“Laidlaw Five” Podcast – Monday 4/13/20 .
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Yes, we managed to squeeze roughly 2 years-worth of expected stock market returns into 4 days with the S&P500’s +12.1% gain, but to be honest it is fair to say the market got by with a little help from the Fed. The $2.3 trillion program announced Thursday 4/9 came on the heels of another record-breaking weekly unemployment claims report of 6.6 million workers.
Note that including the Fed’s efforts, the major Western economies have to now put out relief programs totaling $8 trillion (9% of 2019 global GDP of $87 trillion). Clearly, a tide of liquidity is being unleashed globally in response to the COVID-19 Coronavirus (“COVID19”) pandemic.
In all this, it is becoming clear that perhaps a bottom has been seen for the stock market, barring an unforeseen failure of COVID19 containment measures.
2. On Thursday 4/9/20, The Federal Reserve unveiled emergency programs that could dole out more than $2 trillion in loans to businesses of all sizes, as well as to struggling city and state governments, in a bid to keep the economy afloat as it is ravaged by the COVID19 pandemic. Is this much Fed intervention good and is it needed or is there some “moral hazard” here as they now are buying low-grade debt?
When over 10% of the U.S. workforce has filed for unemployment benefits over the past 3 weeks, the time for contemplating niceties such as “moral hazard” is limited as the overriding goal for the Fed is to salvage as much of the U.S. economy as it can under the employment portion of its mandate. As such, the Fed is engaging in a “no holds barred” effort to address the COVID19 economic downturn, one that is likely to be protracted. The thinking within the Fed Open Market Committee (“FOMC”) was indicated over the weekend by Minneapolis Fed Governor Neel Kashkari commenting that without an effective therapy or a vaccine for COVID19, the U.S. economy could face 18 months of rolling shutdowns as the outbreak recedes and flares up again.
Moral hazard notwithstanding, markets are clearly encouraged by the Fed’s readiness to offer support that will extend into purchasing low-grade private sector and municipal debt. Some speculate that before all this is through the Fed may follow the path of the Bank of Japan to purchase equities directly. Strange times call for bold measures.
These developments have prompted investment firms, such as Laidlaw, to call that the bottom for the stock market has already been reached. Goldman Sachs has withdrawn its previous near-term S&P500 2,000 price target and put up a year-end 2020 S&P500 price objective of 3,000. Our Laidlaw target of 3,420 is more ambitious and will be subject to fine-tuning as more data becomes available over the upcoming 1Q20 corporate earnings season.
3. Relative to the 2020 election, this week with Senator Sanders officially suspending his campaign it appears that Former Vice President Biden is the presumptive Democratic nominee to run against President Trump in November. What might this portend relative to the economy, foreign affairs and the global standing of the U.S.?
While the current U.S. Administration was significantly involved in Russia and Saudi Arabia and other OPEC+ member countries reaching agreement over the weekend to reduce daily oil production by 9.7mm barrels (12% cut from 2019 daily global oil production of 80.6mm barrels), the fact remains that the current U.S. President is clearly a nationalist committed to moving our country away from the global leadership position it has held since 1945.
Although the U.S. Federal Reserve last week took significant action to bolster the U.S. economy and help stabilize global financial markets in the process, this week there are equally critical meetings of the IMF and The World Bank that aim to help stabilize the developing countries where the vast majority of the world population lives. The U.S. interest in having these meetings succeed lies not just in preserving markets for U.S. investment and export, but also in ensuring these regions do not become reservoirs of COVID19 infection and sources of even greater mass migration.
No one nation alone can protect itself in the face of a global pandemic such as COVID19. Going it alone is not an option. Working successfully with existing multilateral institutions and global partners requires a different mentality than the “zero-sum” approach that President Trump personifies.
That said, these times require a different leader. Former Vice President Biden has a demonstrated record of working effectively on a global scale. Known to many leaders across the world, Biden is the person who can provide the leadership expected from the United States. Biden will get the job done and get America on the road to rebuilding its economy. In contrast, Trump would preside only over a continuation of the COVID19 pandemic that his undoing of preceding administration’s prevention efforts brought upon the country.
4. As a follow-on to politics, let’s talk about investments that can be dramatically impacted by political events – commodities and more specifically, Oil and Gold. First, Oil. Last Thursday might have been one of the most important days for the energy markets in years, if not decades, with the OPEC+ meeting. It’s hard to believe that a few months ago we were worried the price of oil might exceed $75 per barrel and today we’re questioning if it could drop below $20. What’s your take on the OPEC situation and what could be expect?
As mentioned earlier, global oil production is on track for a -12% reduction from prior year levels. Whether this will be sufficient to return the price of oil to the U.S. shale-oil producer breakeven level of $45/barrel depends on the extent of the U.S. economy’s decline.
