|We are seeing a split-screen moment. The successful SpaceX launch was a triumph of American innovation and ingenuity. It also signaled partnership – between public and private sectors and across national boundaries. On earth, by contrast, major cities across America were convulsed with a storm of protests against the death of an unarmed Minneapolis African American man at the hands of police. Geopolitical tensions gave investors some pause midweek, as China’s reassertion of its interest in controlling Hong Kong prompted a strong rebuke from President Trump, but then shrugged off concerns. What next?|
Political and geopolitical issues played out against continued disconnect between financial markets and the real economy. Financial markets suggest that the future can be bright, with the American economy building on its famous strengths of flexibility, creativity and “can do.” But as US market strength broadened somewhat beyond the “Famous Five” tech companies that have held up the broader stock indices, April data released last week for economies across the world, from the US to Europe to Japan and South Korea, showed weak consumption, trade and industrial production. April was likely the low point, as economies began to reopen in May and job losses eased. Economists mostly agree: the world has begun to climb out of recession, and markets are cheering that news. But the deep hole blown in the global economy means that the road to recovery is likely to be long.
Fueling the protests in America was widely acknowledged pain and anger at systemic racism and inequities. These issues have increasingly troubled business and financial leaders, who also believe in the promise of American innovation to build a stronger economy. Federal Reserve Chair Jerome Powell pointed out once again last week, those on lower incomes have been hit hardest by job losses from the Great Lockdown. And – as the US passed a sad milestone of 100,000 deaths and rising from Covid-19 – it is evident that communities of color have been hit hardest by the virus.
Looking at the global economy, IMF chief economist, Gita Gopinath, told a Princeton audience on Friday that data has come in weaker than expected. The IMF will revise down its 2020 GDP forecast from the 3 percent decline predicted in April. Gopinath also noted that the relative strength of financial markets is a global phenomenon – one more difference between this recession and the global financial crisis when there was a less dramatic drop in output, but financial markets stayed depressed for longer. Of course, we are not far into this cycle.
As we have noted, the swift and large-scale policy reaction to coronavirus has been a major factor underpinning financial markets. All the more important for the US Congress and Administration to agree on more relief for households, states and small businesses before the end-July “fiscal cliff” – when the boost to unemployment insurance and the special loan program for small businesses (Payroll Protection Program or PPP) are due to run out.
As markets look ahead to 2021 and beyond, big questions remain. How bad will the scarring from the Great Lockdown be? Can continued central bank and government support stave off permanent job losses and bankruptcies – now at the highest level since May 2009? And – perhaps most crucial for investors with their eyes on the long-term – can we go back to pre-pandemic trends or will resources need to be reallocated to fit the shape of a post-pandemic world? Profound uncertainty about the future is the one sure thing.
The pandemic, the lockdown and the recession have been global events. Relations with China, and within Europe, have been affected.
1. Rising US-China tensions are an underlying concern, not least because there is a ratchet effect in this political year, but markets so far expect cool heads to prevail
Apart from the tail risk of actual hostilities – still hard to imagine – the costs to the US and China of a breakdown in economic relations would be huge. This may be what steadied President Trump’s hand on Friday, when his speech was fiery but his actions targeted Hong Kong itself – and the WHO – rather than mainland China. Local China experts see the US actions against Hong Kong as of little short-term importance – not to mention as an unwarranted intervention into China’s domestic affairs. But foreigners likely see this differently: expect last week’s developments to hasten the demise of Hong Kong as an offshore center as its value – to China and the rest of the world – shrinks. Already, the less free-wheeling Singapore was picking up steam as the major Asian hub for finance and business outside China while Shanghai offers an increasingly sophisticated foothold inside China that continues to grow apace.
Looking ahead, dangers remain. Neither President Trump nor the presumptive Democratic nominee for President, Joe Biden, wants to look soft on China. And once tough measures are in place, they are hard to unwind. Look no further than the tariffs that the Administration put in place on Chinese goods before the “Phase One” trade deal was reached. They remain in place, with minor exceptions for some medical goods. Despite the evidence that the costs fall largely on Americans, raising prices and cutting profits, there is no hint that they will be removed any time soon.
