Speaker 1 (00:02):
Hello, and welcome to Actively Speaking. I'm your host, Steve b Weiberg. Join us each episode as we discuss current issues concerning capital markets and portfolio management from the perspective of an active manager.
Speaker 2 (00:16):
Hello everybody. Uh, welcome to Actively speaking. This is, uh, the first broadcast in the age of Coronavirus here. Uh, we are of course, all observing the social distancing and working from home rules. So bear with us. Uh, we're recording this, uh, each of us in our homes, and hopefully this will go smoothly. Uh, my guest today is Kevin Heppner, who is Epic's Chief Global strategist, and we are going to talk about what else the, the ongoing coronavirus, uh, epidemic or pandemic. And we'll talk about first little, the scope of the epidemic or the pandemic and how we're measuring it. And then we'll turn to talk more about the economic impact and the market impact, which I think is, uh, something our listeners are, would be interested in. So, uh, welcome Kevin.
Speaker 3 (01:01):
Hmm. Thank you, Steve.
Speaker 2 (01:02):
So let's start by talking about how we are measuring the scope of the pandemic. And, uh, we know listeners will be listening to this over time, over the, the next few weeks after we've recorded this. So we're not gonna give you any kind of update on, uh, you know, gee, how many cases are there today? And in one particular location that's not particularly timely for listeners. Uh, so let's talk more about the broader issues with the challenges of measuring the scope of the pandemic and, uh, some of the data issues involved.
Speaker 3 (01:34):
Hmm, thanks, Steve. One thing a lot of people do is they just chart the overall number of confirmed cases for each country and eyeball the data and say, well, it seems to be getting, um, worse. It seems to be getting a little better. I think that's very challenging. So what we've done is focused on the change over the last three days in the number of confirmed cases, uh, in the cases of Hubba and China as well as South Korea. We've seen clear inflections in those series. So the, the change in the number of cases in the last three days, uh, in both cases they peaked about <inaudible> six or seven weeks after the outbreak started in those locations. And we think this could be an important metric for markets to focus on. So when things are no longer getting worse and hopefully are getting better.
Speaker 2 (02:27):
And, and are there, uh, any issues with reliability of data from some areas? I mean, some people believe that China is now under reporting new cases. What's your opinion on the reliability of the data?
Speaker 3 (02:40):
I think the data everywhere is quite unreliable. Certainly in the US where we're just ramping up testing capabilities over the last week in the US the number of cases has gone up by 250%, and I don't think it's a coincidence that the number of tests has gone up by, by 315%. So as we ramp up testing, we will ramp up the number of confirmed cases as well. That's true in a highly sophisticated economy like the US with a very developed healthcare system. And one should assume that in other places, China, Indians, so on as, as well as most places in Europe. Uh, there's a similar problem with testing. Uh, a second concern is there's just noise in the data as you'd get in any series. That's why we don't look at the change in the number of cases just in one day. But for example, we follow the data in Iran and Iran's one of the places worth a lot of cases so far in March, we've seen two false peaks in the Iranian data, and every day in the headlines of newspapers, they're making cases like this, oh, the number of deaths or cases in Spain or Italy is lower today relative to yesterday.
Speaker 3 (03:53):
Well, often that system blip, and the next day the number of cases goes back up. Uh, a third issue is the possibility of a second wave and looks like we might be seeing a second wave in South Korea. People are very concerned about a second wave in China. Um, during the Spanish flu global pandemic, there were, there were in fact three waves. So for example, if a country relaxes social distancing too early, and there still are people who, um, have the virus, then that could spread and would get a second wave and increase in the number of cases. So, um, we do look at the data carefully. I think the number of the metrics are important for how the economies and markets are going to to move forward, but one has to treat that the data in, in every, uh, region quite quite carefully.
Speaker 2 (04:46):
Okay. Yeah, you mentioned, uh, an important point I think in the testing issue, that in the US some of the growth in cases, it's not really that those cases are new, it's more that they were there, but we hadn't tested for them. And as the testing has become more widely available, we're certainly recognizing a lot more preexisting cases. Um, and that, that's another, I think, very important point under to keep in mind when you're interpreting the numbers you see in the headlines. And in particular when we talk about, uh, when you see the headlines, there's a lot of references to quote, you know, an exponential curve. It's rising on an exponential curve. And, uh, you've made the point that that's not really true. That, uh, you know, you hit a limit where if every, if everybody got it eventually, then clearly that there would be no new cases the next day. So what is, what do you think is the right way to describe what's happening?
