Rodney Adler discusses the economic impact of Covid-19

After the 2007 – 2009 financial crisis, the structural problems and imbalances that were created by the financial collapse and recession were made much worse by policy mistakes. Governments, around the world, mostly postponed the crisis instead of dealing with it thereby making another crisis inevitable. That crisis has now arrived and by itself would have been a significant event, but it has also been supercharged by the economic consequences of dealing with the coronavirus.

This global unanticipated “Black Swan” event took the world by surprise. Borders closed, industries closed, businesses went into hibernation and will soon close and people had to stay at home. Looking at the facts before us today, it is my considered opinion that the various governments of the world will do everything humanly possible to buy their way out of current problems, especially as it is an election year in America and Trump’s only chance is that his constituency believe his rhetoric that next calendar year will be great and therefore he has to try to keep the economy from falling off a cliff.

I have seen the cycles. I was a young investment manager in 1987 when the market fell 25% in one day (Black Monday). My portfolio went from $1.4 billion to $900 million in the week of the crash. No one can prepare you for that. No one can appreciate, unless you have lived through it, that small market capitalised stocks gap down 20% or 30% because one shareholder needs to sell as they have their own pressing problems and they will do anything to sell a small number of shares to have money. The collateral damage to the company and the other shareholders is manifold. Simultaneously people sell good stocks at ridiculous prices because they can sell (meaning there is a market) and they need the money. It is not and was not a time for the fainthearted and it was definitely a lesson.

The GFC, like the stock market crash of 87, was another manifestation of the normal cyclical nature of the market and while the floods and fires are alarming, they too are part of a normal cycle although concerning, very concerning at any time. No longer can we look to history and previous trends to help us plan the future, we are in uncharted waters, we are playing a game with new rules. We are in a very new world and already we are describing certain aspects of society as the ”new normal”. The trend of working from home, social distancing and expected government aid are part of the new normal.

It is so clear that the cost and convenience of global supply chains has left countries and companies very vulnerable. For decades, the law of comparative advantage and therefore globalisation seemed correct and the right way to evolve, but when borders close and the airline industry virtually closes– it does not take any owner or senior manager to come to the realisation that they would prefer to pay a bit more but have access to an important variable cost in the same country. Never again will corporations and people allow themselves to be subjected to the tyranny of distance to save a few dollars. That paradigm transformation has taken place. That train has left the station.

The stock market is basically priced as if nothing has happened, the S&P 500 is within 8% of its all-time highs and the ASX 200 has not performed as well relatively but has significantly recovered from its lows. Why has the stock market effectively decoupled from the statistics that we are all reading? The market dropped significantly several months ago and has basically recovered yet simultaneously US unemployment is close to 15% and that may be a conservative figure and the consensus for 2020 GDP growth has moved from a positive paltry 2% to -10% and the earnings per share growth is also looking very unhealthy. In Australia, the federal budget deficit hit $40 billion at the end of April as a result of the response to the pandemic and that is just the start of a progression of worse figures coming down the pipeline(that we already know and anticipate).

I don’t want to discuss whether America is opening too early or not because it is a philosophical discussion on the price of human life versus economic prosperity. I readily accept that closing the world down has consequences both positive and negative but if the science is right, a second wave causing new lockdowns would be so much worse than just being strong for a couple more months.

Economic shock from the pandemic has created a ”substantive swatch of long-term unemployed people” that will become more visible and cause a larger hit to the economy as government support programs expire said David Gerstenhaber one of the so-called Tiger Cubs that worked under famous hedge fund manager Julian Robinson.

Ross Garnaut warns Australia is among the countries most exposed to a trade war and he predicts it will be a deep recession saying there is now “no chance” of avoiding a deep recession but ”we can work to ensure that the recession is as shallow and short as possible” the former adviser to Bob Hawke and Australian ambassador to China said. Mr Garnaut went on to say that our economy is relatively small in size and “dependence on exporting primary resources means we have more to gain than most other countries from open borders and international trade.

We also have more to lose from disruptions”. This is a bad time to fall out with China. Just look at our five biggest exports four of which have been particularly hard hit by the crisis. “There have been large falls in gas and coal prices, is a complex response to the reduced economic activity around the world, and these our two of our biggest exports.” There has been a huge, almost a cessation, of trade in travel orientated services dominated by education and tourism and exports of these services are far more important proportionately in Australia than any other developed countries”.

“The other point of vulnerability is all of this is happening at a time of troubles in Australia – China bilateral relations and troubles with our major trading partner” this will have a deep recessionary effect on the Australian economy, whatever the merits of the issues that have led us into this situation.

There are a number of global trends that need to be highlighted that indicates a depression is likely. The Covid-19 crisis has clearly shown us that the consequences of dealing with such a crisis can cause more wide-ranging economic damage than just a normal financial crisis previously experienced. This current pandemic is not a one-off, it is part of a series of pandemics – HIV, SARS, H1N1, MERS and of course Ebola. The severity of each one seems to get worse and worse and the search for a vaccine although widely discussed has not yet been found and a lot of the pandemics just mentioned have been with us for a considerable period of time and still, despite all the effort and medical support(and investment), no vaccine has been discovered for any of those diseases.

