Note May 29,2020- Not Becalmed But Evolving:

Note May 29,2020- Not Becalmed But Evolving: Contrary to the sharp equity index and valuation upswings globally from March 2020 lows, we see pandemic health, economic and political issues as not becalmed but instead evolving. Human traumas do elicit initial ranged responses, including saying all is well. Full responses evolve over fullness of time. The long term ability to manage and solvency are yet to be assayed. Large equity index upward momentum and rapid equity sector rotation contrast with high CCC corporate bond yields and collectively the much larger fixed income, commodities and currency (FICCs) markets. In basically liquidity operations, trillions of dollars in stimulus have been assumed by governments and central banks. As in Japan post 1990 and globally post the 2008 credit debacle, issues now remain about the efficacy of zombie companies, solvency and longer term efficiency.

Valuation is not only a function of interest rates but also of growth prospects. Global and individual country economic contraction emerge. The impact of Covid-19 shutdowns only partially hit in late Q1/2020. Fuller impact is emerging in Q2/2020. The amplitude of recovery beyond is yet to be assessed. Compared to unfettered stimulus, a clear real time alternative was in southeast Asia, post the emerging countries crisis of the late 1990s. There, flexibility and robust restructuring made for renewal and more opportunity than alternate modalities elsewhere at the time.

Increased nationalism appears in the political response to the Covid-19 crisis and not just over personal protective equipment. Currently there exists increased domestic political fissure in many countries. Further of global impact, tensions between the U.S. and China appear now hardening even amid pandemic or perhaps because of it, as is classic between superpowers. Logistics patterns that developed over years have been tested and seem likely to change, perhaps with more government intervention. 

Much as evolved about and between strategically important financial institutions after the 2008 credit induced crisis, increased differentiation in strategically crucial enterprises could now flow from this pandemic induced crisis. Across capital market investments as compared to the momentum/fiscal/monetary largesse post the 2008 credit crisis and again now in reaction to pandemic, a quality of delivery slant is yet to fully evolve. Meantime amid extended valuation, volatility flareups remain likely. Portfolio diversification remains required.

During uncertainty on several issues before and now accentuated by pandemic since the start of 2020, many political developments have taken place that stoke nationalism and many more appear. Traditionally in an election year in the United States, voting intentions tend to gel between Memorial Day and Labor Day. It is likely to be true in 2020 as well. In an already fissured environment and especially so in the aftermath of interference allegations in 2016, stresses over voting have emerged. Racial tensions appear elevating. In addition and continuously since 2016, the U.S. administration has espoused being confrontational and unliterally dismantling of that which it sees as being unfair, from historical friends and rivals alike. It has encompassed trade, climate change, political and even military alliances all of which need global compromise. Its confrontational extension into many strictures in pandemic health and vis-à-vis China suggest a doubling down in such a strategy ahead of an election.

Amid slowing growth and global health pandemic, in its previously postponed National People’s Congress from May 21, 2020, China also appears to be signaling a hardening robustness. Perhaps due to long standing internal pressures for more improvements in its rural areas, China appears less reticent about its interests. It has signaled urgency in improving the quality of life of the poorest third of its population. As well and not least, a stronger global political stance appears from China, including about its border positions more in line with the reality as globally, China being the second largest economy. The risks seem building of increased confrontation between superpowers as they tussle over significance and perhaps dominance. The same can be said about Russia and of developments in the ever turmoiled LeVant.

Elsewhere and from Brazil to Britain, populism has run into the realities of handling the uncertainty of pandemic. Weaknesses were thrown up before when growth was stronger and appear accentuated now amid Covid-19 pandemic. There have been differentiations in leading by example as well as broadly in being able to be flexible and robust in response during crisis. Rhetoric has elevated but it currently counts for less. There appear no easy answers as seen from Sweden to India and in between. In Europe, talks appear at an impasse with Britain  on the mechanics of its exit from the European Union. Within the European Union itself, resentments include Italy seeing itself as slighted over refugee and pandemic management. Realistically, Italy as a G-7 nation has also been unable to politically move domestically with respect to chronic budgetary issues. It and Spain as well as others in eastern Europe need funding urgently but for years have been unable to be cohesive. Meanwhile in crafting a proposed EU funding mechanism that includes massive grants and budget, Germany has sidestepped its own constitutional court decisions. Reactions could flare in taxpayer resentment over seemingly unending largesse into the European Union. It has run into official resistance from other western European countries that have also been net contributors.