Speaker 3 (05:31):
Yes, when we're doing, um, high school map, there's a lot of focus on exponential curves. In the real world, there is no such thing as an exponential curve. At some point, real limits always sagen, for example, with the coronavirus, at some point, the entire population will become infected and immune, and this thing will not be going up exponentially. So exponentially means the number of cases is going up and increasing rate every day or every three days or every week. At some point, there's the inflection in which still we have more people becoming infected, but the rate of increase starts to decline. When, when that happens, we move from the exponential part of the curve to what is referred to as the logistic part of the curve. So the slope is still upward, so we still have more cases, but the rate of increase is declining.
Speaker 3 (06:23):
And, and that's very important and, and a lot of the focus for markets is when, when is that going to happen? That inflection point, for example, in New York, it could be two to three weeks from now, but in lots of other places in the US where the number of cases just starting to ramp up, it could be four weeks, it could be as long as six weeks from now. So I think that point where we move from exponential to logistic growth is really important. That inflection point is crucial, but again, this is not gonna be something that's very easy to, to discern, uh, in the data and will vary a lot from place to place.
Speaker 2 (06:59):
Okay. Uh, let's turn to talking now about the, uh, economic and market impact of all of this. So let's start with question about what, uh, sectors of the economy have been hit the hardest so far, and are, and are likely to continue to be suffering?
Speaker 3 (07:15):
So for example, in the United States, the leisure and hospitality industry, broadly, it employs 15 million people. And, and certainly that industry is at the epicenter of, of the issues retailing. Um, and that's retailing, excluding groceries, pharmacies, gas, things like that. That's another 10 million. The transportation sector has about 8 million people. Other types of services that are affected another 8 million. So in total, that's 41 million jobs that are in danger. And say that one third of those jobs are lost, um, in the next couple weeks or the next couple of months, that alone would push unemployment rate up to 10%, which was the peak during the global financial crisis. Uh, other sectors will be impacted as well, but those are, are the key ones for which the economic impact is, is the strongest.
Speaker 2 (08:09):
Okay. And, uh, so let's now talk about what have the policy responses been or are like likely to be going forward, starting with the Fed? Uh, you know, they, couple weeks ago now cut, um, the, the overnight lending rate, but, you know, it seems like that's, that doesn't really seem like a, an appropriate response. It's not really a financial crisis. Uh, the way the crisis in 2008 was, uh, where, you know, somehow the cost of lending is, is what's making things difficult. That has nothing to do with it. It's literally people can't work. They're being told not to work. You know, was that an appropriate response? And what other tools is fed have? We'll start with the Fed demo alter to fiscal policy.
Speaker 3 (08:47):
So the Fed has done an enormous amount, in particular last Monday. Uh, they pulled out the, their playbook from 2008, so rates are at zero strong Ford guidance. QE four s really ramped up. In fact, it's ramped up more strongly than the, the previous three episodes of QE repos have been increased. The purchasing commercial paper, the liquidity facilities, they started during the gfc, they've reactivated all those. So the feds during an enormous amount already. There are a couple of problems with that. One is the Fed can't reopen factories that are shuttered by the quarantine, Monterey policy can't get shoppers back into the malls, can't get travelers back onto airplanes and so on. Um, so there is the concern, um, that they will be pushing on a string and particular there, there's a concern there. The same concern was 12 years ago, that if they have so much stimulus in the system, and if the supply side of the economy remains weak and demand does come roaring back at some point, maybe in q3, then we could start to see inflation. People were worried about that 12 years ago. Some people are starting to worry about that now. I think the probability of that is, is very low. Um, but ultimately the Fed will do a lot for the really economy, not much impact, but in terms of stabilizing the financial markets, particularly credit markets, uh, repo markets, CP and so on. Um, the markets that large investment grade corporations involved in the, the Fed will continue to be very active.
Speaker 2 (10:22):
And, uh, are, are we going to see some version of, uh, you know, modern monetary theory, uh, come out of this?
Speaker 3 (10:29):
Well, I think we already are and, and in fact we've been arguing for the last two years that we have been seeing, uh, a bit more polite version of mmt, for example, with the tax cuts we had two years ago. A lot of this has been effectively financed through the Fed and its QE program, the 2 trillion package that was announced last week, who's going to pay for the pandemic? Clearly, taxpayers aren't, they're not gonna do that in the recession, probably they won't pay for it ever. The bond market could pay, but I don't think we're gonna see enormous issuance in treasury securities because that would risk a dramatic rise in interest rate. So ultimately, um, the way this is gonna be paid is through the Fed via QE four, and, and the argument of MMT theorist is that's okay, provided inflation remains teed, our guess is inflation will remain teed. But mmt helicopter policies, um, there's always the law of unintended consequences. There's always the risk that inflation comes back. This is very new. All major central banks have signed onto mmt. It's just not the Fed, um, the e ECB Bank of England, b oj uh, even the Bank of Canada. So this is very widespread now. We, we are into a grand experiment, definitely uncharted territory.
