Note June 26, 2020 – Mind The Gaping Hyperbole:

Note June 26, 2020 – Mind The Gaping Hyperbole: We would mind the gaping hyperbole and not just from politicians, where it is a stock in trade. Basic sciences based efforts including engineering and medicine rely on robustness of evidence and replicability while social sciences like politics often include ambiguity. Over Covid-19 pandemic earlier, both appeared to be converging at best and now potentially even seem clashing. Dichotomy between the clarity of science and the ambiguity of politics raises more investment risks than capital markets appear willing to incorporate.

We regard distinctions between types of central bank intervention as ones of semantics when compared to the reality basically of yield suppression. For investment purposes, the anchor of capital markets has been return on savings with efficient transmission of risk and minimal interference. Among some demographics as happened in Japan, minuscule rates may actually boost savings to buttress nest eggs. Central banks may not be as precise as market momentum appears dependent upon.

Corporate results will soon flow. Recent assessors including the IMF, the Fed, the BIS, the OECD and the World Bank stress overall growth recovery is likely to be fractured and protracted with debt burdens rising as risk, especially in a second Covid-19 wave. Fracturing of global trade could depress productivity slowdowns further. Amid central bank intervention, liquidity and long term solvency have yet to play out for capital markets. Contrary to momentum alone, risk premiums capital markets and valuation of equities in particular depend on the level and sustainability of long term growth, not least quality.

Composition notwithstanding, recent valuations appear to be conflating expectations of bounce back momentum implicitly with sustainable growth levels akin to those of pre-2008. If so, momentum activity in fixed income and equities would be justified, including into the lowest quality as recently occurred. Instead, we expect heightened volatility. Unlike recent aspirational decades, the consumer appears likely globally to be more fractiously challenged . We espouse diversification that includes precious metals exposure and short duration cash. We favor focus on quality of delivery (including on debt management) across asset classes. For balance, we favor strong Financials, Healthcare and Info Tech for delivery but also Energy, Industrials, and Materials for recovery exposure..  

Currently more than ever, investors need to mind the gaping hyperbole and not just from politicians, where it is a stock in trade. Gaping hyperbole can be seen in several spheres ranging from premature releases regarding the imminence of Covid-19 cures to little regard to social distancing on reduced restrictions and even in pithy market comments such as there being no alternative as being supportive of espousing fervor in capital markets for momentum. As a situational indicator in the markets as elsewhere when tangible delivery seems difficult, hyperbole appears to rise. In itself, heightened uncertainty should guide investments towards a quality of delivery and a diversification tilt. Unlike the last cycle into 2020, also likely to have less investment relevance are pithy phraseology like “wholesale risk on/off “ in markets or “all it takes”  by central banks.

Whether in basic form such as in physics, chemistry and biology or in applied form like engineering, physical sciences like to deal with clarity and replicability of result. Social sciences like politics seem to thrive in ambiguity. In the cauldron of the Covid-19 pandemic, both appear to have become extensively intersected and of concern for investments. From the global medical responders operating amid diverse populaces, whether from global organizations,  from prestigious universities and indeed from renowned specialists have come assessments that Covid-19 is not a one-time event. It seems instead likely to wane and flare sharply over time as can be seen recently.

Indeed amid the horror of massive deaths worldwide, there appear Covid-19 relapses.  The individual flareups include global individual brand name stores having to close again, spreads appear in high concentration activities like slaughter houses and agriculture as well as  in controlled individual sports settings like baseball and tennis.  As soon as social distancing was relaxed, relapses have also appeared in countries that had been early into containment like Australia, Germany, New Zealand and South Korea. High population areas like Brazil, India and South Africa have suffered massive caseloads that are still rising. Case levels appear rising again in numerous states in the United States which has been suffering the largest numbers of victims, globally.

Amid these facts, the political responses have ranged from initial denial to bellicosity to hyperbole. Politically, there has generally been seen increased use of ambiguity to espouse less social distancing for near term economic gain. In the pandemic, it contrasts with the displaying of leadership for sacrifice for higher purposes as has occurred in the past, for instance during war against evil. We assess that between the clarity of science on purposely tackling Covid-19 and the ambiguity of politics,  the dichotomy taking place raises more investment risks than capital markets appear willing to incorporate.

