Month: May 2020

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Reasons

So what happened…I think its clear to every one that we are in the middle of a pandemic with a new virus, one that we do not know much about and are just discovering its structure, understanding its impact on the human body and figuring out its R₀  (reproduction number i.e. average number of people who will contract a contagious disease from one person with that disease) and its mortality rate (how deadly is the virus). The R₀ appears to be higher (5.7 per some studies) than the early estimates of 2-3.

As if this wasn’t enough of a challenge, we already had a trade war with China with retaliatory tariffs on both sides and then came the ugly spat between Russia and Saudi Arabia which led to a plunge in the global oil prices and some challenges with an ETF (USO) caused oil prices to go negative for a few days when all storage capacity for oil was full and no one was ready to take delivery from oil producers and refiners.

As a result of the pandemic (and related geo political conditions) , in the US we have lost 36.5M jobs the past 8 weeks and the unemployment rate has skyrocketed from 3.5% to 14.7% last month. But there were other reasons, why this crisis hit us so hard. In addition to the demand and the supply shocks that came from this pandemic we had ongoing geo political strains and trade wars; our classic response was to lock down to flatten the curve to not max out our hospital capacity. So it was going to be bad, but it feels worse given a number of stresses that had already been built up in our society:

• Inequity & Inequality: While globalization delivered on overall growth and in aggregate seemed to raise all boats, it wasn’t able to address inequity and inequality within individual countries and in a crisis it appears that more of the suffering and pain is experienced by the poor. Having very meager reserves and sudden loss of employment is not easy to deal with in a global pandemic resulting in food scarcity. There is also a very different death rate experienced by communities of color as compared to others. One way to understand why the lack of reserves matters so much during a pandemic, is the lack of buying power prevents an individual to adjust to the availability of items especially during a breakdown in the food and essential items supply chain. Think about this – a person who buys toilet paper for his/her needs every week, given the break in supply chain they may not find TP on their weekly trip to the store. Without reserves it is very hard to stock up on essentials when the tradeoff is food/healthcare or other necessities…
• Lack of a safety net: Mostly in the US, not having a health safety net and universal health coverage has prevented a number of people and illegal immigrants from either being able to avail testing or treatment. In a global pandemic its important to identify and isolate not just look at the ability to pay for healthcare or legal status of the individual. While congress enacted free testing and treatment, it was a little too late and did not universally cover everyone.
• Unbridgeable ideological fault lines: We have become so ideologically fractured that we cannot even objectively evaluate one another’s arguments as can be seen by one side arguing for closing longer till certain metrics are met while the other side arguing for lifting all shelter in place restrictions in the name of liberty and damage to the economy. At this time, we cannot even have a rational conversation on immigration, guns or abortion. Given this deep divide neither side is willing to accept the other’s arguments on good faith and therefore we do not have a unified response or a coherent public policy. And a dysfunctional federal government has not helped during this pandemic.
• Climate change impacts: We are all aware of the massive climate change impacts on our eco system, whether it be in the form of droughts, forest fires, rising seas, or the excess energy in the atmosphere and thus more violent and destructive storms. All of this will result in mass migrations of both humans and animals. These massive disruptions, given our tendency of looking inwards by closing borders and ignoring our neighbors does not bode well for our future.
• State and local government financial predicament: With their finances already under strain from pension obligations and past mismanagement, the covid-19 crisis has been an incredible strain on local governments who have had to deal with much larger commitment towards first responders, cover testing, support for medical facilities, contact tracing and work on identifying and isolating patients to prevent spread. With a larger opposition from republican majority leader on bailing out state and local governments, it is not clear how much support they can get from the federal government, and without the ability to print money this is a crisis just waiting to unravel.

Response

Most governments have had a multi pronged response to the crisis:

