RBC Dominion Securities Inc. Global Insight Daily May 8, 2020 Good morning all, Global markets moved up this week but for me the best news about the market’s behavior was not the solid gain but the relative calm. We did not see anything like the volatility of the past two months which has been good for the nerves of investors (and their investment advisors). Canadian markets were up over 2% while US markets were up almost 2%, held back a bit by Trump’s threats on Chinese trade. Europe was up 2% as they begin to emerge from their COVID 19 lockdown, while the Emerging markets bested them all, gaining almost 4%. Oil prices jumped dramatically, gaining over 25% although these gains were just as artificial as the drops in the last 2 weeks of April (they have less to do with Supply and Demand and more to do with options trading and short term issues). The global COVID data continues to suggest that the virus is plateauing as active cases have fallen in the EU, plateaued in North America but have picked up in South America and Russia. The narrative has incrementally shifted to the economy.
Transcript
RBC Dominion Securities Inc.
Global Insight Daily May 8, 2020
Good morning all,
Global markets moved up this week but for me the best news about the market’s
behavior was not the solid gain but the relative calm. We did not see anything like
the volatility of the past two months which has been good for the nerves of
investors (and their investment advisors). Canadian markets were up over 2%
while US markets were up almost 2%, held back a bit by Trump’s threats on
Chinese trade. Europe was up 2% as they begin to emerge from their COVID 19
lockdown, while the Emerging markets bested them all, gaining almost 4%. Oil
prices jumped dramatically, gaining over 25% although these gains were just as
artificial as the drops in the last 2 weeks of April (they have less to do with Supply
and Demand and more to do with options trading and short term issues). The
global COVID data continues to suggest that the virus is plateauing as active cases
have fallen in the EU, plateaued in North America but have picked up in South
America and Russia. The narrative has incrementally shifted to the economy.
The week started off on a somewhat sour note as the first ever virtual Berkshire
Hathaway AGM was parsed for tidbits of investment ideas from Warren Buffett
and there was not a lot to work with. Buffett was sanguine about the short term
outlook though very positive for the long term and offered more warnings about
what not to do than what to do. Below are some highlights:
‘Nothing can stop America’ – Sounding more like a Trump campaign
slogan, Buffett reminded everyone that despite the current challenges with
COVID 19, the US has been through much worse and will get through
COVID just fine. Adding to this, he stated something obvious for the long
term; stocks are the far better place to be than bonds.
Don’t buy airline stocks 2.0 – Buffett had quite famously poked fun at his
failed foray into airline stocks a few decades ago, telling all of us never to
make the mistake he made and then to my surprise he made a second foray
into airline stocks over the past couple of years. Well, the foray is now over
and the results were the same; Buffett sold all his airline stocks, taking
steep losses…the optics were bad on this but his total investment was very
small relative to BRK’s value.
No big investments made…so far – I was surprised to find out that he has
not tapped into any of the $125 billion in cash and has in fact raised more
cash (see above). Many so-called experts are extrapolating that this means
he does not see stocks as attractive but this is not what I take from this.
Buffett greatly prefers to buy companies outright and I suspect that since
the cash hoard is large enough to buy an elephant or two he is preferring to
keep his options open to a full acquisition rather than adding to his stock
portfolio. He made it clear that they are open to ideas and ready to buy,
however.
Don’t borrow to invest – it would be very tempting to do so right now with
record low interest rates and cheap’ish stocks but he advises against this as
the uncertainty of the pandemic is too great to take this chance.
US banks are much healthier, more able to endure this recession than they
were in 2008.
Pandemic impact still too hard to quantify – he said that certain sectors
such as travel, leisure and real estate will have significant impacts but he
was reluctant to get specific… change is something he avoids when
investing though.
As countries around the world prepare to re-open their economies, economists
are trying their best to estimate what this will look like. There is no precedent for
this which makes the range of opinions very wide and the reliability of any
particular opinion questionable. Morgan Stanley’s chief economist categorized the
economic contraction as sharper but shorter, an opinion I agree with. “While
global growth will trough at -7.5%Y in (the second quarter) on our estimates (far
below the -2.4%Y in the first quarter of 2009), global and Developed Markets
output will reach pre-recession levels in four and eight quarters, respectively, as
compared with six and fourteen quarters during the Great Financial Crisis… As
we move towards this gradual reopening in parts of the world outside China, we
have been closely observing developments in China to see how various sectors of
the economy are normalising and how this experience may inform our outlook
for the rest of the world … In China, the manufacturing, infrastructure and
construction sectors recovered relatively quickly. The manufacturing data is
back in expansionary territory, while steel and cement demand and property
sales are growing again in year-over-year terms, just ten weeks after the peak
in new cases … However, as the US and Europe are more consumption-based
economies, it is the experience of the Chinese consumer that is drawing the most
investor attention. Consumption in China is also showing signs of progress, but
the pace of recovery has varied across different segments, and the phased
relaxation of social distancing measures has dampened the overall pace to some
extent.”