Speaker 2 (11:50):
Let's turn to the fiscal side. Uh, you know, congress, uh, in the US passed a being labeled as a 2 trillion package, and I'm sure most people don't really know much about the details of what that entails. So you know, what's in that, how do, like, how do the, you know, the restaurant on the corner that had to shut down because they're not allowed to, you know, well, they told to shut down, you know, how do they get access to this money? Uh, seems like it's, you know, something that's targeted more. It's easy to see how the airlines get the money. You know, there's a few of them. They're big, but there's hundreds of thousands of little small businesses that need access to liquidity just to tie them over. How, how is this gonna work?
Speaker 3 (12:28):
And, and that is, um, our major concern is that small, medium sized businesses are the ones who are going to bear the brunt of the pain. Uh, a lot of the measures in the fiscal stimulus package, and also a lot of the monetary policy measures are to help funding and liquidity issues that are faced by investment grade large corporations. They're also a number of elements of the fiscal package, which directly help individuals, um, through direct payments, extensions of unemployment insurance and so forth. But the concern is small businesses, particular in the service sector that don't have a lot of cash, typically they have three to four weeks of cash, uh, businesses already plummeting for them. How will they do? And there isn't very much in terms of the types of programs and how the programs are delivered, that is likely to help the small businesses.
Speaker 3 (13:23):
And, and the concern is that if these businesses end up going into bankruptcy as a result and closing down, then, then when the smoke does clear and we start to have recovery, we're going to, these businesses aren't going to exist anymore. And so it's gonna be a very tepid recovery relative to what otherwise took place. So that is the big concern. The Fed is working particularly with the, the Small Business Administration. Um, the Treasury Secretary has said that they, they are focused on the issue getting the help to small medium enterprises, but it's very difficult to see exactly how that's going to work.
Speaker 2 (13:59):
Mm-hmm. <affirmative>, it's, it's worrisome. Uh, so, so we talked a little bit about both sort of what the fed's doing, what the Congress is doing on the fiscal side. What do you see as potential kind of unintended consequences or negative externalities in the economist language, uh, of these policies?
Speaker 3 (14:16):
Well, one, one is that because the Fed is making decisions that are inherently political, much like they did in 2008, I think the notion of Fed independence is, is definitely going to be watered down a second is there's a concern about inflation. Um, hopefully we won't have an inflation coming back, but we have had boats before of inflation, particularly after World War I, world War ii, with the opex shock in the seventies in which there were supply side disruptions or changes in the structure of the supply side. And afterwards, uh, inflation did come roaring back. I think a third concern will be that the Fed is presenting a fian bargain to corporations, also to households. The idea being it's encouraging them to load up on debt, have a minimum amount of cash with the idea that anytime we get into trouble, the fed's always gonna come in and bail you out.
Speaker 3 (15:11):
So the moral hazard issues involved with this are, are real. And certainly that's what we've seen since the start of the Greenspan era with the Greenspan put. The Feds always come into bail out companies bail out the economy when things fit rough. And since then we've seen, uh, a record level of corporate debt development. And this, this is dangerous. And I, I think finally with new approaches to policy like mmt with the notion that the government really doesn't have a budget constraint, that they can have as much debt as they want. There isn't a cost provided. Inflation remains kepted. This is a big dangerous experiment. The love unintended consequences, lots of things can go wrong that we're not thinking about. One hopes that people are thinking very carefully about this and the way things could go wrong, because there certainly are a lot of ways this could move pear shaped.
Speaker 2 (16:04):
Uh, let's talk a bit about the, the markets. Now, this has been certainly a, uh, sort of record setting speed bear market. We lost, uh, markets around the world, lost basically about a third of their value in, in just over a month or so. Uh, how does this compare to the impact of other crises we've seen in the past, like the financial crisis and, you know, uh, how has this played out in the markets compared to other crises in the past?
