We have extensively commented on the economic and political situation in the United States. However, what about other regions? All investors should be globally diversified, so the situation in other parts of the world matters greatly for US investors. In this commentary we’ll start with Europe. We’ll discuss the Asia-Pacific region in due course.

It’s All about the Virus

As Larry Summers outlined in an interview recently, time should nowadays be measured not in calendar time units but in virus time units. In virus time, Europe was the second epicenter of the coronavirus pandemic after Asia. As of now, the new epicenter is the Americas with most parts of the continent being severely impacted. While it may seem like the worst of the virus outbreak is over in Europe, nobody can be certain. While the worst might be over from a narrow medical point of view, the economic impact has been severe and will be long-lasting even if we do not see a second wave of the virus. Of course, if a second wave is realized, then we will have to reassess our outlook.

Pre-Coronavirus Times

Even before the coronavirus, the European economy had been stagnating even though the European Central Bank (ECB) had implemented ultra-loose monetary policy. The European economy has been artificially propped up by irresponsible ECB policies since the financial crisis in 2008. Most of these policies are short-term in nature or purely cosmetic, such as, for example, the measures taken to prop up otherwise bankrupt European financial institutions by “embellishing” their balance sheets in various ways. In classic Italian tradition the former ECB President Mario Draghi has managed to sweep most of the fundamental problems with the European economy under the rug. Moreover, the European economy as well as its political system has been weakened by Brexit. While the impact of Brexit is likely to be much more severe for the United Kingdom than other European nations, it has been a disruptive force that can be felt in all of Europe. Conceptually, the idea of Brexit has some merit, its implementation, so far, has been somewhat disastrous. The fact that the task at hand has now been handed to someone who is often labelled a “European Trump” is extremely unlikely to help matters. Trumpian politics seems to revolve around carrying a big stick and using Twitter to insult anyone who offers constructive observations. Crudeness has replaced civility.

The advent of the Virus

Developments in Europe have been dominated by the coronavirus since the beginning of March. Italy was the first country to be affected and the virus has had devastating effects on both the people and the Italian economy. Despite the fact that the European Union exists on paper, most things of importance are still done on an individual country basis. In that spirit, we have seen almost no coordination on a Europe-wide level to address the virus. As a result, borders were closed, and different European countries adopted completely different policies to fight the virus. While some countries such as Germany and some Scandinavian countries (and notably Greece) started preparing for the pandemic in a timely manner, other countries, such as the UK, procrastinated all actions until the last moment and then muddled their way through. The results of these differing policies can now be seen very clearly.

The economic consequences, just four months after the crisis started, are devastating. Many companies have gone out of business. The unemployment rate has not skyrocketed yet because of furlough schemes that have been put in place, financed by public money. These furlough schemes, however, cannot continue for long because they are extremely expensive.  Economic uncertainty has increased exponentially and thus consumer spending has plummeted. In many areas, even though lockdown measures have been lifted, consumers have meaningfully reduced spending, presumably because they don’t know whether they will still have any reliable income in a few months’ time. Interestingly, European talking heads, like in the US, try to spew platitudes of recovery in an effort to alter the behavioural impact of the past several months. Who can believe them? What else are they going to state? They can’t state the truth as that would exacerbate the situation. Once free money is expended, then what? That’s when we’ll begin to observe the true economic consequences of the virus.

While some companies received emergency loans and subsidies that have kept them alive for now, these are short-term measures that are impossible to sustain in the longer term. The way the global economy works nowadays is that most industries are very competitive.  This means that if an entity has meaningfully reduced revenue as a result of health mandates (eg, social distancing), it will result in substantial losses. Reduced revenue is a very realistic prospect for many companies nowadays, such as airlines, restaurants, small business owners, etc. Most of these companies know that by continuing to operate, they lose money. If they are unable to address this dynamic through cost cutting (eliminate employees) they will go out of business. This cycle will take time but, in our opinion, it is inevitable despite fiscal profligacy.

European growth was anemic prior to the pandemic. It is difficult to believe that over the near and intermediate term the pandemic doesn’t severely dampen this low growth environment further. European exposure will need to be tactically selected in any well diversified portfolio.

Political Problems resulting from the Economic Crisis

As has been the case for decades, the stronger and more responsible countries in Europe (e.g. the northern countries) will have to bail out the other countries (e.g. the southern countries). The Mediterranean countries (with the possible and notable exception of Greece this time) will have to be bailed out again by other stronger economies. While the German government at the beginning categorically denied this basic fact, they have now already initiated an enormous transfer of wealth together with France. This further highlights the fact that the EU can only work as long as richer nations pay for the poorer ones. However, unlike their governments, people in richer nations are increasingly frustrated by this fact. They ask themselves, why as a German citizen with a comparatively high income, do I have to pay more than 50% tax on my income to support poorer European nations that have never acted responsibly and which have to be bailed out repeatedly? The consequence will be a shift to the right along the political spectrum. That has happened to some degree already but, in our opinion, it is likely to increase in the coming years. One problem with this shift to the right is that in many European countries the right is made up of primarily populist political parties. We already have populist governments in the UK, Italy, Hungary, Poland as well as a few others.  Populism is more about retaining power and very little about a disciplined ideology that voters can understand and depend on. Populists exploit a frustrated and desperate electorate. They generally aren’t leaders with a clear vision on how to make their country a better place for its citizens. Exploitation of anger is not a productive plan. However, the more ideologically disciplined parties have created this environment by refusing to adhere to any kind of principles. They deserve to be ousted. In the end, this political chaos will not lead to sound economic growth for a very long time. The EU as an experiment will end as it is a source of great angst across the populations of many countries. Populists will use its destruction as a rallying cry. It’s just a matter of time. Again, European exposures must be tactically managed within any investment strategies.

