merkel’s legacy?

During the Eurocrisis, German Chancellor Angela Merkel moved only reluctantly and in small incremental steps to provide the financing and support for ECB actions that held the euro area together.  As a result, the crisis dragged on much longer than it needed to. Fiscal austerity, forced on weaker economies in southern and western Europe in exchange for more financing, inflicted long-term damage to employment and growth.  

Germany is now acting differently.  With a pandemic rather than fiscal profligacy blamed for hard times in Italy, Spain, Portugal and elsewhere, helping these economies is more palatable to German citizens than it was in 2010-2012.  Moreover, after the blow to Europe of Brexit (remember that?), Merkel wants to leave office having done all she can to build European unity and strength. Her willingness to support more spending at home and a big financing package at the EU level is good news. The other Northerners –including the Frugal Four of Austria, Denmark, Sweden and the Netherlands – would not sign off on the package at the European Council meeting of June 19. But all agreed on the importance of action. Merkel will be chairing the next leaders’ meeting, in July, and expects to make progress. She has also been quietly supportive of the unexpectedly large ECB action to support liquidity, further amplified last week by ECB President Christine Lagarde. The two grew close during the previous crisis, when Lagarde led the IMF.  Their partnership remains key.


4. How should investors position themselves as the tug-of-war plays out?


With many believing that equities are downplaying the dire prospects for the real economy, it might be surprising that last week’s Covid-19 fears pushed the S&P 500 down by only 2.9%, after a gain of 1.9% the previous week. The outsized influence from Apple, Microsoft, Amazon, Google, and Facebook is causing headline market indicators to suggest things are more rosy than they really are. Although the S&P 500 is down 6.9% year-to-date (June 26), the median return of the index’s underlying stocks is -15%.

While retail investors appear eager to roll the dice and make bets on financially distressed stocks, hedge funds and other institutional investors have been more guarded. Positioning has been concentrated on the strongest likely survivors of the crisis across industries. Meanwhile, elevated volatility levels have enabled managers to actively trade around these positions, gaining attractive entry points and locking in short-term gains.

As it is becoming clearer that the lifting of lockdown restrictions is leading to a resurgence of disease, investors of all stripes started this week fleeing from investments that may have looked like bargains in a best-case scenario. The worst performing stocks in the S&P 500 were mainly airlines, cruise lines, and hotels & casinos – namely American Airlines, Royal Caribbean Cruises, Norwegian Caribbean Cruises, and Wynn Resorts, which were all down in the neighborhood of 20% to 25% for the week. Not surprisingly, e-commerce plays like eBay and Amazon outperformed. And we would be remiss not to mention GAP, the S&P 500 leader for the week. Its shares surged almost 19% on Friday thanks to an agreement with Kanye West to collaborate on his fashion brand Yeezy.

The longer the Covid-19 crisis persists, likely the greater the permanency of today’s trends. One trend we believe is not getting nearly enough attention and presents potential investment opportunities is the migration of more and more people away from the biggest and most expensive cities into the suburbs. According to a recent Brookings Institution analysis, cities grew about 18% faster in 2010 than the suburbs. Last year, before the Covid-19 crisis, suburbs grew twice as fast as cities. Some cities, including New York and Chicago, have experienced a population decline over the last four years. There are many reasons –including high taxes, unaffordability, and more millennials wanting more space for their growing families. Now we have this great work-from-anywhere experiment taking place across businesses that were not previously considering it – oftentimes to greater success than many companies would have predicted.

A Kaiser Family Foundation poll in May found that 34% of people with jobs said they were working from home. According to LinkedIn data, people in hard hit cities were searching for remote work opportunities significantly more than the rest of the country. According to apartment listing platform Zumper, June rents were either flat or falling in the 10 most expensive cities in the US. Rent on a one-bedroom apartment in San Francisco fell by an unprecedented 9%. Mortgage applications have surged for 5 straight weeks, driven by pent-up demand, record low mortgage rates, people seeking more space. This will lead to a surge in demand for home goods as people set up new residences with equipment to maintain their yards, and with cars to drive errands. In fact, furniture and home furnishings store sales picked up significantly in May, growing by 89.7% over April’s revised totals, which were down 48.4% from March 2020.

We are looking closely at these trends and more to support longer term positioning across our public and private market investments that would align with such permanent behavioral shifts. As investors looking to the future, we are cognizant that our portfolios need to be well allocated for this volatility and continuous tug of war across market factors. However, it is important not to lose sight of the return opportunities when we come out on the other side of the pandemic and find ourselves in a hopefully “better normal”, not just a “new normal”.
 
RockCreek Update
RockCreek Summer Analysts have had stock competitions, a Zoom meeting with Ken Lay, Senior Managing Director at RockCreek and previously Treasurer of the World Bank, who with his team was responsible for the first Green Bond, to discuss innovation and sustainable investing, and have joined more than thirty investment calls while learning how to use Bloomberg systems, RockCreek technology tools, and more. We look forward to keeping our community up to date on how we onboard, retain, and mentor new talent remotely.

While the RockCreek team continues to work efficiently remotely and remains close through daily video calls, coffee hours and book clubs, we continue to find ways to communicate and are bringing back our meditation and other wellbeing programs remotely. We continue to monitor best practices from health experts, and scientists to update our internal committee guiding our Covid-19-related decision-making processes and office safety measures.

The global health crisis has marked a tipping point in the push towards impact investing. Investors and markets alike have recognized the growing need – and the increasing returns – of investing for positive social and environmental impact. Last year, RockCreek, alongside a group of diverse, world-class investors, worked with the IFC to develop and launch The Impact Principles. These Principles created a set of market standards that have laid the framework for successful governance in impact investing, where RockCreek was one of the first investors to sign. On June 25th, the IFC announced that the Principles received their 100th investor signatory. RockCreek is proud to be a force for change in the investment community, and we are excited to see where this global momentum continues.

Our team and partners continue to contribute to organizations that are assisting communities during this time of need. We encourage our readers to check out organizations that have been supporting our community and increasing food security during the Covid-19 crisis. If you have any questions or know of other ways we can partner with organizations helping throughout this pandemic, please let us know.

Team RockCreek

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