In this week’s article, I wanted to take a slightly longer term view. Investing is forward looking, so at some point we need to look past the current maelstrom of economic and virus-related uncertainty, and look at the big picture.
Now the world will inevitably emerge from COVID-19, and as investors, we need to understand what that world may look like – so that we can invest accordingly.
As always, this article is written on 24 April 2020, and will not be updated. Updated thoughts are on Patron.
How long will COVID19 take to play out?
Not everyone is going to agree with me of course (and feel free to disagree in the comments below), but my current base case assumes that COVID19 will be with us for some time.
Why do I say this?
A couple of reasons:
The virus has traits that make it incredibly hard to be eradicated completely
There’s still a lot we don’t know about this virus, but preliminary reports so far indicate that:
- The virus is most contagious right before the onset of symptoms
- The virus has an ability to go dormant in a host and reemerge later
- Virus tests are not foolproof (there was a girl in China who tested negative multiple times and then went on to infect many others)
- Incubation period can potentially go up to 3 weeks (China has recently increased quarantine periods to 3 weeks for foreign returnees)
Not all these reports have been scientifically verified, but waiting for full confirmation in times like this are not wise. These are wartime conditions, and in war, you just take the best intelligence reports you have available, and you go with it.
And China has demonstrated that they are way ahead of the curve in this war, which is why we take the cue from China.
And the combination of traits above, mean that containing this virus, is going to be a real challenge. How do you contain a virus that is contagious when asymptomatic, can have incubation periods of up to 3 weeks, can go dormant and reemerge, and where testing is not foolproof?
You can, but the measures taken will be incredibly draconian, and the impact to the economy will be massive – like what we are seeing now.
The world is a big place
The world is a big place, with many places for the virus to hide. And for as long as one country in the world has a case of COVID19, there will always be a risk that the virus will return.
And not every country in the world is equally competent at handling this virus. Maybe the US/Europe can do it. What about the Middle East, Latam, or Africa?
And each country works on different timelines. In Q1 we had China, in Q2 we have Europe/US, and in Q3 we may have Emerging Markets struggling with COVID19. This kind of rolling lockdowns means that for the bulk of 2020, there will be some country in the world fighting COVID19.
Distrust between nations
Imagine you’re Spain, 6 months on. COVID19 is under control in your borders.
Do you then allow Italians to travel into your country freely, without quarantine restrictions? The Italians say that their COVID19 situation is under control, but do you trust them? Do you trust them given the traits that this virus has?
And if you trust Italy, what then about Russia? What about Indonesia?
Because of this, international travel looks tricky for the rest of 2020.
Only a treatment / vaccine will really make this go away
Long story short – I think reopening up after lockdowns will not be straightforward. More likely than not, some form of COVID19 restrictions and social distancing will be with us for much of 2020.
Certain world leaders like Merkel and Lee Hsien Loong also seem to follow this line of reasoning.
And COVID19 *probably* doesn’t go away for good until an effective treatment / vaccine is in place.
Based on what I’m hearing from the medical community – is that optimistically, it’s about 1 year away.
What will the world look like?
But let’s fast forward all that. Let’s just ahead 1 to 2 years, when the world finally brings COVID19 under control, and we emerge on the other side victorious.
What does that world look like?
And I think that world will look very different from the world that went into COVID19.
We’re still in the early days, so it’s probably a bit premature to be commenting on this. But this will be the key theme going forward, so I wanted to do a really early take on this topic, and we’ll revisit this and refine the vision again in the months to come.
We’ll split the discussion into 3 parts – Political, Economic, and Financial.
Politics
I think that the only parallel for the impact COVID19 will have on global politics is the 1930s Great Depression / World War II period.
The impact is just massive.
Many things will change, from the role of the state, the use of electronic surveillance, the rethinking of social welfare etc.
But the biggest impact to me, may come from the further rise of populism.
It’s early days, but if we keep going down this path that we’re on, the outcome is likely to be increased inequality. If you inject stimulus to buy Treasuries and Junk Bonds, it will be the rich that benefit more than the poor. It’s a time when the rich are applying for interest free business loans that do not need to be repaid, and the poor are struggling to find jobs in an Amazon warehouse to pay rent.