• Health/Medical – The primary focus at the moment has been to manage the most severe symptoms from the disease and provide life support in patients under critical condition. This includes ventilator support once a patient’s lungs have been inflamed to a point where they are unable to exchange oxygen to support respiration needed for bodily functions. The focus has been on flattening the curve i.e. to slow down the infection rate so that the number of severely affected and critical patients does not exceed the local area hospital capacity, the ICU units and ventilators. In parallel there are efforts underway to discover both a vaccine and an effective cure or treatment for the disease. The human body’s immune system goes into overdrive and attacks the virus. In many cases, it may be this reaction that is fatal for the patient rather than the original infection. Remsidivir seems to be a promising treatment, although it only weakens the body’s immune system when attacking the virus – so not a real treatment to the disease but a remedy to one of our body’s critical response from the infection. Again we do not know much about how this works or the other impacts that the virus has on us. We have had reports of blood clots and arterial infection in kids similar to Kawasaki disease even when they haven’t exhibited any symptoms from the infection. The hardest part in controlling the infection in the population is that people who are infected and may not be exhibiting symptoms may still be passing on the infection to others. Hence the necessity of antibody test to determine if you have been infected. There also isn’t consensus on whether the antibodies produced from an infection results in immunity against the disease in the future.
• State/Immigration/Domestic Policy response – While I have mostly followed the government policy in the US, most countries have behaved similarly – closing borders, escalating trade tensions, a hardened response to immigration whether it be towards limiting net new immigration, or excluding immigrants from any fiscal policy responses that they have come up with. This absolutely does not help since infection in the immigrant community still causes the same kind of death, devastation and further infection potential as it would in the native population. There has also been a very stiff competition for acquiring medical equipment like ventilators, ppe and other testing supplies including a number of shady and unscrupulous players who have taken advantage of the desperate nature of the crisis.
• Fiscal Policy: I can describe the fiscal response in the US. Most other countries have enacted similar policies of fiscal stimulus, employment support and fiscal support in the form of loans or grants to small and medium scale businesses. The US congress initially started with $8.3 B funding for the public health agencies. It was followed up by a Family First Corona Virus Response Act for $192B. Next came the CARES Act costing about $2 T, followed by PPP- II for $483 B. Congress has passed another $3T package in unemployment support, fiscal help to families, state and local governments and other tax cuts. Not sure if this makes it all the way through (given the opposition in the senate and from the white house), although if the crisis worsens, a lot more people may come around to it.
  
• Monetary Policy (Items listed are Fed actions from before April 30, 2020): There has been a wide range of actions from the Fed towards a Monetary policy response. It started with the Fed reducing the Fed funds rate from 1.5% to almost 0 along with the guidance for rates to be low as long as necessary. The treasuries and mortgage backed securities that had become dysfunctional since the outbreak were supported by the Fed to the tune of $500 B in treasuries, and $200B in government guaranteed mortgage backed securities. On March 23rd the Fed increased its commitment to open ended support. Also extended support to include commercial mortgage backed securities, treasury securities and agency mortgage backed securities. The Fed next started the PDCF (Primary Dealer Credit Facility) for very low interest rate (0.25%) loans up to 90 days to 24 large financial institutions known as primary dealers. Next came the MMLF (Money Market Mutual Fund Lending Facility) lending to banks against collateral they purchase from primary money market funds. The Fed followed this up with Money Market Support with repo operations to funnel cash to money markets. The Fed then started direct lending to Banks, lowered the rate it charges banks for loans from its discount window from 1.75% to 0.25%. This was followed up by relaxing regulatory requirements to encourage dipping into regulatory capital and liquidity buffer so that they can increase lending during the downturn. PMCCF (Primary Market Corporate Credit Facility) is a program for direct lending to corporate employers by buying new bond issuance sand providing loans. Borrowers may defer interest and principal payments for at least 6 months to have the cash to pay employees and suppliers. SMCCF (Secondary Market Corporate Credit Facility) is used by the Fed to buy existing corporate bonds as well as exchange traded funds investing in investment-grade corporate bonds. With the CPFF (Commercial Paper Funding Facility) the Fed buys commercial paper, essentially lending directly to corporations for upto 3 months at a rate between 1-2% points higher than overnight lending rates. SMB loans are the Fed’s main street lending program, announced on April 9th and expands on April 30th, aims to support businesses too large for the small business Administration’s Paycheck Protection Program (PPP) and too small for the Fed’s two corporate credit cavities through new loans facility, expanded loans facility and priority loans facility for up to $600B in four year loans. For households & consumers the Term Asset-Backed Securities Loan Facility (TALF) helps support student loans, auto loans, credit card loans and loans guaranteed by the SBA. The Fed is also lending to the state and local governments through the Municipal Liquidity Facility created on April 9 and extended on April 27th. For Muni bond support, the Fed is also using two of its credit facilities to backstop munis. It expanded the eligible collateral for the MMLF to include highly rated municipal debt with maturities of up to 12 months, and also included municipal variable-rate demand notes. In addition for International Swap Lines, the Fed is making U.S. dollars available to other central banks, so they can lend to banks that need them. The Fed gets foreign currencies in exchange, and charges interest on the swaps. The Fed also is offering dollars to central banks that don’t have an established swap line through a new repo facility called FIMA (for “foreign and international monetary authorities”). The Fed will make overnight dollar loans to the central banks, taking U.S. Treasury debt as collateral. Finally, the Fed is also putting $2.3 trillion in lending on its balance sheet to support households, employers, financial markets, and state and local governments

• It appears that the executive, legislative and the monetary policy arms of the US government is literally throwing the kitchen sink at the problem to figure out what sticks. Eventually what will be needed is a full monetization of the fiscal deficit, if we are to move past this crisis.

