ECM Global Growth and Innovation Perspectives: June 2020 Quarterly Newsletter
by Grant Nader
Brief overview of Q2 2020
The past quarter saw record-breaking rallies in many global markets and proved a painful reminder for many that the economy and the stock market can deviate for long periods of time. Many a bull market has been born in an economic recession (and many a bull market has been helped along by Central Bank stimulus).
The massive global equity market rally has left many questioning the sustainability of the move, highlighting the growing risks of secondary waves of infections and renewed lockdowns.
The US markets have been the best performer along with bonds, certain commodities and gold, while the S&P finished June up 19.9% for the quarter, (the best quarter since 1998).
Domestically the benchmark Shareholder Weighted All Share Index finished the quarter up 24% (with the usual caveat “Naspers being a significant driver of the move”), and yet remains down 12.4% for the year.
One of the key questions we are asking – to what extent will lockdowns be re-introduced?
The fact is: there will be second waves of infections as economies reopen.
The fact is: we have had far deadlier viruses before but as some have pointed out, this is the first social media pandemic, and this has played a part in that reactions have been extreme. Yes, the virus is deadly but according to the CDC data (source: Realclearpolitics) over 80% of the deaths in the USA are people over 65 years old and most have pre-existing medical conditions. If the range is further expanded to include people over the age of 55, this grouping accounts for 93% of the deaths.
Below 55, the rate is currently only one death per 45 000 people. Every year, 647 000 Americans die of heart disease and the current US coronavirus death toll is 132 000.
While the global death toll is now over 500 000, it is highly unlikely there are full lockdown reversions as the economic cost is just too great and does not appear to be supported by the statistics.
The power of the human spirit – near misses, remote misses and covid’s lasting impact
In thinking about the long-term impact of covid-19 on the human psyche and behaviour we can perhaps look to history.
Canadian psychiatrist JT MacCurdy developed the theory of remote misses, a topic further explored by Malcom Gladwell in his book David and Goliath. In WW2 the German military expected the wholesale bombing of London to cause untold trauma, shock and panic among the citizens, leading to an inevitable capitulation and surrender as people flee in fear and emotional trauma. The British established psychiatric facilities on the outskirts of the city in anticipation of this self-same impact on the people from sustained bombing. History tells us this did not happen.
MacCurdy separated people subject to the London blitz into 3 groups. Those who died, the near miss survivors and the remote-miss survivors. The near misses were people so close to the blasts and destruction that they potentially lost limbs or were shell shocked and horrified by what they saw.
The remote-misses were further removed. They heard the sirens, the enemy planes, the explosions, but they escape unharmed. This escape from physical injury, harm and destruction resulted in many of these survivors building a sense of invulnerability, they became emboldened, sometimes excited and more resilient rather than fearful. The reason for this attitude is that they had been through the worst of times and survived. This group of survivors played a key role in reducing the overall effect of the Blitz on the psyche of greater population.
If we apply this to our situation today, Covid near misses will be those who themselves have been gravely ill or have lost a loved one. They will be devastated by the impact of the deadly virus and carry emotional scars. Perhaps questioning every reopening or fearful of every second wave. I would potentially add to this many of the older population who have been isolated for months in the near certainty that they will die if they catch the virus.
Covid remote-misses are the people who are essentially unaffected but have been close to the virus. They have been infected and recovered or had few to no symptoms. They might know people who have been infected even severely ill but who have survived. They will acknowledge the virus but be downplay the risks, they will be the first to restaurants and public gathering events. I imagine most of the younger generations may fall into this group. Currently this represents a vast chunk of the global population and assuming a vaccine arrives by early next year, the majority of the 8 billion people on the planet will either be unaffected or remote misses.
What does the economic data suggest about the recovery thus far?
Economies are reopening and there is no going back. Almost every economic measure has been improving since the March and April lows. The world has had the chance to prepare hospitals, ICUs etc but we cannot wait the pandemic out as the economic cost is too great. The sustainability of these improvements remains to be seen, but there are positive signs.
Global sentiment and production measures such as PMIs and consumer confidence have been improving sequentially in every major economy, as well they should after the near standstill in many places. It remains to be seen how long pre-crisis levels will take to be achieved.
China’s industrial sector has been leading the way out of the crisis. The industrial sector posted its first profit increase in 6 months which is a very positive sign and shows recovery momentum is building. While some of this can be attributed to some level of inventory restocking a sustained demand side recovery hangs in the balance.