This sort of precarious environment seems like the perfect time to start a trade
war, right? It is if you’re the president of the United States. This week Trump
made a number of overtures to remove global supply chains from China, while his
Secretary of State is accusing China of creating COVID in a lab. While Trump has
been planning to bring manufacturing back to the US for some time, the
administration is now pushing to accelerate the initiative amidst the economic
slowdown that stemmed from the coronavirus pandemic. “We’ve been working on
[reducing the reliance of our supply chains in China] over the last few years but
we are now turbo-charging that initiative,” the undersecretary for Economic
Growth, Energy and Environment, Keith Krach, stated. In particular, officials
noted that the government is looking into moving the production of goods
deemed “essential” outside of China. US Secretary of State Mike Pompeo said last
week that the government is working with Australia, India, Japan, New Zealand,
South Korea, and Vietnam to “move the global economy forward.” According to
United Nations data, China became the world’s top manufacturing country in
2010, surpassing the United States, and was responsible for 28% of output in
2018.
But by the end of the week it seems this was another Trump bluff as US and
Chinese negotiators pledged to implement the phase one trade deal (remember
when that mattered??). Chinese Vice Premier Liu He was invited to speak with US
Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin
Friday morning Beijing time. The call came after President Trump threatened to
“terminate” the trade deal if China failed to buy promised goods and services from
the US. China has agreed to purchase an additional $200 billion in US products
and services over two years compared with the amount in 2017 but analysts say
the pandemic has made it hard for Beijing to realize that goal… “both sides agreed
that good progress is being made on creating the governmental infrastructures
necessary to make the agreement a success. They also agreed that in spite of the
global health emergency, both countries fully expect to meet their obligations
under the agreement in a timely manner”.
This week I was surprised to see interest rates drop; normally when stocks move
up interest rates fall. By the end of the week a possible explanation surfaced.
There are a few experts, and a few fringe players, who are calling for The Fed to go
to negative interest rates. RBC Economics does not have negative rates in their
base case forecasts, either in the US or in Canada, and Stephen Poloz repeatedly
stated the BoC already have rates at their lower bound. It remains likely that the
Fed and the BoC will exhaust all other measures of tools they have in front of
them, before considering the venture of moving rates into negative. It is a path
well-trodden by other central banks without much success in Europe or Japan.
Sweden famously reversed course last December due to the negative implications
they believed it was having on the psychology of businesses and households.
Proponents of negative rates are suggesting that without them there will be
widespread bankruptcies and no inflation. The fear-mongering about widespread
bankruptcies is a little much (there will be some defaults but it will not be as bad
as the negative rate folks say). As for no inflation I question the ability of negative
interest rates to address this and, more importantly, I question why we should
even care.
Inflation was never much of a concern until the period from the mid-1960’s to the
early 1980’s. During that time inflation sky-rocketed and it was then that one of
the great dogma’s of economics was created; preventing inflation from getting too
high or too low (aka. deflation) is equally as important as having a good economy
and high employment. Moreover, this dogma suggests that extreme inflation or
deflation would lead to a bad economy. As such, for the past 40 years central
bankers have doggedly kept inflation in the 2% zone by adjusting interest rates
with equal regard to inflation and economic health. During this time, inflation in
and of itself has never presented a significant problem for the economy…certainly
not as much of a problem as a recession or unemployment has. No one would
argue that we should encourage a strong economy but it’s high time we question
the merits of fighting the inflation bogeyman. The data makes it very clear that
negative, or nearly negative, interest rates has not fixed the inflation problem (ask
Japan and Europe). As such, I think economists who are espousing negative rates
should pull their noses out of the textbooks and re-engage with the real world;
going to negative rates would have little benefit to the lay-person, would
encourage more debt and would make it very difficult to unwind…when borrowers
are accustomed to low rates and they go up just a bit it has an outsized negative
impact vis-à-vis a higher rate environment. Negative rates has never created
traditional inflation (ie. higher food prices, energy prices and higher wages). All it
has done is encourage more asset price inflation (the prices of investments go up).
This does not create sustainable economic improvement, it just fast forwards
future investment returns to today and widens the gap between the poor
(employees whose wages do not materially changes) and the wealthy (investors
whose value increases). I am not trying to make a moral argument about wealth
dispersion…we ALL need a broader foundation of economic benefit from these
policies for a recovery to be sustainable and negative interest rates would be just
plain stupid for all. So far economic policymakers have done a fabulous job of
providing assistance to mitigate the economic damage from COVID 19 but this
new idea would create long term problems that would be hard to fix. Fortunately,
I doubt it will happen but the continued belief that it might will have some short
term impact on the markets…that’s a whole other essay!
Have a great weekend,
Nick Milau, BBA (Fin), FMA, CIM, FCSI | Vice President & Director, Portfolio Manager and Financial Planner | Milau Private Wealth Management Group