Speaker 3 (16:29):
If you look at the bear markets, say over the last 40 or 50 years, on average, it takes about nine months for the s and p 500 declined by 30%. In this case, it happened in about a month. So the pace was much faster. And in fact, really the, the only instance that was similar was probably 1987, um, that did not involve a recession involved a lot of technical things, portfolio insurance and crashes and options in futures markets, for example. But I think fundamentally it was different. And I don't think that's like to be the playbook. A second period that was similar was the period from September 26th, 2008, where Lehman went into bankruptcy. At that point, the s and p 500 declined dramatically similar to what we're seeing now, but my, my guess is the fundamentals in the economy, cuz that was really a financial shock. This is a really economy shock that neither of them are, are great analogs for how we should see markets moving going forward. Okay.
Speaker 2 (17:32):
So you talked about, you know, the risks that if some of these issue, a lot of these small businesses have to shut down, then when the all clear is given and we can all, you know, go about our lives mostly of the way we used to. Uh, it's not gonna be very helpful if all the restaurants are, are outta business. Uh, so what, what do you see happening? What sort of scenario do you see, uh, or, or potential scenarios do you see for the, the emerging out of this?
Speaker 3 (17:57):
Now? The, the scenario that most commentators are talking about is as a snap back scenario, which Q2 is very weak, but then we start to see the positive impacts of monitoring fiscal policy and we see an inflection point in the number of new infections. And then we get a V-shaped recovery. Economists love mean reversion. They love v-shaped recoveries to some extent. This, this goes back to Milton Friedman's plucking model of economic recoveries. That is, you, you pluck on a string, you pull it down, and then when you let go the string rebounds very quickly. And, and that's the model that's embedded, I think in most forecasts by economists. I think there's a lot of challenges with that. It requires an awful lot of things to go right and nothing to go wrong. A second scenario that some more bearish commentators have in mind is a stagnation scenario in which we, the market remains jittery for a long time.
Speaker 3 (18:54):
Investors, consumers remain jittery for a long time. Policy is not very effective and it ends up that investment employment are depressed for a long time. I think, I think that's extremely unlikely given that policy has been quite aggressive and by and large has been pretty well designed, a clear scenario. And, and the one that I think I have the most sympathy for is that we get a subdued pickup. So after Q2 we start to see improvements in employment investment and so forth, but it's relatively subdued because there's still a lot of dead out there. Um, there still will be a lot of infections, including new infections also in the us So people are going to be hesitant to go back to work, to go on the train, to get to work, to go shopping, to go for children to go back to school. So I think it will be, until we get testing ramped up to very high levels and then personal protection equipment, gloves, mask, and so on, widely used, I think it's gonna be very difficult for the economy to get the snap back that a lot of people have in mind. So I, I would put the highest probability on a subdued pickup scenario.
Speaker 2 (20:09):
And, uh, do you think there's likely to be differences in, in how this plays out, uh, in different parts of the world?
Speaker 3 (20:15):
Yes, uh, that's, that's certainly the case. For example, in Europe, the policy response is much weaker than we're seeing in the us The fiscal response is less than half what the US has implemented in the E C B, which is being reasonably aggressive, but much less so than the Fed. So there would be a lot less of a tail went from the fiscal side. Also, in Europe firms are much, and this is uh, the same in Japan as well. Firms are much less likely to lay off workers because of, um, legislative requirements and the culture in those local countries. So unemployment will look less bad, but ultimately it's going to be a major headwind for corporate corporate profitability. European corporate profit growth has led that in the US for at least the last 14 years, and my guess that continues to be the case. So some of the economic numbers in Europe might not look as weak as the us but corporate profitability will be much worse when we start to get the recovery much worse than the United States. And my guess is overall European markets continue to underperform US markets.
Speaker 2 (21:28):
You know, at Epic, one of the things we like to point out is about, you know, where does your return come from as an equity investor? And a, a big chunk of it historically has come from dividends and you just talked about the threats to corporate profitability are, are dividends, uh, under threat here.
Speaker 3 (21:44):
Certainly companies that have a lot of leverage, it's gonna be a big issue for them, but least experience from the global financier crisis is that dividends held up quite well over the last 40 years. Every time we've had a recession, we've seen the s and p 500 dividend yield spike up. And part of that is because prices came down so much. We've also seen the payout ratio of s and p 500 companies go up quite dramatically during 2008 and 2009, cash usage by corporate. So corporate's usage of cash on buybacks, dividends, m and a r and d, CapEx and so on. So cash usage in total declined by 16% N oh eight and a similar amount in oh nine. During that period, buybacks declined very significantly. For example, 46% in 2008, but in fact in oh eight dividends paid out, actually increased by 2% and then declined slightly in oh nine. Based on that one would think dividends will hold up relatively well. It's reasonable to expect the dividend payments overall go down a little bit, but the dividend payments hold up certainly better than buybacks and that dividend yields overall rise in this type of environment. But that's based on previous experiences and, um, my guess is that's a reasonable conclusion, but it might take a couple quarters to know that for sure.
