Markets are upbeat at two prospects. First, a potential vaccine for COVID. Second, the Franco-German proposals for a €500bn recovery fund financed via EC borrowing and disbursed through grants to those countries most affected. Our top picks are less upbeat, however, with commentators remaining focused on the dire economic fallout from COVID and the widening inequalities it is causing. We feature an excellent note from Brookings on the disproportional impact of the lockdowns on low paid workers, and one from Project Syndicate looking at inequality driven by differences in fiscal space across countries.
On markets we feature BlackRock on opportunities in TIPS and a comparison between Bitcoin today and oil markets in the 19th century. Meanwhile on monetary policy this week, we feature the case for a continued rally in bonds and the prospects for higher inflation in the US while rising private savings are drawn down as restrictions are relaxed and the economy normalises.
Global COVID-19 Tracker In the DM world, both cases and deaths have very low increases today with no country registering increases larger than 1%.
The EM world sees slightly bigger numbers in both categories. On cases, we have Pakistan in today’s pole position with a 10% increase, which comes just after the Supreme Court ordered the government to lift some of the restrictions imposed on businesses…
US Election Tracker President Trump’s approval rating has bounced up again over the past week with the gradual reopening of the economy and the massive fiscal support acting in his favour. Renewed stock market gains likely helped too. For the November election, prediction markets continue to see Biden ahead…
(Bilal Hafeez | 19th May, 2020)
How Bitcoin may be the new Oil, and why BlackRock is bullish TIPS
Bitcoin Is “Right Where Oil Was in 1890” (Advisor Perspective, 4 min read) The recent “halving” of bitcoin (a decrease in circulation and issuance of new Bitcoins) will limit supplies. Its demand is like oil in the 19th century: no one knew its value before the emergence of automobiles. So in the future, more innovation and new application of cryptocurrency could cause a surge in demand.
Current opportunities in the TIPS market (BlackRock, 6 min read) According to BlackRock, the TIPS market is attractive for the following reasons: (i) “Liquidity deterioration has made the TIPS index cheaper”, (ii) the front end of the curve has overpriced disinflation, (iii) “TIPS provide targeted exposure to the expected real interest rate”. And without negative rates, nominals have less price appreciation potential relative to real rates.
Dud stock picks, bad industry bets, vast underperformance — it’s the end of the Warren Buffett era (Market Watch, 6 min read) From 9 March 2009, the last bear market low, through to 19 February 2020, Berkshire trailed popular S&P 500 index ETFs by more than 100 percentage points. So far in 2020, Berkshire stock has lost nearly 25%, significantly worse than peers.
A scenario under which COVID-19 maybe inflationary, and how the US is suffering from the ‘Japan Syndrome’
The 2020 US private saving boom: An unexpected result of COVID-19 (PIIE, 7 min read) Federal cash transfer during the crisis is projected to push the US net private saving rate to its highest since WWII. But that could mean that as restrictions on business and personal activities are relaxed in the coming months, aggregate demand will accelerate economic recovery and cause a temporary uptick in inflation.
Why Siegel Is Wrong About End Of Bond Bull Market (Advisor Perspective, 10 min read) Jeremy Siegel of Wharton, who sees rates rising in the US, is mistaken. The US is suffering from ‘Japan Syndrome’ (liquidity trap), where the current level of interest rate is “fairly valued” and represents the fundamentals of the economy (sluggish growth, low inflation, and low demand for capital).
Negative monetary policy rates and systemic banks’ risk-taking: evidence from the euro area securities register (ECB, 21-page read) Negative monetary policy rates in the euro area induce systemic banks to reach-for-yield as they do not pass negative rates to retail customers; they, in turn, invest more in risky securities and take higher risk in loans. The effects are stronger for less capitalised banks.
Inequality in global fiscal space, and how the FED is engaging in fiscal policy
Messages from “Fiscal Space” (Project Syndicate, 7 min read) “[Differences] in fiscal responses across countries can be explained by longstanding systemic inequalities in the global economy, in which developing countries must borrow in internationally accepted reserve currencies. As a result, they simply do not have the fiscal freedom enjoyed by countries that issue such currencies. That is why a new issue of the IMF reserve asset, Special Drawing Rights, has become such an urgent priority”.
Fed Is Doing Quasi-Fiscal Operations by Buying ETFs (Sounding Line, 2 min read) Mohamed El-Erian believes that via Special Purpose Vehicles, the Fed, who are now buying ETFs with credit default risk, have distorted the lines between monetary policy and fiscal action. They are potentially violating the 1913 Federal Act and creating dislocations in the markets.