Deglobalisation– this pandemic is accelerating the trends towards balkanisation and fragmentation that had already commenced. It is clear that the two superpowers, China and the US are in the process of decoupling and of course China is making it very clear that any country that does not support it will not be considered friendly and will suffer economic damage in many different forms but definitely lack of buying of raw material and finished goods and of course the use of tariffs. The protectionist policies of various countries to protect domestic firms and jobs will continue and it does appear that the world will be defined by tighter restrictions on the movements of information, technology, capital, labour, goods and services. As difficult as that concept sounds today, we have already witnessed the start with various governments imposing export restrictions in the pharmaceutical and food sectors.

Whichever economic theory you subscribe to, the key in my opinion is the consumer. It is the consumer who purchases goods and services and it is small business sector that is the backbone of any economy because it is that sector that employs the greatest number of people. When people are at home and businesses close then you have an obvious drop in capacity and labour which places considerable pressure on commodities which is deflationary and needs to be considered.

As stated previously countries and companies will be very wary of supply chain shocks and will move to protect themselves from that situation happening again, this will obviously result in onshoring from previous low-cost geographic locations to higher domestic markets. However, companies will wish to mitigate that higher cost and will bring in technological developments such as robotics and artificial intelligence and anything to reduce the cost to the production line thereby causing higher unemployment and lower wages.

We have already seen a significant differential between “haves” and “have nots” emerging and it appears that the digital world will continue the trend and we will see a continued widening in the income and wealth gaps of society. There are considerable social and economic consequences to that statement.

Right now, investors have the choice of chasing expensive stocks that have had a pretty good run or cheap stocks that only appear cheap that may go bankrupt by the end of the year. Like the banks in Australia with their unreasonable (large combined percentage) influence on the market—Microsoft, Apple, Amazon, Alphabet, Facebook, Netflix and Tesla have a significant influence on the US market making the overall American index look strong, but truthfully the majority of shares have not made a reasonable retracement of this year’s losses.

Companies are restructuring their businesses at a rapid rate and this can primarily be defined as digitizing the business as much as possible and letting the rest go. We are absolutely in the digital age, be under no illusion, and this pandemic has allowed major companies to lower their staff and reduce costs in a way that was never expected or appreciated. All companies that make it through this next couple of years will make reasonable profits on much lower sales. What will be left after the meltdown will be very investable and probably very good value.

Looking at America as the capitalistic barometer of the future, housing starts collapsed by over 30% in April and yet prices aren’t really falling which does mean a lot of people are still looking to purchase a house or apartment utilising the very low long-term fixed-rate mortgage that is available. Existing home sales fell an incredible near 18% in April which is the largest one-month drop since 2010. Inventory dropped a staggering near 20% for the same month.

The unemployed in America is touching 40 million people. That means one out of four Americans is now unemployed which eerily matches statistics for the Great Depression. How is it possible that US deaths are over 100,000 people 20 times China’s fatality rate which is where the disease originated and yet China has four times the American population? It calls into doubt the Chinese figures, but also people will continue losing jobs until the death rate peaks. The genius of Frank Lowy is apparent when you understand that up to 60% of mall tenants aren’t paying rent with nearly $8 billion not being paid April alone.

China has effectively taken over Hong Kong and even though there is nothing that the world can do about it— it provides a great opportunity for Trump to send the 7th Fleet, even if just the presence alone manages to take the attention away from his current management of the country knowing that an election is just around the corner is reason enough to start to threaten and send a few hundred tweets which markets to his constituency.

But from Australia’s perspective it’s just another pressure that is not needed at this time. Trade and investment between Australia and Hong Kong is healthy. In 2018 –19 Hong Kong was Australia’s 10^th most important destination for merchandise exports at $8 billion and seventh largest services export market at $3 billion. Hong Kong was the fifth largest resource of total foreign investment. There are about 6000 Australian owned businesses in Hong Kong and its home to about 100,000 Australians. As tension rises, which is an inevitability, many must be preparing to relocate or return to Australia.

The President of the United States announced a number of retaliating measures against China as Beijing moves to introduce new national security legislation in Hong Kong. America will end the special trade status and suspend visas of Chinese graduate students suspected of conducting research on behalf of their government. Beijing responded by saying that America will pay a” heavy price” for their “reckless action”. For the purpose of this discussion, it does not matter who is right or wrong at this time other than to say that Australia will absolutely be caught in the crossfire and we will be collateral damage whatever path we take, whatever side we pick. The diplomacy needed now is more significant than ever.

I need to introduce the word chaos, at this time, if the above is not enough with the obvious overdue recession and then the black swan event of the pandemic, we have now witnessed a disgusting and totally unacceptable ”lynching in America”. We have all watched the killing of George Floyd on video, there was rioting in 20 states of America and despite the pandemic and the necessary social distancing practices hundreds of thousands of people all around America are coming together (and rightfully so) in disgust at what happened.

The curtain has fallen away that prejudice is still alive and cannot be allowed to continue. America is struggling on the global stage, is burning internally, is having cultural and economic issues and is in desperate need of leadership and direction. The November elections are just around the corner and assuming they happen, it may be considered one of the most important elections for several decades.

The old adage that we live in interesting times has now been replaced with, we now live in troubled concerning times where logic and common sense have been replaced by bravado, electioneering and an abandonment of fundamentals.

 

Author: Rodney Adler

https://rodneyadler.com.au

https://www.linkedin.com/in/rodneyadler/