Vaccines versus the Virus

The Coronavirus Recession is not over yet, at least not in Europe and America. Financial markets seemed to register that briefly last week. But many investors are now looking to a post-vaccine future, and cheering. With the extraordinary success in developing safe and effective vaccines, the US will start to vaccinate people from today, joining Canada and the UK. Help is on its way. But not soon enough for the thousands of Americans dying every day from Covid-19. And, as President-elect Biden has reiterated, millions face economic pain as well as fear of infection, as fiscal relief runs out this month. Today’s formal Electoral College vote may be the signal for acceptance by all in Congress of the reality that Biden will become president on January 20. That acceptance should translate into support this week for the fiscal action the President-elect is urging, as he calls for a focus on equity and a better life for the less advantaged. But time is running out for congressional compromise. As a result, eyes are turning once again to the central bank to help. Can the Federal Reserve reassure investors when it meets this week? Last week’s pre-holiday boost from the European Central Bank (ECB) was not enough to spark market joy. 

Yes, there will be more quantitative easing (QE) for longer, with an additional euro 500 billion for the Pandemic Emergency Purchase Program and an extension of the program by nine months, but that was already baked in. ECB President Christine Lagarde’s message that the support might not be used in full “if favorable financing conditions can be maintained,” worried markets. At least in Europe, the way was cleared for more fiscal help, as German Chancellor Angela Merkel coaxed Poland and Hungary to drop their opposition to the fiscal package. Can the EU also manage the Brexit risk that investors last week realized is now, after four years and counting, real?
Renewed Covid-19 lockdowns in Europe have contained the second wave of infections there, while the historic start of vaccinations in the UK reminded everyone that a brighter future is in sight. But the lockdowns that curbed infections have likely pushed Europe back into recession this quarter. And in Germany —  the driver of the European economy — stricter lockdown rules will be put in place for the Christmas and New Year holidays after Germany’s autumn “lockdown light” did not bring infection rates down as much as hoped. 

In the US, we are witnessing how bad things can be when Covid-19 is ignored. The post-Thanksgiving surge in infections is now leading to rising hospitalizations across the country and a terrible death toll. The data is hard to comprehend — more Americans are dying every day than died on 9/11, or in Pearl Harbor. Governors and local officials are increasingly clamping down on activity, worried that hospitals cannot cope. Small businesses that invested in short term measures to stay open, such as restaurants that bought outdoor furniture and heaters, now have to shutter their doors again in New York and elsewhere. Too many Americans have ignored the pleas from public health officials to stay home or, when you cannot, to wear a mask, keep socially distanced and wash hands. With mixed messaging about what activities are really dangerous and to whom, public confusion is not surprising. 

It is clear that the US economy has slowed again this quarter with surging infections and increased restrictions: witness a renewed spike in new US unemployment claims reported last week. Investor sentiment has remained bullish — buoyed by hopes for 2021. Successful vaccine roll-out and continued fiscal support will be key.
Observations and the takeaway for investors:
1. Juggling: central banks and governments — and European comity

Central banks in developed markets have been pressing for governments to take more of the burden of supporting the recovery. In the US, political compromise seemed to dance just out of reach again last week, putting more pressure on the Fed this week. Contrast that with Canada, where the central bank was able to stand pat in December, following the promise of more fiscal support. In Japan, the government is also preparing a stimulus package. As is often the case in Tokyo, the planned measures may not be enough to fully offset the fiscal drag that is baked in already. 

The EU is another story. The most important shift here has been its show of solidarity on both fiscal and monetary demonstrations of collective interests in the face of the pandemic. Europe’s policy makers have learned from the euro crisis of almost a decade ago. That crisis was exacerbated by misplaced fiscal austerity, delayed monetary action and uncertainty about commitment to solidarity within the eurozone. This time around, governments put in place fiscal support as the pandemic hit and the ECB acted swiftly and decisively to ease monetary policy across the eurozone.   