Inequality Everywhere You Look (Wealth of Common Sense, 5 min read) The divide between rich and poor is broadening in all walks of life. Mega-cap companies like Disney raised $11bn on ultra-low levels of interest (1.7% to 3.8%), whereas SMEs have no funding at all. The bottom 25% of the income percentile are four times more likely to get the coronavirus relative to the wealthiest 25%. 85% of capital in the stock market belongs to just 10% of the population.
How non-oil commodity shocks are more detrimental, and a case for automation tax
Commodity Price Uncertainty as a Leading Indicator of Economic Activity (Essex Finance Centre, 23-page read) Uncertainty shocks in agricultural, energy and metals markets have a more long-lasting dampening effect on U.S. economic activity and its components when compared to the effect of oil price uncertainty shocks. Non-oil commodity shocks are also less likely to be used within central bank information set when making predictions on future economic activity.
Which jobs are most at risk because of COVID-19? (BROOKINGS, 6 min read) “COVID-19 induced labour market pain is disproportionately borne by young, poorly educated and poorly paid workers, and by regions that are already less well-off and characterised by a greater prevalence of temporary contracts. Through its employment effects, the lockdown is bound to increase inequality.”
Does the US Tax Code Favour Automation? (NBER, 43-page read) US taxes labour heavily and favours capital significantly. While labour is taxed at an effective rate between 25.5% and 33.5%, capital faces an effective tax rate of about 5% (down from 10% in the 2010s and 20% in the 1990s and early 2000s). Reducing labour taxes or combining lower capital taxes with automation taxes can increase US employment to an optimal level.
A case for how COVID-19 may ignite a food crisis, and how India’s Modi is moving away from China
Preventing a COVID-19 Food Crisis (Project Syndicate, 6 min read) It requires global policy coordination. Food-producing countries have resorted to food protectionism (export bans and quotas). This, accompanied by global stockpiling and shortages of animal feed, fertilisers, and pesticides (due to supply chain disruption), may drastically raise food prices and cause shortages. Mostly developing, but even some of the developed countries, are vulnerable to these food crises, which can cause social unrest and exacerbate income inequality.
Modi ramps up plan to reduce India’s dependence on China with new ‘self-reliant’ campaign (South China Morning Post, 7 min read) Modi is pushing a case for import substitution away from China and towards domestic production. Critics believe it is a political manoeuvre (a revival of the old ‘make in India campaign’) and that India neither has the fiscal space nor infrastructure to implement this successfully.
Macroeconomic eﬀects of ‘sudden stop’ episodes, and using investors’ psychology to predict asset return
Modelling the Global Effects of the COVID-19 Sudden Stop in Capital Flows (N.Y. Fed, 9 min read) Unusually fast outﬂows of dollar funding from emerging market economies (EMEs) leads to a contraction in their output, and local currency depreciation adversely impacts private-sector balance sheets with dollar debts. The ﬁnancial stresses in EMEs, in turn, can also spill back to the US economy, through both trade and ﬁnancial channels, and US GDP can fall up to 1.5%.
Prospect Theory and Stock Market Anomalies (NBER, 35-page read) A popular behavioural economic model can be used to predict 22 stock market anomalies ranging from value stock outperformance to post-earnings announcement drift and momentum effect.
Bullish Chinese equities, and how China is mobilising fiscal resources
Three reasons to like Chinese stocks (BlackRock, 4 min read) First, Chinese equities are exceptionally profitable, ranking highly on the return-on-invested-capital (ROIC) minus the weighted-average cost-of-capital (WACC) metric. Second, Chinese equity has cheaper valuation – 11x FY1 earnings for (Shanghai exchange). Third, its first-in-first-out (FIFO) virus exposure means that it is “the only place in the world where manufacturing surveys are positive”.
China’s Finance Minister Signals Rise in Deficit Cap (YicaiGlobal, 3 min read) China fiscal deficit to GDP ceiling appears to have increased from 3% to 3.5% this year. China is also expected to issue CNY1 tn ($140 bn) in corona bonds.
Spillover effects of ESG implementation, and how ESG will replace shareholder primacy
The Unintended Consequences of ESG Activism (Forbes, 6 min read) One of the largest asset managers is divesting from fossil fuel stocks from their active funds to adhere to ESG criteria. Due to their sheer size, this could significantly impact stock price and hence harm their own investors within their passive funds. Since a lot of these investors are pension funds, this poses a market risk and violates social responsibility.
COVID-19 and ESG: Prepare for the New Normal (Advisor Perspectives, 3 min read) Firms that solely focused on shareholder value were exposed during the pandemic. After this crisis, a firm’s ‘preparedness’ for the next crisis would be evaluated on their ESG practices and goals.
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