The number of single-family houses in the US sold in May jumped 16.6% from April. The 676,000 number was 12.7% higher than the 600,000 houses sold in May 2019. Buying houses is a 20+ year decision and requires a good deal of confidence in your future and/or job security, so this is definitely a positive sign.
Sales of US durable goods increased 15.8% in May, admittedly off a very low base. However, much like housing, people tend to purchase durable goods when confidence is higher do to their more permanent nature and bigger cost, so this is also a positive sign!
The winners just keep on winning…What does the market tell us?
The fact is the leadership of the markets has been dominated by the technology heavyweights. The so called FAANGM (Facebook, Amazon, Apple, Netflix, Google and Microsoft) now accounts for close to 25% of the market capitalisation of the S&P 500. In addition, the super six also contribute an extra 2.4 pips to the forward PE multiple of the S&P 500.
New highs and all-time highs are not characteristics of bear markets. The Nasdaq is one of the only indices not to break is long term bullish trend during the March selloff. The fact that most of the new highs are being driven by technology stocks is not without reason. We have talked often about the covid-19 accelerated benefits to certain sectors and stocks. We fully expect a meaningful amount of this accelerated benefit to become a covid-19 endowment. That is, even in a post coronavirus world, many companies and industries will enjoy these benefits for years to come.
We cannot ignore the fact that these stocks have been such drivers of the market rally and this means they also pose a similar risk in the event that they sell-off.
Too many bears, too much money. The overall sentiment remains very bearisharound markets and the sustainability of the rally. Almost every market news site has bearish articles expressing concern that the rally has gone too far too quickly or is driven by only a handful of technology stocks or the second lockdown wave is coming etc. Something I have seen many times over the years: when the majority of people are underinvested or bearish and sitting on a lot of cash, and markets are facing a laundry list of worries, the next move is usually higher.
Prior to 2008, global central bank assets were in the region of $4 trillion. Currently this figure is around $26 trillion. This kind of liquidity sloshing around in the system can only be good for markets. What about inflation? The quantitative and fiscal stimulus globally could become a real threat once we tend towards full employment and rising wages and consumption demand. However, this is still a long way down the road given the severe global recession, and the developed world was flirting with deflation long before this crisis. Suffice to say that we do not believe inflation to be an imminent risk but this is an important topic for another day.
As for sovereign debt downgrades? How long can the US keep printing such vast sums of money? As long as people keep buying the dollar, this is the privilege of a reserve currency. The same applies to the quasi-reserves of the Euro, Yen, Pound and Renminbi. This will become an important topic at some point in the future.
The ongoing strength of the gold price could at least be partially explained by the issues above.
Global growth outlook, positioning
Excessively cheap money, historically low savings returns plus the safety net of Central Banks buying corporate debt and potentially equities as well. The natural functioning and corrective mechanisms of capital markets has been crowded out and capital is not necessarily being efficiently allocated. There are very few investments offering growth potential right now outside of equities, high yield debt and perhaps certain commodities.
This has been a key driver of the market rebound, coupled with the growing the wealth effect of rising markets and the recovery becomes something of a self-fulfilling prophecy. So yes, markets can keep going higher from here even subject to secondary waves of infections.
Profits will rebound more quickly than jobs as companies will be slow to hire with so much uncertainty around (this hiring trend so far evident in China).
The market dichotomy has never been clearer and more pronounced. Technological and business trends that were already in place have been accelerated. There are those stocks and sectors that are beneficiaries of this changing world and there are those who are not. Those who are not are still dependant on old world habits and technologies. While there is no doubt opportunity and value in both camps, we prefer to err on the side of those companies with genuine, long term secular growth prospects rather than those dependent on other factors such as recovering consumer habits. The leaders will keep on leading and the strongest of the survivors will get stronger.
The ECM Growth and Innovation Fund (GIF FUnd)
How have we performed given our positioning?
Coming into the quarter the ECM Growth and Innovation Fund (GIF) was positioned to benefit from pre-covid trends that we expected to be accelerated and from post-covid trends such as changing work and consumer behaviour. The Fund’s focus on technology and innovation in areas such as cloud-based technologies, healthtech, fintech, AI, and software services has served us well.
Many of the Fund holdings are beneficiaries of what we call covid endowment and the surging stock prices have been accompanied by surging revenue and earnings.
A raft of new technologies and innovations have been accelerated by and will continue materialise out of this pandemic and we see this as a significant opportunity for investment.