Recently, plans have been put forward to re-start the U.S. economy from its current state where 95% of the population is under “stay at home” orders. On balance, the plans indicate the economy will return to roughly 80% of its pre-COVID19 levels. Now, although that may sound encouraging, it still represents an economic collapse in line with The Great Depression.
Presume the U.S. experience would be matched by the rest of the world economy and quick math would tell you a -12% oil supply cut will be swamped by a -20% economic contraction. The markets are reflecting oil prices staying the $20-30/barrel range for now with WTI trading at $23, down from the $29 price spike on Friday 4/3 when OPEC+ discussions were getting underway.
5. Next as far as Gold, our Investment team at Laidlaw Asset Management has had a Gold allocation for some time and as a member of our Investment Policy Team you know we increased that recently. However, for every article written about the portfolio benefits of having an allocation to Gold there are two saying things like “gold is a barbaric relic that no longer holds the monetary qualities of the past. In a modern economic environment, paper currency is the money of choice” or “gold’s only benefit is the fact that it is a material that is used in jewelry.” With Gold being up 15% YTD thru last Thursday, does an allocation still make sense and if so why?
Like all investments, the price of gold reflects a carrying cost which is namely the interest rate charged to finance a position.
With interest rates declining dramatically worldwide, the cost of owning gold has fallen accordingly. Given the expected monetary relief over the next 18 months, interest rates are likely to remain low. So, this is one good reason for gold to appreciate in value. Second, there will be record levels of fiscal stimulus which over time may result in a return of inflation. Gold has historically been considered an inflation hedge.
That said, gold is up +14.7% so far in 2020 and likely to hold these levels, if not trend higher.
6. To bridge back to another of our “Laidlaw Five” themes, Healthcare. I read last week that according to Informa Pharma Intelligence, there are more than 140 experimental drug treatments and vaccines for the coronavirus in development world-wide, most in early stages, including 11 already in clinical trials. They went on to say that counting drugs approved for other diseases, there are 254 clinical trials testing treatments or vaccines for the virus, many spearheaded by universities and government research agencies, with hundreds more trials planned. In fact, researchers have squeezed timelines that usually total months into weeks or even days. I am assuming this massive response to COVID19 not only supports our investment thesis for healthcare but maybe offers some new segments for our listeners to consider?
The healthcare sector has been a greater area of focus for investors than even the Laidlaw Investment Committee had considered in December 2019. Dealing with the COVID19 pandemic requires testing, healthcare system capacity building (e.g. staffing, equipment, supplies), palliative measures and, eventually, curative vaccines.
As is well known, developing a vaccine is a process that will take time. Experimental therapies can be developed and put to test in 6-12 months, but to get to a proven, commercially available vaccine may take 18-24 months. That said, it is important to see what palliative measures are already commercially available that can serve to stabilize patients and thus reduce the burden on existing equipment (e.g. ventilators).
In this category, we are interested to see that Pfizer’s Viagra may prove effective in treating COVID19. A pilot study in China is testing the drug in COVID19 patients with breathing troubles who do not yet need mechanical breathing assistance. Like nitric oxide, Viagra, known generically as sildenafil, dilates blood vessels. As such, Viagra may help open the tiny vessels that draw oxygen from the lungs, allowing patients to overcome the respiratory distress that occurs in some cases of COVID19.
7. As we near the end of this week’s episode, let’s come back to overall markets and economy. Recently there has been a “parade of pundits” suggesting their thoughts or vision on the shape of the recovery. I have heard everything from a W, V, U, L, a Check Mark and this weekend Barron’s even referenced blips of an electrocardiogram or “EKG.” Can you offer some guidance on this “alphabet soup” and what your best guess is for the shape of the recovery.
In estimating the path of the U.S. economy’s recovery, the process of containing and eradicating COVID19 will bring a “start, stop” character to the economy as expected periodic outbreaks will lead to re-imposition of social distancing measures. Consequently, it is likely that “W” will end up the winner in this forecasting alphabet contest.
Meanwhile, in anticipation of COVID19, available capacity is likely to be cut significantly for businesses such as airlines and restaurants, moves for which there may not be a pricing benefit as demand is still suppressed. For example, Lufthansa has mothballed a substantial portion of its aircraft and stated that air traffic volumes may not recover to pre-COVID19 levels for 40 years.
Longer term, research on the economic impact of pandemics has shown that real rates of return are depressed for up to 40 years as demand is suppressed and input costs (e.g. wages) are moderately higher.
As part of developing a longer-term view, it is important for investors to consider that firms surviving the COVID19 crisis will have to master a business environment which sees the acceleration of three trends: 1) an energized adoption of new technologies, 2) a reconfiguration of global supply chains, and 3) the likely ascendance of well-connected oligopolies.
We will discuss these trends further in the weeks ahead.