The preoccupation of the capital markets appears to be with momentum still. It relates to central bank intervention underway for decades now and which can only be classified as both massive and continuous. Back in 2008, central bank intervention was initially promulgated as being temporary and necessary. Over a decade of such can hardly be characterized as short term. Opportunities to transition to more neutrality were globally missed in 2017-19. They could have nudged governments into better budget deficit balance before pandemic reared up. Among companies, such transition could also have helped becalm financial engineering of record equity buybacks and sharply higher debt ratios in capital budgeting.

Currently amid the necessities of response to Covid-19 pandemic, attempts appear being made to distinguish between central bank quantitative ease, fixed income purchases and yield curve intervention. When compared to the reality basically of yield suppression, we regard as being ones of semantics, the much espoused distinctions between types of central bank intervention. For investment purposes, the anchor of capital markets has been return on savings with efficient transmission of risk and minimal interference. Central banks may not be as surgically precise as market momentum appears to increasingly have become dependent upon.

A number of recent in depth assessments stress that overall economic growth recovery is likely to be fractured and protracted. In the semi-annual Monetary Report to Congress of June 2020, the Federal Reserve points out that significant uncertainties are likely to be present for several years. The Bank for International Settlements and the International Monetary Fund have been pointing to the solvency risks down to the individual level lying behind ballooning credit and repayment pressures. Recent projections of annual growth from the IMF, the World Bank and the OECD point to global GDP contraction potentially of (6%) or more  such as (7 ½%) in the event of a second flareup in 2020 amid Covid-19 pandemic and bounce back of 5% or less (such as only 3% in the event of a second wave spillover) for 2021. Such global GDP performance would compare to close to 3 ½% over 2012/19 in entirety and around the 4 ½% bracket in years that had been experienced prior to the flaring of credit crisis in 2008. Productivity slowdowns have been a reality even before the credit crisis for still obscure reasons. Now amid the Covid-19 pandemic, the fracturing of global trade could depress them further.

The relevance is likely to be manifold for capital markets. Even with massive central bank intervention, liquidity and long term solvency sequences have yet to play out among countries, companies and individuals in these crises. Contrary to momentum alone, risk premiums in general in capital markets and valuation of equities in particular depend upon the level and sustainability of long term growth as well as its quality. Changes in composition have been raised as a reason for changes in the markets towards higher equity valuation.  Still, equity market swings of hundreds of points in the DJIA and large intraday swings have become common place around the world. They indicate a lack of conviction and a surfeit of momentum, based still on expectations of central bank intervention singularly overriding other aspects. Present valuations appear to be conflating expectations of bounce back momentum implicitly with return of sustainable growth levels akin to those of pre-2008.

If so, momentum activity in fixed income and equities would be justified including into the lowest quality as has recently taken place. In reality checkpoints, companies have been scouring the complete corporate financing spectrum from private placements to convertible issuance to plain vanilla offerings with more likely. They appear preparing for a less robust business environment. Result releases will emerge once more and are likely to be less forthcoming on potential and focused more on restructuring. Covid-19 pandemic driven change may be accelerating long term change into on-line activity for instance. Among the more vulnerable are likely to be those with direct consumer exposure on aspirational spending that was of particular focus in the last two decades.

Many theoretical models of economic activity do appear based primarily on the rational man cornerstone of neo-classical economic theory. In reality, behavioral economics displays many variances. Instead of a seamless interface between low interest rates on savings and consumer activity,  of relevance now in many demographics may be that minuscule rates could actually boost savings to buttress nest eggs. In Japan for instance in recent decades, low interest rates have also been accompanied by individual choosing to compensate for low rate returns by instead building up nest eggs accumulated for a rainy day. Such behavior is entirely logical among individuals fearing or having experienced hardship within their families. It currently has potential to expand globally. If so and as compared to the prolonged momentum fervor seen in markets and not least in the first part of Q2/2020, it would be contributory to a greater quality and value focus. Unlike recent aspirational decades, the consumer appears more fractiously challenged.  

We expect heightened volatility in capital markets. We espouse diversification that includes precious metals exposure and short duration cash. We favor focus on quality of delivery (including on debt management) across asset classes. For balance, we favor strong Financials, Healthcare and Info Tech for differential delivery but also Energy, Industrials, and Materials for recovery exposure. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.