In today’s Macro Briefing we focus on how the coronavirus pandemic is likely to transform the global economy. Last week, we previewed the most recent research from Barbara Gray at Pennock Idea Hub, and today we provide more details on her thesis that we are entering a new cyber age, outlining which sectors and companies are most likely to benefit and which are likely to get left behind. Meanwhile, as a follow up to a recent piece we featured on how investors should price intangible assets here, JPMorgan sets out its ideas on the subject and why need investors need to pay more attention to intangible assets, while Economic Perspectives and MI2 Partners lay out the potential for the return of inflationary pressure in the long and short term respectively. Elsewhere LC Macro Advisors explains the state of play as EU leaders continue to wrangle over a potential rescue package for the region.
Substantive's Top Themes - Best of the Broker Notes
1. European Council – it is not yet over
The latest note from LC Macro Advisors’ Lorenzo Codogno sets out the state of play as EU states continue to work towards agreeing a rescue package in the wake of the coronavirus pandemic. Differences remain over the overall size of the package, the split between grants and loans and the allocation of funding but he remains confident that a deal will eventually be struck. There is, according to Codogno, still some degree of scepticism about the European policy response in financial markets, however, and a timely implementation will be of the essence. He says both in terms of size and direction, the potential policy response from the EU is probably underestimated, however. Indeed, everything else being equal, European financing should help reduce the debt burden at the national level and, together with ECB asset purchases, contribute to a narrowing of European government bond spreads according to Codogno. More than the actual flows, however, he says it would be the strong message that the EU is again united in fighting the economic downturn that should trigger decisive price action in financial markets - but we are not yet there.
2. Inventory cycle and inflation
Strength in US economic data continues to surprise and the inventory cycle should continue to support the recovery narrative says Julian Brigden at MI2 Partners. Traditionally, the inventory and investment cycle used to rank side by side as the most aggressive drivers of swings in GDP, he says, but, courtesy of modern “just-in-time” inventory management, the sort of cyclical manufacturing volatility seen prior to the mid-‘80s is now largely a thing of the past. But that doesn’t mean that such cycles have completely disappeared, never to return, according to Brigden, who says this is especially true given current events, which have thrown a wrench into logistic supply chains and bottled up demand in a way that is anything but normal. Indeed, his models suggest this month’s ISM Manufacturing should rebound very sharply and could easily beat current expectations of 48.3. In turn, this potential mismatch between supply and demand raises the prospect of inflation, which is fast approaching an inflection point, says Brigden. In normal times, he would expect strong growth (or at least a sharp acceleration in growth as evidenced by PMIs) and the rising prospect of inflation to hurt fixed income, especially at the long end. However, he says with ambiguity surrounding how aggressive the Federal Reserve would be in suppressing the long end with de facto or explicit yield-curve control, he sees paying break-evens as the better trade.
3. Global inflation – a lone wolf
Long-term inflation risk looks to be seriously under-priced by the financial markets says Peter Warburton at Economic Perspectives. He believes this is no ordinary economic recovery and its inflationary dynamics will be distinctive, not least because of the gargantuan efforts of the authorities to prevent an economic catastrophe. Indeed, Warburton says neither economic models nor historical precedents are likely to be of much help: this episode is one of a kind. Rather than a sustained deflation or a destabilising lurch towards hyperinflation, a more credible alternative is stagflation, last endured in the 1970s as another shift in monetary regime was underway, he says. The extraordinary, albeit brief, contraction of the global economy has imparted an initially deflationary adjustment, notably via energy prices, but as the year wears on, the supply shocks and self-inflicted adjustments as companies and countries seek to reorganise supply chains, are likely to supplant demand effects and spark inflation, says Warburton. An inflationary surprise, he says, would be viewed with leniency by policymakers mindful of the massive financial adjustments that will be needed for wealth redistribution and debt reduction. As Warburton puts it: a successful financial repression will require a second act in which unanticipated inflation melts debt burdens and devalues future claims.
4. Equities: Revisiting value
JP Morgan’s Dubravko Lakos-Bujas has released a report focused on the growing importance of intangible assets and the implications for equity valuations. He says value’s sustained underperformance post-GFC, and especially over the last few years, has many questioning the validity of value investing, while some have even gone so far as to claim that value is dead. While value’s underperformance remains a conundrum, says Dubravko Lakos-Bujas ,it could, at least partially, be explained by the fact that coming up with the correct definition of value has become increasingly difficult, especially when using a broad based systematic approach for valuing the cross-section of stocks within a large universe. In the fastest growing segments of the global economy, he explains, intangible assets are becoming the main value generators for a majority of companies and industries, however, valuation of these assets within the existing accounting framework is complicated due to identification, recognition, measurement, validity and accuracy issues. To prevent a systematic valuation bias against companies with large internally generated intangibles it is important to properly treat and value these assets, says Dubravko Lakos-Bujas. Accordingly, he has enhance two common value factors - Price/Book and EV/EBITDA - by adjusting total assets to include key internally generated intangibles currently not recognised on the balance sheet. Construction of better value factors is not a quick panacea for the structural malaise that value faces, says Dubravko Lakos-Bujas, but nevertheless, there is significant room to improve and better capture the value risk premium by evaluating unrecognised intangibles.
5. The three ghosts haunting the new twilight zone economy
Barbara Gray is a leading expert on global industry disruption having published several books: “Secrets of the Amazon 2.0”, “Secrets of the Amazon” and “Ubernomics,” based on her extensive research. Instead of analysing companies in silos through a rear-view mirror, Barbara pieces together emerging structural disruption trends across industries, using her proprietary Value Pyramid strategic framework to identify new variables and angles to help investors better look at and value companies. The Value Pyramid illustrates how the value equation is changing for companies. Barbara has written extensively on how COVID-19 is disrupting multiple industries across the globe. ‘’The Survival Guide to the Ghost Town Economy” was published in April, while more recently she published ”The Virtual Life” which explores how some of these disruptive trends have started to manifest themselves as more and more business activities go virtual. Gray has just published her latest work ”The three ghosts haunting the new twilight economy, ” where she explains, although the dark months of the ghost town economy are behind us, dawn has not yet broken and in the twilight lurk the three ghosts arising from the coronavirus pandemic. These three ghosts are: Ghost of the Past – Ghost Ship (Economic Ghost): The Great Recession is back as the coronavirus is capsizing companies, big and small, and causing economic ruin for many who have lost their jobs or businesses. Ghost of the Present – Ghost Castle (Safety Ghost): Home has been our safe haven and as we re-enter the world, safety is the new risk factor. Ghost of the Future – Ghost Unicorn (Digital Ghost): The coronavirus pandemic is acting as a catalyst to fast-forward structural disruption to the inflection point. According to Gray, we are entering a new cyber age that will widen the distance between the “haves” and the “have-nots”, with the coronavirus having created a digital abyss, attacking companies stuck on the wrong side while the digital world is thriving. She describes a “future shock” in which the pandemic has effectively delivered two-year’s worth of digital transformation in just two months, highlighting the firms and sectors that are likely benefit. Certainly, says Gray, big tech is likely to get bigger and the changes to the economy are likely to be significant and long lasting. Describing how the home has emerged as the centre of society, she describes how that combined with the acceleration of the trend towards the digital economy is likely to affect everything from the healthcare sector - for example with the rise of tele-medicine- to retail, food supply, entertainment, travel and the auto sector. If you would like to learn more about Barbara’s analysis or organise an introductory call click below to contact Ed Pennock directly.