So, where do we stand?

While Europe, at least in the most optimistic scenario, might be over the worst of the coronavirus, the problems caused by the virus and those that came to the surface because of the virus are severe. The pandemic has exacerbated an already fragile EU structure. Some would argue that the timeline toward an inevitable end of the EU may have been accelerated by the pandemic. It is very hard to imagine a good outcome anytime soon, even if a coronavirus vaccine is found before by the end of the year. Many problems that have existed for a long time and which have now prominently resurfaced will haunt the European economy for the foreseeable future. Once the ECB has run out of productive policy ammunition to push up financial markets, investors will exit rapidly. Tactical exposures that properly account for risk and liquidity are the only sensible approach.

Corona Craze

The Global Corona Craze

Self-isolation lockups are now the new normal. It is amazing how much has changed in a few weeks. Brexit is no longer front-page news and the US-China trade war is now something far different. The only headline that seems to matter is COVID-19.

It has become clear that almost all countries in the world have been incredibly unprepared for the crisis, from both a medical point of view and an economic point of view. The vulnerability of major economies to undiversified supply chains is frightening. An addiction to cheap manufacturing has created this phenomenon. Sometimes there is only one or a handful of suppliers for certain goods or inputs to a production process. The face mask is the most obvious example. Undiversified supply chains worked well as long as there is no disruption but now during this crisis, those supply chains are easily broken leaving most of the world in a state of complete confusion. As we have written in other commentary, addressing this weakness will become major geopolitical and infrastructural issues for the foreseeable future.

Perhaps the timing of the coronavirus crisis was somewhat unforeseeable (although medical researchers would argue otherwise), it is extraordinary to see how unprepared major economies have been to disruption, medical or otherwise. Lassitude and self-preservational politics created a situation where essential goods and services relied on undiversified supply chains. This was evident to anyone with a bed cell and a pulse.  For many, it was obvious that there had to be domestic options that could be activated during emergencies. For example, vital food or medical supplies. Extremely short-sighted political and corporate decision making has prevented these backup solutions from materializing. Many vital services were stretched even during normal times, particularly the health sector in many countries, even in most of the wealthiest economies. Now during the crisis, the health sector is just completely collapsing. In the UK, doctors fear for their lives. I have several friends who are doctors and they made their last will over the past few weeks. They have very little protective equipment, sometimes they have to purchase or produce home-made face masks themselves. The UK was laughably ill prepared for this emergency. Just ask Boris how well prepared they were!

We see large differences here: some countries such as the UK and the US and, as usual, most Southern European countries, have reacted in a very dysfunctional manner that went from first denying that there was any crisis at all to then overreacting and already announcing school closures, etc. for many months ahead or even until the end of the year. It’s politics by pandemonium. They have no actionable information. It’s quite pathetic to watch. And we all suffer as a consequence.

Once again, in the COVID-19 crisis, the UK has become the laughingstock of the entire world. UK politicians, in their infinite wisdom, went from calling the virus just a minor flu that did not deserve much of their attention. They followed this with then accepting the untested theory of herd immunity (note we are convinced that they really had no idea what this even meant); then after that the implemented a complete lockdown where UK citizens have even been prohibited to use their own backyard! The British government then put social distancing on top of their priority list. Social distancing apparently applied to everyone except the political class who, by their obvious exceptionalism, must have been deemed to be immune to the virus judging by how the UK parliament functioned until recently. Below is a picture of the UK parliament taken on March 24th, well after store closures and social distancing measures had been put in place.

No wonder that over the last few weeks almost half of the UK cabinet has been either in self isolation or confirmed to be infected by the virus. In fact, prime minister Boris Johnson himself just narrowly escaped death in the intensive care unit of a London hospital where about 50% of patients in the same situation die. If he is incapable of learning from this experience the UK is doomed to failure!

Compare that with some more sensible countries like Singapore, Hong Kong, Germany and other Northern European countries. They all share an underinvestment into the health sector as well but have approached the crisis far more systematically. Curiously, below is how the German parliament looked like on the same day as the above UK photo, March 24th.

The Economic Aspects of COVID-19

To the economy.  Retail businesses are now mostly closed, unless they are able to deliver goods without any personal contact. Unemployment rates have skyrocketed or are about to skyrocket. Yet many governments are claiming that they are able to manage the crisis through generous government handouts and loans – the US government being the most profligate (it is an election year after all!). This must be welcome news to consumers and business owners. However, how are these unprecedented government handouts going to be financed? We have not even reached the peak of the medical crisis but governments have already committed several trillions (that’s 1012) of dollars. There will be lots of new debt and/or inflation and probably both. When do governments simply run out of resources? Has any elected leader studied economic history?  

In our view, even if the coronavirus crisis ended tomorrow, economic consequences will be severe. There is no way of getting away from that. Capital markets don’t seem to realize this at all and are still operating on wishful thinking. More depressingly, the current medical crisis is almost certain to last for another couple of months with the accompanying disastrous consequences for the economy. Despite those bleak prospects, the S&P 500 has already recovered almost 50% of the previous losses due to the crisis. To us, it looks like these movements have very little to do with reality and much more to do with cosmetic government measures and the story that Trump is trying to spin in order to insure his re-election. Market participants are only too happy to buy into any kind of potentially positive news because this is what they have been doing successfully over the last ten years. We believe that this time is different, possibly disastrously different. It is very possible that we are not heading into a recession but rather into a depression. It is self-fulfilling given the policies in place and their impact on human behaviour. Anyone who argues otherwise seems to be assuming that we will have a globally available vaccine that can be distributed effectively by the end of the year. That seems to be a hope and a prayer at this point and even still will not impact the damage done already. Risk remains very much our primary concern as we evaluate the capital market landscape.