So, what now? For all the complaints that American businesses have about China – including unfair trade practices, appropriation of trade secrets, disregard for intellectual property rights, and weak rule of law – big US firms remain keen to do business there. Just last month, Honeywell went ahead with the opening of its emerging market headquarters and innovation center in Wuhan. The enormous and growing Chinese market is the draw for many, beyond the traditional role of China’s manufacturing in reducing costs and boosting efficient supply chains for goods sold in the US. As China has grown to become the second largest economy in the world, its dependence on the US market has lessened. But American expertise and innovation are still envied in China and are key inputs for some cutting-edge domestic firms, including Huawei.
As China and the US face off, at least politically, other countries would like to avoid being in the crossfire. Not so long ago, many US allies were reluctant to confront China on economic issues, from European allies such as Germany, the UK under Prime Minister Cameron to those in the region, such as Australia, whose economy is much more closely tied to that of China than to the US. China’s economic and trading weight means most would prefer to stay friendly. But what many outside China see as President Xi’s heavy-handed treatment of Hong Kong, initial denials and delay over Covid-19, and clear ambitions, have tempered enthusiasm.
2. “Merkel Moment” holds promise for Europe, even if investors are not yet believers
Markets underestimate European cohesion at their peril. This was a clear lesson from the Eurocrisis in 2011-2013. However, back then, it took a long time for policymakers to demonstrate their commitment to hold the eurozone together. And rather than governments, it was the central bank that made the critical move, with ECB president Mario Draghi’s famous promise to do “whatever it takes” to support the euro. That left doubts about the deeper political commitment to solidarity across Europe. This time is different. It may not quite be a “Hamiltonian” moment, but the proposal from EC President Ursula von der Leyen to issue substantial amounts of debt in the name of the EU (all 27, not just the eurozone) to fund a special €750 billion program for rebuilding and recovery after the pandemic marks a dramatic shift in the politics and dynamics of Europe. It would not have happened without Angela Merkel taking the lead.
Before Covid-19, it seemed all but certain that French President Macron’s ambitious goals for joint funding in financial markets for European spending would founder on opposition from Germany and other northern European nations to any hint of responsibility for the fiscal burdens of the generally weaker economies of the south. In the early days of the health crisis, Italy called in vain for help from its European partners. They did not respond until after China had sent emergency equipment. Since then, Germany’s effective response to the virus has boosted Chancellor Merkel’s standing and vastly increased her ability to lead. This she has done, agreeing with Macron on a plan to raise money in the name of all of Europe. The “Frugal Four” – as Austria, Denmark, the Netherlands and Sweden have been tagged – are fighting against this. Merkel needs to convince them that European cohesion is at stake.
3. Investing in a time of uncertainty
Institutional investors have had an onslaught of geopolitical pressures, new economic data releases, and corporate activity to digest in the last few weeks. Elevated US-China tensions have given some investors a pause as they consider longer term portfolio implications depending on the different outcomes from these strains. ECB’s indication of a larger than expected stimulus package is raising questions of potentially stronger European equity markets in the near term. Meanwhile, US equity markets continue to churn higher, supported primarily by the same 5 largest companies in the S&P 500 Index. The top 5 S&P 500 Index companies (equating to about 19% of the Index) through May 29th are up 15% year to date, with the remaining 495 stocks in the S&P 500 Index down collectively almost 10% year to date. A similar story in the Chinese market exists. The top 5 MSCI China stocks (equating to 40%) through May 29th are close to flat while the rest of the Index is down approximately 8%.
Meanwhile Fed support for the markets, a perhaps quicker US reopening from the pandemic-induced lockdown than some had feared, and a downward trajectory in coronavirus cases is keeping the bulls, and, especially retail investors, happy for now.
Longer term however, there are still serious concerns about certain companies and sectors withstanding a slowdown and recession. Despite plentiful cheap and easy access to debt markets – $1.22 trillion of corporate debt in just 5 months – we expect the speed and rate of companies defaulting on loans and filing for bankruptcy to accelerate in the upcoming quarters; a potentially attractive opportunity for a distressed exposure if allocators partner with patient and experienced investors that understand the bankruptcy process and have deep credit analysis and legal expertise.
European markets have been another puzzle for investors to decipher as they grinded higher this month, mostly on the back of positive stimulus. Perhaps due to this positive trend, there has been a number of opportunities materializing on the short side in Europe. We have seen this week, with the removal of the short ban across every European country, some retracement in Europe and an uptick in volatility. In line with our longer-term views, European investors also seem to be talking more about ESG factors in assessing the future long-term value of companies. Companies with renewable energy models, such as PNE AG, and other ESG angles continue to hold up well relative to the broader market.