Continuation of current trends in weakening Renminbi and Euro exchange rates versus the U.S. dollar could also inflame political and trade tensions. On monetary and fiscal matters in Argentina, Brazil, Pakistan, South Africa, Turkey and Ukraine and elsewhere, several emerging economies appear under stress. It has been classical in prior cycles when interest rates were more elevated. Compared to a so-called V-Shape global economic recovery, several central banks, not least the Federal Reserve, have warned that the likelihood seems elevated of a more plodding recovery and hence to be unlike a repeat of the post 2008 credit crisis realities. Several umbrella organizations like the BIS and IMF have also documented the public and private, corporate and individual leverage risks currently existent in advanced and emerging countries alike. Currency volatility could become elevated with more risk in emerging countries but also among G-7 countries.

The focus of momentum has especially been prolonged and extended in equities and within the sovereign debt of major countries in response to central bank largesse and quantitative ease. Equities have engaged in sharp momentum recovery from the March 2020 lows. Swift sector rotation from growth to cyclicals to defensives has become common. Large even intraday index swings have also taken place. Salient in corporate discussions since March 2020 has been emphasis on the steepness of the drop in Q1/2020 results as has also been a marked reticence to engage in outlook expectations. Bankruptcies and the reaching for government assistance among large and small businesses have been acute, whether for guarantees or grants. In the much larger fixed income, commodities and currency (FICCs) markets and beyond, benchmark sovereign yields led lower by the Federal Reserve, the European Central Bank and the Bank of Japan in response to economic crisis. However, spreads between Italy and Germany and the overall levels of CCC corporate bond yields indicate continued pressures as do several individual emerging countries. Unlike the seemingly robust response upwards in equities in expecting becalming, we see more evolution as being likely.

Global and individual country economic contraction continues to emerge. The impact of Covid-19 shutdowns only partially hit in late Q1/2020. Fuller impact can e expected in Q2/2020. The amplitude of recovery beyond is yet to be assessed. Compared to unfettered stimulus, a clear real time alternative was in southeast Asia post the emerging countries crisis of the late 1990s. There, flexibility and robust restructuring made for renewal and more opportunity than alternate modalities elsewhere at the time. Even in the much commented upon Information Technology space where valuation has expanded on growth expectations supposedly less dependent on overall conditions, these alternatives are still evolving,.

The inverse of yields of CCC Corporate bonds would indicate a P/E in middle single digits and suggests ongoing acute pressures. It in turn illustrates a gap in expectations seemingly between sharply higher equity prices and fixed income. We underscore that valuation is not only a function of interest rates but also of growth prospects. Equity valuation in the S&P 500 as benchmark seems elevated to us, even if  it is partially due to the sharp increase in weightings of Information Technology. Aspects of momentum that appear in rapid rotation in equities between sectors and in pricing could also be indicative of latent nervousness. A parallel reality is that in basically emergency liquidity operations, trillions of dollars of assistance have had to be extended by governments. For large and small companies alike, solvency and the long term ability to manage is yet to be assayed.

Increased nationalism has become part of the political response to the Covid-19 crisis and not just with respect to shortages in personal protective equipment. Logistics patterns that developed over years have been tested and seem likely to change, perhaps with more government intervention.Much as evolved about and between strategically important financial institutions after the 2008 credit induced crisis, increased differentiation in strategically crucial enterprises could now flow from this pandemic induced crisis.We stress that market volatility remains likely and that portfolio diversification remains required. Across capital market investments as compared to the momentum/fiscal/monetary largesse of the post 2008 credit crisis and again now in reaction to the pandemic, a quality of delivery slant is yet to fully blossom. Meantime amid extended valuation, volatility flareups remain likely. 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.