Last week, EU countries meeting in Brussels cleared the last obstacle to agreement on collective financing for emergency fiscal spending in an individual country. As with most things European — or maybe just most political agreements — this involved settling a quite different issue first. Poland and Hungary, whose governments are believed by many to have drifted towards authoritarianism, refused to agree to the budget plan without a softening of language around democratic institutions. The first tentative steps towards this agreement earlier this year were hailed as a “Hamiltonian moment.” That was exaggerated, but the shift was genuine and important. It reinforces steps by the central bank to share risk. At the ECB, restrictions were loosened in the use of the so-called capital key, which had linked purchases of a particular government’s bonds to the share of each country in ECB capital. European QE has, as a result, been targeted this year where it is most needed, without the blowback that could have occurred from “creditor” nations, notably Germany.  

2. The unequal recession: jobs, education and wealth gaps grow

Last week’s jobs data reaffirmed that the pain of unemployment is still being felt by many. New unemployment insurance claims climbed back up to September levels, spiking to 875,000 in early December. Although far better than in the Spring, when the nationwide lockdown threw millions of Americans out of work, the claims figure compares to a weekly high of just 586,000 during the global financial crisis a decade ago. 

We have noted before how the Coronavirus Recession is hitting employment particularly hard in the lower-income communities in the US that depend on low wage service jobs. President-elect Biden told NBC last week that “The middle-class and working-class people are being crushed.” His economic policies will have to focus on these communities if he hopes to close the growing wealth gap. Two other data points illustrate the widening disparities between rich and poor in America.  

First, as schools in most major cities remain closed to in-person teaching, it is becoming clearer that those children impacted most are the ones who are most vulnerable. Remote learning is just not as good as learning in schools, especially when parents cannot help. If the tools for remote learning are absent — high speed internet and suitable computers or smartphones — the problem is even worse. President-elect Biden has called for actions to allow most American children to go back to school in the Spring. Those must include vaccination priority for teachers and funding for schools to improve safety, with better heating and ventilation. Books and supplies would be good as well — as Oklahoma teachers who went on strike pre-Covid-19 called for.

Secondly, the disconnect between financial markets and the real economy has, unsurprisingly, widened the wealth gap in America, including the persistent Black-white wealth gap. Those in upper income brackets were more likely to own stock and their own home, going into the Coronavirus Recession. As shown in the latest Federal Reserve survey, the top 10 percent of households benefit disproportionately from stock market gains. In contrast, many lower income Americans have no stocks, little savings and may not own their own homes, making it harder to weather a downturn.

3. America ready to lead again — and what about China?

As President-elect Biden continues to build out his team, it is notable for experience, competence and close connection — over decades in some cases — with President-elect Biden himself. The first order of business will be addressing the health and economic crisis at home. But engagement with the rest of the world is also high on the agenda. Many allies and friends, including the UK and Italian governments that will host the G7 and G20 next year, are cheering the prospect. Renewed American leadership on health, climate, jobs and security would mostly be welcome. But four years of America First have reminded nations that they need to look after their own as well. It will be important for the incoming Administration to be sensitive to the needs of others. The US-China relationship remains the trickiest to manage, as well as the most important for the future. China expert and former US Treasury representative in Beijing, David Dollar, spoke to this in the first of RockCreek’s year-end Roundtable series. Watch here

4. Investor Takeaways

In last week’s letter, we previewed the pipeline of high-profile IPOs expected over the coming months. Two of those, Airbnb ($ABNB) and DoorDash  ($DASH), went public this week with a level of enthusiasm that drew comparisons to the dot-com bubble. The IPOs represented two of the  largest US new issues in 2020 with Airbnb debuting at $3.5 billion and DoorDash at $3.4 billion. With these issues, 2020 could be close to taking the crown for largest IPO volume, surpassing only 2014, when Alibaba made its $21.8 billion public debut. In a response to the IPO pop of Airbnb and DoorDash, both Roblox and Affirm subsequently postponed their own initial public offerings. Citing the desire to include employees, shareholders and future investors both big and small, both companies are wary of the current IPO market conditions preventing them from being inclusive of a larger audience. 
According to the Renaissance IPO Index, the 2020 cohort of US IPOs has gained more than 110 percent in 2020, versus what looks like a relatively paltry 15.7 percent for the S&P 500. Airbnb and DoorDash were similarly situated to their index peers with day one gains of 113 percent and 86 percent, respectively. Going forward, investors looking to buy at these higher valuations will need to convince themselves that these two businesses can sustain the pandemic-induced momentum. Will Airbnb continue to gain market share from traditional hotels while navigating increasingly complex regulations? Airbnb is valued at the combined market cap of six of the world’s largest publicly traded hotel brands (Marriott, Hilton, InterContinental, Choice, Wyndham and Hyatt). Similarly, will DoorDash continue to be able to capitalize on the shift to suburban living while proving out the unit economics of its early cohorts, or will profitability attract greater wage expectations for Dashers? 