How will populism change the world?
If we look at the 1930s, populism and the whole left v right debate was a major driving force for Hitler’s rise to power, and we all know how that turned out. If populism has even a fraction of the impact this time around, the world will still look very different.
Economy
I just don’t think a V shaped recovery is realistic. In absolute terms, a V is very close to impossible for me.
What is more likely is an asymmetric V, or a U if you like.
So economic output will fall drastically, and then it will take a much longer period to recover to where it was pre-COVID19.
The simple reason here I think is that demand is not going to bounce back so quick. A lot of people are getting laid off, and a lot of small businesses are looking at bankruptcy or a drop in earnings. Even if you’re not laid off, all the virus and recession related fears will dampen your mood to spend.
Sure, once all this is over I’m still going out to a mall to have a meal, but will I really be spending as much as I was in December 2019?
A lot of people are still expecting that once this virus goes away, life goes back to normal. But again, I’m really not so sure about that.
I think that once this is over, we can then start to find out just how bad the underlying economic demand is.
Financial
The way I see it, there are 2 ways out of this crisis for the world (in economic terms).
We can either go with (1) the Austerity path, or (2) the inflation path.
The logic goes like this – imagine you are the US, and you have $20 trillion in debt. Your GDP is $20 trillion, but because of COVID19, there is a 10% drop in GDP to $18 trillion. Let’s say tax revenue is 10% of that. Your tax revenue used to be $2 trillion a year, but it has now dropped to $1.8 trillion because of the fall in GDP.
How do you repay all that debt?
Under the Austerity path, you will cut spending. Let’s say you used to spend $1 trillion of the tax revenue. You now cut that spending to $800 billion, to make up for the fall in tax revenue. This allows you to use the rest of the money to repay the debt.
This was that the EU tried to do to Greece a while back, and this never works. This is a deflationary path. If we go down this path, we will have another 1930s style great depression – and it will be so painful that governments eventually change their mind.
The other path is the inflation path.
Back to the example, you now decide to issue another $10 trillion in debt, and use it for spending in the economy. This creates inflation, so while the overall economic output stays at $1.8 billion, the value of that output in dollars now goes up to $4 trillion.
Companies are now happy because their earnings go up, and their debt amount stays the same.
This is the easy path out, and I suspect is the one the world will adopt.
The consequence of the inflation path? It’s the rise in public debt levels. In our example, the US government had to issue $10 trillion more debt. Extrapolate across the whole world, and we have the EU, Japan etc all issues new debt.
Unless they all do it at the same time (in which case relative impact matters), this *should* result in a rolling devaluation of global fiat currencies. So the Euro will drop against the USD, then the Yen, then the Yuan. And finally, the USD itself will drop against a real asset like gold.
What Portfolio do I want to have for the recovery phase?
I think the portfolio positioning for the recovery phase is the easy part. It’s a reflation trade, with a strong emphasis for positioning in an inflationary regime.
So light on bonds / cash, heavy on gold, commodities, high quality REITs, and equities with pricing power.
How do we get from here to there, is the tricky part.
How quickly do governments decide that they need to print copious amounts of money – and how do they fund it?
And I think the simple answer is that it depends on the country.
US has already done it, so they look to be ahead of the curve here. They have reserve currency status, so no matter how much USD they print, the rest of the world will still buy it.
The EU wants to do it, but they are constrained by politics. Japan has been doing it for 20 years, and they’re going to take it to hyperspace mode soon. China did it in 2008, but this time around they’re a lot more cautious. Singapore has already done it, but it remains to be seen if we will keep it up going forward.
The real tricky one though, is the Emerging Markets (EM). If you’re a country like Argentina or Brazil, you really can’t do that kind of fiscal stimulus without creating a big depreciation in local currency. If you thought the depreciation in the Brazilian Real was bad so far, wait till they decide to inject a massive fiscal stimulus via money printing. It’s the same dynamic that played out in the Weimar Republic in the 1920s that eventually fuelled Hitler’s rise to power, and I think there is a real possibility this could play out in certain EM nations the next few years.