Speaker 2 (23:09):
Okay. Let's, uh, let's wrap up with one last question. Uh, we're, we're all in a new world here. Uh, this is, uh, really an experience unlike anything any of us have ever been through. And we tend to fall back on certain metrics that we think are, have always been our, you know, g guideposts in the past, but we're probably in need of some new metrics, uh, in this situation. So what are you looking at? What do you think are gonna be the, uh, the best metrics for us to be following going forward? To give us some sense of where we are in this and when we're starting to come out of it?
Speaker 3 (23:42):
Typically, strategists and and portfolio managers look at things like PMI and ISMS to sort of, to get an idea of where the economy is. The problem is these indicators are very lag. Typically the leg is three to four weeks, sometimes longer, and sometimes there's noise in this data. But now with so many companies having digital business models and putting an awful lot of data onto, um, their websites, there's a lot of information now that we have to track how things are developing that we didn't have before. For example, OpenTable, um, has put on their websites all the data about bookings on their sites by city by date and also by country more or less in real time. So you can get a real sense of who's going out and eating in restaurants and how that's changing by city by day. And, uh, when things start to get better, we will look at that data, do people feel confident to go out, eat in restaurant and so on.
Speaker 3 (24:43):
I think that'll be a metric. There's a second company called Citi Mapper that has a mobility index and it looks at commuter activity relative to, to normal. And this is done for a host of cities in quite a few different countries. Right now, New York is about 8% relative to normal, and we can update this data daily to get a sense of when commuters think our commuters are comfortable going back to work. This is true in New York or London, Toronto and a host of cities. A third database that's useful. There's a company called homebase.com and this keeps track of payrolls, especially for, um, hourly employees and small businesses, and they provide data on hours worked. You can track that day by date. You can also track it in different industries and you can track it in different cities in the US and so on. And so for example, if we look at that, you can see that our worked is down about 87% for people in the beauty and personal care industry, but it's only down about 30% for people who work in home repairs. And so you can see sector by sector what the differences are, and then by updating the database day to day, you can see where we're seeing improvements by Citi and by industry. So I think instead of having to wait three weeks, four weeks, six weeks to get isms, pmmi, and this type of data, there'd be a lot of these new metrics that we can use to monitor almost in real time to see when green shoots are sprouting up and when we're moving into the recovery phase of the cycle.
Speaker 2 (26:25):
Okay, thanks. Well, of course you've now set yourself up, uh, to be a re return guest in a month or two months, so we can quiz you on those metrics and, and how they, how they're working. This has all been, uh, incredibly helpful and informative. Uh, thanks for joining me, Kevin.
Speaker 3 (26:40):
Uh, thanks very much Steve
Speaker 2 (26:41):
And, uh, to our listeners out there, uh, now that we have found a way to start, uh, doing these podcasts remotely again, hopefully you'll be hearing more from us, uh, shortly. And in the meantime, please stay safe, uh, obey all the, the social distancing working from home. Uh, do whatever you can to, uh, to flatten the curve and, and, uh, protect lives. And we hope, uh, that you are all in good health and we'll talk to you again soon.
Speaker 1 (27:09):
Remember to subscribe to actively speaking on Apple Podcast, Spotify, or Google Play. You can find all of our previous episodes and additional content on our website, www.eipny.com.
Speaker 4 (27:23):
The information contained in this podcast is distributed for informational purposes only, and should not be considered investment advice or recommendation of any particular security strategy or investment. Product. Information contained herein has been obtained from sources believed to be reliable but not guaranteed. The information contained in this podcast is accurate as of the date submitted, but is subject to change any performance information. Reference in this podcast represents past performance and is not indicative of future returns. Any projections, targets, or estimates in this podcast are forward-looking statements and are based on epic's research, analysis, and assumptions made by Epic. There can be no assurances that such projections, targets or estimates will occur and the actual results may materially be different. Other events which were not taken into account in formulating such projections, targets or estimates may occur and may significantly affect the returned or performance of any accounts and or funds managed by Epic. To the extent this podcast contains information about specific companies or securities, including whether they are profitable or not, they are being provided as a means of illustrating our investment thesis. Past references to specific companies or securities are not a complete list of securities selected for clients and not all securities selected for clients in the past year were profitable.
Speaker 5 (28:51):
Stop audio.
