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Whiplash

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It is hard to hold two alternative realities in mind. But that’s what we had to do last week, and maybe for some weeks to come. On the two biggest issues shaping the outlook this year — the global pandemic and US politics and policy — we toggled between extraordinary uncertainty and a joyous prospect of a return to normal. News, first from Pfizer on November 9 and now, a week later, from Moderna, indicates that highly effective vaccines against Covid-19 may become available within weeks. It contrasts with terrible numbers in recent days on the spread of disease across the US and Europe and warnings of worse ahead this winter. And relief felt around the world that the contentious Presidential election was over was almost immediately tempered by the refusal of President Trump — and most other GOP leaders — to accept the result. The most likely outlook for 2021 remains a gradual return to normal: with a peaceful transition of power to President-Elect Biden on January 20 followed by a gradual loosening of the hold that Covid-19 has had on our lives and livelihoods this year. Here’s to boring being the new normal. 
As if there wasn’t enough uncertainty for investors to manage, US-China economic relations have shifted back into the limelight. The surprise White House ban on US investment in 31 Chinese companies left many scrambling to work out what this means for their portfolios. Effective January 11, 2021, the executive order prohibits U.S. entities from owning or trading securities that are derived from or exposed to the banned firms, which the Trump administration claims supply and otherwise support China’s military-industrial complex. At RockCreek, we believe this highlights short-term risks of further unpredictable executive action in the several weeks before the new administration takes office. As noted in our commentary on the executive order, we see this latest move by the Trump administration as largely symbolic. US investors only own 2 percent of the value of the companies traded on China’s stock market and only a handful of publicly listed Chinese companies are believed to be linked to the country’s military.

The big question going forward: how will a Biden Administration shape policy towards China and will it change President Xi’s approach? Investors will need to consider if political concerns on both sides are going to take precedence over economic and business issues. The US executive action closely followed China’s surprise upset of Ant Group’s IPO. According to the Wall Street Journal, President Xi Jinping was personally involved in halting the Chinese fintech’s $37 billion public listing, a stunning rebuke against Jack Ma’s criticism of the government’s increasingly tight financial regulation. We discussed the move with RockCreek Senior Advisor Alan Greenspan, who saw it as a “major change” in the way the government traditionally deals with businesses. Watch the full conversation here. We believe that while China’s market continues to offer tremendous opportunities, unpredictable political intervention will affect international interest in Chinese investments. At RockCreek, we generally invest in impactful investments that benefit from the enormous domestic growth in China which continues even as Covid-19 has hurt other economies.
Observations and the takeaway for investors:
1. In the West at least, 2020 will be remembered as the year of Covid-19

This year may be bookended by the first signs of a deadly pandemic in January and first deployment of a vaccine in December. The announcement last Monday from Pfizer that its vaccine was over 90 percent effective in early results rightfully sent markets shooting up. It is the best Covid-19 news all year — maybe the best news altogether for the world, although some looking for the US to shift from “America First” back to a more predictable leading nation may see the Biden victory as equally great news. Moderna has now followed up with the news that its vaccine is 94.5 percent effective in early trials. The distribution and supply chain challenges that these vaccines pose should only dampen spirits slightly — both must be kept at very cold temperatures, although Moderna’s requirements are much less challenging than those for Pfizer. It is likely that other vaccines will follow,  in what is an extraordinary demonstration of the power of scientific innovation and collaboration.

President-Elect Biden has warned nevertheless of a “dark winter.” Why?

Earlier this year, there were hopes that shifting behavior and scientific advances would contain the spread of Covid-19. This happened in China and some other countries in Asia — from wealthy New Zealand to developing Vietnam — as well as parts of Africa. The economic benefits were clear: after a hit to output from drastic lockdowns, economic activity has recovered in China to pre-pandemic levels. In Europe, a sharp drop in infections and continued low case numbers over the summer, led to hopes that the Coronavirus Recession would move into the rear view mirror there too, leaving the US the outlier with a summer surge in cases. The past few days and weeks have seen the virus roaring back in Europe, and now in America. Across the US, Covid-19 is spreading more rapidly now than ever before, topping 180,000 new cases last Friday, with the overall number of infections in America climbing above 11 million on Sunday, a mere six days after crossing the 10 million mark. Hospitalizations — a leading indicator of deaths — are also surging. Experts agree that without a dramatic change in behavior, infections — and deaths — will rise dramatically further over the winter, making distribution of a vaccine all the more urgent. 