What EM needs is an external country like US or China, or an external organization like the IMF to come in with foreign currency to save them. It’s the most logical outcome to me.
But who will save them, when will this money come in, and who will be saved, is the million dollar question.
The US under Trump is a lot more discerning about who it saves and who it doesn’t. China has its own problems too, so their money isn’t going to come so easily and without strings attached. And if you leave out the US and China, who else has the kind of financial firepower to save EM?
Long story short – I think that EM is going to be in for a rough ride short term.
Closing Thoughts
If I can sum up this entire article in one line, it will be this: Now is the time to be active investing.
Every asset class, and every geography, needs to be analysed separately. If you buy a stock in Indonesia, and a stock in US, you’re going to get very different returns.
The way I’m starting to see it these days – this is really the end of the global monetary regime as we know it. And not the one that started in the 1970s post Volcker.
I mean the one that started in 1944, towards the end of WWII when the allied nations came together at Bretton Woods and agreed on a new monetary framework for the entire world – with the USD at its center.
The paradigm shift that is coming will change just about everything in the world as we know it – from politics to economics to finance and trade.
This will create unbelievable dislocations in financial markets. If you get a call right, there’s going to be big money to be made.
My advice – stay nimble, stay open minded, and read lots of history. What going to happen in the next few years has no precedence in recent times. We need to go back to the 1970s, and we need to go back to the 1930s, to understand what is to come.
And for those who are keen – my personal investment portfolio and stock watch are available on Patron. This may give you further insights into how I’m positioning my own money.
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My only concern with QE is printing money alone is not going to solve the problem until the vaccine is available for cure. US now injecting money without real economic activity is going on which will further increase inflation without real jobs for people.. the period now until the vaccine available commercially for everyone is kind of unparalleled in history wherein we don’t really have much data to analyse the past pandemics
Yeah the demand and reopen is a tricky one. I suspect its going to be a lot more complex that what the stock market seems to be predicting.
I largely agree with your views. Partly what we have touched on last week. 🙂 I think we should look beyond 1930s though, back then the world wasn’t as connected.
One of the areas we can look at is to study existing global supply chains. I think this is going to restructure massively. EM should be the ones getting out of this last, and currently these countries are the ones producing for the developed world. So countries that have stabilized will look towards more regional cooperation.
Post covid, countries will also re examine their existing food security issues and healthcare system. So that’s another area that should open up potential opportunities.
Yeah really interesting point on global supply chains. Definitely one to look at.
Absolutely agreed on deglobalisation and regionalisation though. We’re already seeing signs of that in companies getting out of China, and even Singapore is looking at greater control over our supply lines. In a way it’s the opposite dynamic of what happened in the post 1930s era – which was protectionism in the early 30s, then removing them after WWII under the new world order.
Hi Financial Horse,
Very insightful sharing, as always. One fundamentally difference between 1930 and now would be that then Fed did not have the tool as the current Fed does, i.e. QE, because in the 1930s, the gold statement was in-place, which limited the firing power of the Fed. Had it been possible to introduce QE in the 1930, maybe the history as we know it would be a little different?
Stay healthy!
Haha the gold standard was removed in 1933, after which the Fed’s firepower became unlimited (like what it is now). Interestingly, the delinking of the gold standard in 1933 marked the bottom in prices for the great depression. An argument can be made that what the Feds and Govt did in early April was equivalent to what was done in 1933, marking the bottom in this COVID19 crisis.
Hi Financial Horse,
Insightful sharing, as always. One fundamentally difference between 1930 and now would be that then Fed did not have the tool as the current Fed does, i.e. QE, because in the 1930s, the gold statement was in-place, which limited the firing power of the Fed. Had it been possible to introduce QE in the 1930, maybe the history as we know it would be a little different?
Stay healthy!
Hi FH,
Thanks for the sharing. Would like to ask about the example of issuing another $10 trillion in debt, and use it for spending in the economy.
I get that spending drives up demand and creates inflation, but not quite sure what you meant by ‘value of the output in dollars now goes up to $4 trillion?’. Would also like to find out how you arrived at $4 trillion?