We believe three topics, one return related, one risk related, and one paradigm shift related, will be increasingly relevant in 2021.
Supply Disruption = Investment Opportunity
The stock market surge since late March 2020 has been relentless. The price charts of beneficiaries of increased online economic activity are breathtakingly vertical. Are there any undiscovered investment opportunities? We think so.
In many downtrodden industries, demand destruction has caused supply disruptions (see Supply Chain Pain). Unless downtrodden industries are on the road to extinction, companies with scale, strong balance sheets, and intangible capital, like a valuable brand, will survive. From a Porter’s Five Forces framework, weaker competitors will disappear, new market entrants will be unlikely, substitute products may not exist, and the companies may gain more influence with their own suppliers. Eventually, customer demand (the 5th force) will return and the surviving companies will prosper. Sysco, the food service company, comes to mind.
COVID-19 immunity, more likely…Credit Risk immunity, still unlikely
In November and December, we had a double whammy of good news: first, studies showed the mRNA technology based vaccines, one developed by Moderna and the other by the Pfizer / BioNTech partnership, were highly efficacious in treating COVID-19 and then the regulatory authorities approved the vaccines for widespread emergency use. Overall population immunity suddenly became a near term possibility.
If only there was a highly efficacious vaccine to solve the problem of deteriorating private sector and public sector finances globally. In the U.S., we remain concerned about the rising level of non-financial corporate debt relative to economic activity.
This graph illustrates the increase in non-financial corporate debt relative to Gross Domestic Product over the last several decades. The graph does not account for the spike in non-financial corporate debt in 2020.
Source: UNCTAD
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A common refrain is contagion risk is low due to the health of the U.S. commercial banking system. Unfortunately, much of the rest of the U.S. economy is not as healthy. The COVID-19 health crisis serves as a reminder shocks cannot be foreseen and limiting their transmission is difficult in complex systems with a high degree of global connectivity like our current global financial system (same is true with viruses). In addition, the global economy remains weak and banking systems in some European countries are still not well capitalized.
Another common refrain is monetary policy will be a “vaccine” for combating credit related shocks in the economy. But as interest rates have approached the zero bound in the U.S. and pierced it in some parts of the world, central bank monetary policy doses have become increasingly less effective at stimulating economic activity.
This charts shows negative yielding debt (essentially debt with negative interest rates) is approaching $18 trillion. Yes, $18 trillion.
The only “vaccine” left is fiscal policy. Will ongoing fiscal policies be efficacious in stimulating economic activity while allowing the corporate sector to gradually delever? Will they safely generate sustainable growth via improved incentives and productivity enhancements? Or will they be unsafe, either one-time misallocations of capital and ultimately deflationary in impact or excessive (via Modern Monetary Policy type interventions) and highly inflationary? The global historical track record of politicians “threading the needle” warrants caution and we remain on alert.
Cryptocurrencies…digital gold or the economic vaccine?
December saw a massive surge in the price of cryptocurrencies, in particular Bitcoin, which spiked over 50% in the month. Many well-known professional investors have jumped on the Bitcoin bandwagon as a hedge against the failure of monetary policy and fiscal policy. Monetary and fiscal policy represents centralization. To its adherents, Bitcoin represents decentralization and an associated boost to economic productivity.
To achieve the glory being accorded it, Bitcoin will, at minimum, have to satisfy the three conditions of a viable currency:
store of value
medium of exchange
unit of account
Bitcoin is well on its way to meeting the first condition, due to its scarcity, security, and low carrying cost. Whether it can meet the second and third conditions is to be determined. We will have more to say on this topic in future updates.