The Fund investments will remain in several core areas where we see a clear path of growth delivery through innovation, disruption, or trend acceleration:
- Biotechnology and healthcare technology (see the GIF fact of the month below)
- Fintech solutions (online payments, processing, funding, wallets and more)
- Robotics and 3D printing (collaborative and industrial, driven by de-globalisation)
- Cloud-based technologies (every form of work and social collaboration and related services)
- Online commerce and entertainment
On the political front: the initial showing of strong leadership in the face of the corona crisis has long since given way to a fractured and at time nonsensical approach to the grave matter of saving lives and preserving the economy. As infections inevitably explode (as they must) the economic damage will be exacerbated. The now fractured, crisis leadership does not bode well for the much-needed solidarity that is required to make tough economic choices.
On the economic front: SA seems set to endure one of the world’s most severe pandemic induced recessions of around -8%. Three factors have set the tone :
- SA underwent one of the most severe and prolonged lockdowns,
- the SA economy was already weak heading into the lockdown,
- the fiscal balance sheet was so weakened by 10 years of corruption that we have comparatively few tools with which to bail out the economy and ignite a recovery.
Our thoughts on the South African market outlook from here:
Global and cyclical winners that will benefit from the global stimulus and recovery:
- Demand for industrial commodities as global infrastructure and stimulus kicks in (the general miners)
- Luxury retail (Richemont)
- Paper and packaging such as Mondi (this will be further helped by the move online)
- Reopening of restaurants, food delivery and rise of dark kitchens (Bidcorp)
- Technology (its really only Naspers and Prosus but luckily for all South Africans, this captures some of the biggest technological megatrends playing out)
- Gold – a must have safe-haven
What about SA Inc?
We are not interested in bottom picking turnaround plays and deep value stocks. Given that SA economy is stagnant to shrinking, our focus is entirely on the best of breed in each sector.
By best of breed we mean those with the highest ranking on our ECM Innovation Scorecard and the balance sheet to survive this downturn. These companies will not only survive but will capture market share and grow relative to the peer group, even in a shrinking profit pool. We apply this philosophy to every economic sector (retail, property, financials and industrials) and every company.
Some of the biggest risks are still ahead
The obvious downside risk is a significant secondary wave of infections coupled with new and severe lockdowns and economies that sink rapidly back into recessions.
Another real risk we see on the horizon is market disruption as we move closer to US elections. The chance of dramatic posturing and renewed US-China tensions are high. Trade wars, coronavirus recriminations and sabre rattling are all on the table.
There are also upside risks: An earlier than expected vaccine. We continue to believe that the record focus of money, research and human energy coupled with the available technology will deliver a vaccine sooner rather than later.
The lack of earnings visibility for the next 6-12 months poses two-sided risk to the accuracy and reliability of valuations and market pricing. While the market has run hard and valuations have expanded. We are focused on areas where we see continued and sustainable earnings growth.
Did you know: Growth and Innovation fact of the month
The future of medicine: Converging technologies and innovations
Cancer is the second leading cause of death globally at 9.6 million people in 2018 (WHO). The global economic cost of cancer was $895 billion in 2008. The direct medical cost of cancer was $80 billion in 2015 in the US alone. This is an industry ripe for disruption and innovation.
Great leaps in innovation happen when more multiple technologies converge. We are on the verge of massive changes in healthcare as there is an intersection of cheap genome sequencing, gene editing techniques and precision medicine. Below we touch on some of these cutting-edge technologies.
Genome-sequencing: A genome consists of all the DNA contained in a cell’s nucleus. The first fully sequenced human genome was completed in 2003 after 13 years and took the form of the Human Genome Project. The total cost $2.7 billion. In 2007 it cost $1 million and now it costs as little as $300. This rate of improvement over the 20 years is significantly faster than Moore’s Law.
Chimeric Antigen Receptor (CAR) T cell therapy (CAR T): T cells are key players in our bodies adaptive immune system, from killing infected cells to activating other cells and regulating our immune responses. CAR T involves harvesting these T cells from cancer patients, re-engineering them to have a cancer fighting CAR antigen and transplanting the cells back into the patient to fight the cancer cells. To date there has been significant early success, mostly in treating blood cancers.
CRISPR-Cas9 is a genome editing technique discovered from the natural gene editing that takes place in bacteria. It is the cheapest and most efficient gene editing tool thus far. By adapting the genome editing system in bacteria, scientists can now accurately add or remove genetic materials in human DNA.
We believe that in the coming years, the combination of these technologies (along with AI) will change the outlook for single cell diseases forever.