Global Equity Markets. Despite the flurry of activity in the IPO market, global equity markets were otherwise in a holding pattern this week as investors awaited resolutions around the prospect of US fiscal stimulus and the posture of the incoming Administration towards China and Brexit. On the margin, sentiment remained risk-on as small-caps and cyclical industries and regions saw relative outperformance to the broader market for the week. The level of bullishness remains elevated with the AAII Sentiment Survey showing that 48 percent of individual investors believe US stocks will trade higher over the next six months. This is an “unusually high” reading, more than one standard deviation above its historical average of 38 percent. Such readings historically have been followed by “lower-than-average six- and 12-month returns for the S&P 500 index.” Signals of market exuberance, including investor sentiment, remain high and something to pay close attention to as we enter the new year. Bullish investor positioning levels may remain strong for a long period if the macro environment including stimulus remains supportive.

It was an eventful week for investors in European assets. Investors in peripheral European bonds had a strong week, with yields on 10yr Portuguese and Spanish bonds flirting with, and pushing through, the zero level. The overall spread to Bunds stayed relatively flat, widening slightly as German bonds also rallied in anticipation of increased bond buying by the ECB. As a result of this massive amount of QE, the ECB will likely hold nearly half of Italy and Germany’s bonds by the end of 2021. Despite the extremely accommodative monetary policy, the euro finished the week essentially flat against the US dollar, and is roughly 8.6 percent stronger against the Greenback year-to-date. 

By contrast, in the UK the increased likelihood of a no-deal Brexit sent the Pound 1.5 percent lower against the dollar, catching more bullish Brexit investors off guard. In addition, interest rate markets are starting to bet once again that the Bank of England will have to cut rates into negative territory, with overnight indexed swaps assigning a roughly 60 percent probability of a negative target rate by September 2021.

Interestingly, UK equity markets were seemingly indifferent to the Brexit developments as the FTSE 100 returned +0.2 percent in local currency for the week. This aligns with investor positioning in Europe, which has been at lower levels throughout the year given caution on Brexit and concerns around lockdowns as both the UK and mainland Europe have lagged behind other developed markets and emerging markets. This past week, European equities in aggregate (measured by STOXX 600) continued to fall short with Financials, including UK banks and peripheral banks falling 10 percent during the week after rallying 82 percent from end October through December 4.
RockCreek Update
The RockCreek team continues to work efficiently from home with some team members choosing to go safely to the office. The RockCreek Book Club met this week to discuss Guy Spier’s The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment. January’s pick is Marcus Aurelius’ Meditations

Last week, RockCreek Senior Advisor Caroline Atkinson spoke with former Treasury Secretary Lawrence H. Summers and the OECD’s lead economist Laurence Boone about the need for continued fiscal support to underpin demand after Covid-19, equality, jobs and a new way of viewing federal deficits. The discussion provides more color on the shifts in thinking about the role of fiscal policy, which we touched on last week. This was the inaugural panel of her new series with the Peterson Institute for International Economics called Global Connections. Watch here

RockCreek Founder and CEO Afsaneh Beschloss was featured in a Barron’s series last weekend that asked the biggest names in finance what are the greatest challenges — and opportunities — we face in a post-pandemic world. Climate, “is going to be huge in terms of investments — both in the move toward efficiency and making sure systems are such that less gas gets into the environment,” said Ms. Beschloss. Read the full story here

Team RockCreek


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