There is some better news on the recent path of the illness than just the daily infection count. A report from the Washington Institute for Health Metrics and Evaluation (IHME) calculates that the US fatality rate from Covid-19 is now 30 percent lower than in the first wave in the spring. It also seems that the spread is faster in states that have not so far seen big outbreaks, suggesting that some immunity is building up in places that have already suffered or that those individuals who did not get sick in earlier outbreaks are more resilient and less likely to succumb to the disease. And — so far — the virus has not mutated dangerously as many had feared could happen over time.

Three important caveats: first, it is likely that much of the improvement in fatality rates comes from improved care. And this care may suffer as smaller hospitals become overcrowded in the rural states of the US now seeing the sharpest rises in case loads and hospitalizations. Already, the death rate in rural areas, according to the CDC, is double that in urban centers that are more likely to be well served by nearby major hospitals. Secondly, lockdown — and Zoom — fatigue is affecting everyone. In addition to analyzing economics, the IMF has turned its attention to data on physical distancing. In a
recent blog, it showed that there has been less of it than public health experts would wish. Finally, there are some who fear that the virus could yet mutate into a more damaging form. They point to the Danish experience with mink, where the virus seems to have infected the animals, mutated in the mink population and then reinfected humans. Hence the decision to mount a cull — or maybe a time to stop wearing fur?


2. The real economy is still sub-par, it’s hurting women and the way forward still lies through fiscal

One of the striking characteristics of this recession has been the agreement among central bankers, and economists, that it is really time to stop worrying about fiscal deficits — at least for now. Three major central bankers — Andrew Bailey of the Bank of England, Christine Lagarde of the ECB and Jerome Powell at the Federal Reserve — agreed at last week’s
annual forum on central banking that a robust economic recovery will require more of a boost from governments to address the scars from Covid-19. Unfortunately, it is unlikely that any action will happen in the US this year. The White House has withdrawn from negotiations and the Senate and House leaders remain far apart. Don’t expect either side to compromise, with control of the Senate in the balance until two run-off elections in Georgia on January 5, 2021. 

As to that scarring, another piece of the Biden agenda — if the Senate will go along with it — aims at addressing an important part of this, with investment in the “Care Economy.” There is growing evidence of the uneven costs of this recession on women, particularly those with children and particularly women of color.
The Federal Reserve Bank of Dallas analyzed shifts in labor force participation since the pandemic began. While both women and men left the labor force in the early spring as the economy shut down, fewer women than men have returned. And while there was no difference for men between those with young children and those without, for women that made a huge difference, especially for women in lower income brackets. In other words, the Coronavirus Recession is particularly bad for families and those who take care of them. Looking at the October unemployment figures, the National Women’s Law Center found the jobless rate among white men has now fallen to 5.8 percent from the March high. For Black women, Latina women and younger women (ages 20-24), the rate hovered between 9 and 10 percent. 


3. Where you live matters — for innovation as well as the environment

Covid-19 data shows that where you live matters for your health in a pandemic. We have also learned from recent research that children born and raised in low income areas have less success in life than others born into similar households but in different neighborhoods, with less crime, less homelessness and better schools. Simply moving the children can lead to better outcomes. It would of course be better if there were effective interventions that improved the neighborhood. Much of President-Elect Biden’s domestic policy agenda will aim to find and implement those interventions, including public investment in infrastructure, housing, education and training. Another way in which neighborhood matters: the latest results from
Milken Institute’s State Technology and Science Index (2020) assessment conducted every two years shows that Massachusetts, Colorado and California top a list of US states with the greatest “capacity for achieving prosperity through scientific discovery and technological innovation.” States can make a difference to the innovation opportunities through investment in educational institutions and research centers, such as Utah. These investments have spillover impacts into local communities. 

4. Investor Takeaways

The combination of Pfizer’s vaccine announcement and the news about President-Elect Biden — and the certainty that it brings to the economy and markets, as well as a possible divided government — had the markets roaring early last week. Investors saw an aggressive risk-on rotation across asset classes — global equities roared higher, bonds sold off and breakeven rates jumped, safe haven currencies and gold weakened sharply and oil prices increased. 

Gains among stocks were far from uniform however, with massive dispersion seen between Covid-19 winners and losers. The US small cap value universe gained 7.0 percent on Monday and 9.2 percent for the week. Contrast this with the large cap growth universe underperforming small cap by a massive 871 bps on Monday alone and 1,041 bps for the week. Despite the sizable rotation seen this last week, large cap growth’s year-to-date return is still 36 percent higher than small cap value. While we do not expect the gap to converge towards zero, the speed and size of last week’s move provides insights into how under-owned cyclical stocks are and how much room there is to go. Investors who were used to a one way ticket up for the last few months will want to watch for a market whipsaw that may affect portfolios in the interim.