Even more important in the aftermath of the Covid-19 pandemic have been our longstanding themes across healthcare, education, food sustainability, climate and innovation. Complacent public markets have seemingly been a calming force on continued, robust private market activity in these sectors and others. RockCreek recently invested in Apeel Sciences, alongside GIC, Viking Global, Upfront Ventures, Tao Capital and Oprah Winfrey. This $250 million funding round in May led by GIC, valued Apeel Sciences at a $1 billion valuation. RockCreek invested in Apeel Sciences given it is well positioned to address climate change by using its plant derived solutions to reduce food waste around the world and relieve pressures across the food supply chain. All the while, building a global coalition of farmers and suppliers and bringing longer-lasting produce to grocery stores. Apeel’s innovation reduces food waste from the packer, to the retailer, to the consumer at home – positively impacting the global food supply chain along the way. It’s technology also reduces energy use by reducing refrigerated transport and storage.
Innovation in food technologies such as Apeel is promising – as was the momentous innovation in human spaceflight and spacecraft technology witnessed over the weekend. The SpaceX Falcon 9 rocket with the SpaceX Dragon capsule successfully launched, pulled up to the International Space Station (ISS) and docked automatically. It was the first time a privately built and owned spacecraft carried astronauts to the orbiting lab in its nearly 20 years. The ISS orbits about 250 miles above Earth and travels more than 17,000 miles per hour. Over the last 9 years, and until this weekend, the US had not launched its own astronauts into space, rather NASA astronauts relied on Russia and trained on the country’s Soyuz spacecraft. In the quest for innovation and reduced costs, NASA asked the private sector to develop a spacecraft capable of ferrying astronauts to the ISS. Going forward, and given the successful SpaceX Dragon mission, NASA will be pushing for more public-private sector partnerships – a move that we think will be replicated across industries.
Despite the uncertain economic environment, funding for new innovations, technologies and products continues. The number of companies that have raised new funding or been acquired is proof that longer term trends in appealing sectors will continue to attract capital. Themis Bioscience, an Australian biotechnology company with a very promising measles vaccine technology, was recently acquired by Merck. Merck hopes to use Themis technology to develop a measles-vectored Covid-19 vaccine. Adjuvant Capital – a RockCreek investment – was the largest investor in Themis prior to the Merck transaction.
In the same vein as the growing appeal of online gaming, e-sports, and social media, ByteDance, the parent company of TikTok, reported a recent valuation north of $100B via secondary transactions, 30% higher than its last primary round in mid-2018. ByteDance uses AI to personalize the experience for its users and is able to rapidly reach consumers. The Covid-19 quarantine accelerated app usage, a trend the company is hoping to quickly capitalize on in terms of revenue and user base.
These private companies and many others seem to be benefiting greatly from continued interest by investors in those longer-term trends that are experiencing tailwinds in sectors ripe for future growth. Shorter term, public markets continue to seesaw and debate between value and growth, cyclicals or defensives, and work from home stocks vs. reopening winners. Investors can be certain that the rulebook for portfolio positioning will continue to evolve in the coming weeks as the markets continue to digest the implications of Covid-19.
We look forward to welcoming our 2020 interns in June. The 2020 intern class increases RockCreek’s intern count since inception to over 335. This is a team with over 80% diversity and, in addition to a number of data scientists, AI and computer scientists, includes students from DC schools.
As we all adjust to a new market and working environment in the aftermath of Covid-19, we continue to keep our clients, colleagues, and partners abreast of our actions and share best practices on ways to recover and thrive. 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 safe office work plans.
While the RockCreek team continues to work efficiently and seamlessly remotely, we recognize the need for thoughtful and sensible planning so that certain team members can return to the office during the summer. This includes planning around space guidelines, cleaning and mail services, food services, building rules, meeting spaces and more. Alifia Doriwala, as quoted in Bloomberg last week mentioned, “We’ve bought masks for our staff to wear. We’re thinking of closing the kitchen and limiting bathroom use to 2 at a time.” She also mentioned our virtual coffees, team happy hours and book club as other ways our team continues a sense of cohesiveness during this time. We supported local restaurants to provide food to our team and others on Memorial Day weekend.
Our team and partners continue to look for additional ways to contribute to the organizations that are assisting communities during this time of need. If you have any questions or know of other ways we can partner with organizations helping throughout this pandemic, please let us know.