Across sectors it was also no surprise given the small cap rally that energy (+17.1 percent) and financials (+8.3 percent) were the main beneficiaries last week. Again the week’s market moves highlighted the stark contrast between what had worked most of the year and what gained new life because of the vaccine news. The year’s winners technology (-0.4 percent) and consumer discretionary (-1.1 percent) were the lone sectors in the red. Unsurprisingly, shares of cruise lines, airlines and commercial property owners saw some of the biggest gains, while high profile stay-at-home winners such as Zoom and Peloton saw shares down nearly 20 percent.

Providing more color on the magnitude of Monday’s cross sectional moves in stocks — Goldman Sachs long/short momentum pair was down 23 percent on the day, the biggest one-day move in a decade and approximately twice the magnitude of the second biggest move — an 11 standard deviation move. The rotation in markets last week had ramifications for hedge funds as both fundamental and systematic equity strategies had their worst alpha day since May, offsetting somewhat strong beta contribution. Funds also increased their net and gross leverage on the news, buying on both the long and short side of portfolios. Net leverage in equity hedge fund portfolios is now at record highs and gross exposure is at a high for fundamental strategies. Active management has performed well in this environment that seems ripe for stock pickers. 

Emerging market investors had their own set of dynamics to wrestle with last week between reactions to the vaccine news and regulatory action by both China and the US. Opportunities outside of North Asia are looking more attractive as the news of an effective vaccine begins to lift all boats and the USD remains innocuous to local currencies. Latin America and South Africa are showing signs of renewed economic activity buoyed by the ongoing recovery story in China and increased demand for basic materials. For the first time in months, foreign investors turned net buyers last week in Brazil and South Africa. The recovery in these markets is not just benefitting iron ore and precious metals companies — online travel and leisure companies also witnessed strong rallies last week as did e-commerce platforms. Likewise, Indian equities continued their strong run as foreign investors continued strong net buying for the sixth week in a row.

We also witnessed a bifurcation between Chinese equities and much of the rest of emerging markets last week. Chinese equities began the week with markets reeling from the local regulators hitting the brakes on the Ant Group IPO and ended with the Trump administration issuing an executive order banning US investor participation in a number of Chinese companies that aid the country’s military. We do not think that either externality changes the calculus on the Chinese growth story, but they could deter investors from considering increasing allocations. Ant Group may be a special case of Chinese regulators — or leadership — reacting to a CEO who has increased his economic power base and may be seen by the leadership as speaking out of turn. It is not a repudiation of the technology space or IPOs in general. The Trump administration’s move may be largely symbolic. US investors own about 2 percent of the value of the companies traded on the Chinese stock market and only a small number of publicly listed Chinese companies are believed to be linked to the country’s military. At RockCreek, our portfolios’ emphasis on impactful investments in companies with improving governance benefiting from local growth themes have the added advantage that they generally would exclude defense related companies that are largely SOEs.

The executive order would have been more significant had it included more consequential names from China’s technology ecosystem. The risk remains that these stocks could be the next wave of a US ban in the next ten weeks. We continue to talk to policymakers in China and the US to be prepared for that possibility. Chinese equity markets have rallied 27 percent this year despite a severe pandemic and the subsequent global slowdown. The domestic consumer has been and will likely be the driver of economic growth in China for years to come. As if to underscore the power of the Chinese consumer, hidden in the headlines this week was Alibaba’s $56 billion worth of goods sold on “Singles’ Day,” a 38 percent increase from last year.
RockCreek Update
The RockCreek team continues to work seamlessly and efficiently remotely, with some team members going into the office while taking the necessary precautions. We are starting to work with our team and partners for an eventual return to more normalcy in travel and a new normal in the use of our office space in Q3 2021. 
 
RockCreek Senior Advisor and former Chair of the Federal Reserve Alan Greenspan joined Afsaneh Beschloss for a discussion on US-China relations, Covid-19 and what a Biden presidency means for the economy. Watch here.

On Friday, Afsaneh Beschloss spoke about the latest vaccine news and investments in ESG on Bloomberg’s Wall Street Week with David Westin. Watch here. Earlier in the week, she joined the inaugural session of the Toronto Global Forum to discuss how the global economy has been impacted by Covid-19 and how countries can be prepared for future risks of economic instability. Watch here

Team RockCreek

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