Predictions

For the Economy:

• V-Shaped Recovery: A V-shaped recovery is a sharp downturn and then a very quick recovery. It is possible when structurally there is no problems with the economy or the markets and right after the pandemic is over, things get back to normal. It is hard to make this case at this point of time given that there will be lingering doubts about a second wave, or we would be muddling through with cases without a clear end. Also a vaccine or treatment is at least a year away, so the case for a V-shaped recovery appears implausible.
• U-Shaped Recovery – This is the case where there is a prolonged downturn, but after the crisis is over – things come back to the state it was before the crisis. This is also hard to argue for because a 15% unemployment for even a few months is a hard knock to recover from, given the average saved emergency fund for an American is not even $400. So a longer downturn means more bankruptcies, more food and housing insecurity and therefore not an easy path back to normalcy. Also given that we have had a business cycle boom for the last 10 years, a recession is overdue.
• I or L Shaped Recovery: This implies a sharp drop and the economy muddling through at the bottom. At this point this seems likely, given the incoherent policy from the federal government. Although the one contrarian point here is the unprecedented support from the Fed, even greater than the 2008 financial crisis.
  • Greater Recession: In my opinion, this is the likely scenario. Given that there is nothing fundamentally wrong with the economy, the productivity gains we have had over the past decade are meaningful, although the unemployment and lack of emergency savings is definitely an issue. Hence the case for a longer recession.
  • Greater Depression – this is unlikely given the extraordinary fiscal and monetary support to the economy described above from the lessons we have learnt from the 2008 financial crisis.
  • Stag Depression – I do not believe we are going in for a stagflation depression. There is the case for inflation, given the massive amount of public debt. At some point of time, there will be a massive package of infrastructure investment to decarbonize the economy which will push up the productivity and the returns from such an infrastructure investment will prevent stagnation. It will be the case of the US having the cleanest of the dirty shirts and given that the $ still enjoys reserve currency status, stag-depression looks unlikely in my mind.

Trends in Response to the Crisis:

While these trends may not all pan out, it is important to call them out. These are emergent patterns, that the right players with some wind on their back can hope to capitalize and create a unique differentiated model for themselves.

• Globalization & Trade: We have seen a lot of anti globalization and protectionist trends manifesting themselves as either trade wars, or anti immigrant sentiments, hardening of immigration policy or pulling back from international commitments or global bodies. While it will be hard for companies to immediately move supply chains out of certain countries, given the need to preserve cash for contingencies, but longer term, everyone will be looking to de-risk their supply chains, if there is an outbreak in any one region of the world. Automation will certainly accelerate, especially in AI, Vision systems, self driving vehicles. Given the trends in automation and 3D printing, disruption is inevitable where any new product/need will create new workloads, new configurations of production that are much more automated and may be near shore instead of using the lowest cost supplier.
• Technology & Innovation:
  • Manufacturing as we know will change with automation & 3D printing. Robots will be used for hazardous work/disinfection in rescue and disaster site, drones will be used for patrolling, thermal imaging, disinfecting, compliance to social distancing.
  • Where and how we work will also change, given that most of us have proven to ourselves and our employers that we can be as effective working remotely as we were in the office. While there was a lot of hesitation initially when remote work started, where employees were worried about being out of sight, out of mind. But given that we were all forced into it, without any stigma, we have each discovered that not having to commute gives us a lot more time during the day for other pursuits, and it is possible to be as effective as before. Companies having discovered this as well, will look to reduce their physical office footprint and thus fixed costs.
  • Video conferencing/ AR-VR will become mainstream especially with 5G rollout happening in most countries as this is being published.
  • Another trend that will significantly accelerate is Gig or Job work instead of full time employment for a certain role. Companies at this point will not want to commit to hiring full time, but instead seek to define job specs for what they need in the short term and put this out to bid.
  • There is an accelerated shift to digital currencies and online/virtual transactions given concerns about virus contamination on currencies. We have seen most retailers/suppliers/merchants completely move to digital payments at this time. It does not look to be a trend that will reverse.
  • Supply chain auditing and assurance will take a completely new page given the fear from infection of the supply chain with covid-19. We have seen Amazon investing all of their Q1 profits into securing and strengthening their supply chain as an evidence of this change.
  • Disruption from nimble operators with just good enough products and digital only footprints
  • Moving to a more permissive ethical mindset especially given the moves towards location tracking and contact tracing
  • Using AI in a big way for synthetic bio/drug discovery towards finding a cure/vaccine for covid-19, trends that will easily move to helping combat and prevent other diseases.
• Downturn drives Efficiencies
  • Assets available for repurposing: Given the expectation that most commercial real estate will be looked at for continued investment, there will be a lot of assets that will be available for a different or novel use.
  • Top talent would be more accessible: Given the economic disruption, and certain companies going out of business a lot of top talent will be available to take on new and different challenges.
  • VC’s would be more discerning & stringent. They would only invest in compelling founders, startups and use cases.
  • Disruption means opportunity: We have the opportunity to reinvent both healthcare and retail – both absolutely massive parts of our economy. The stimulus that is being put together as a part of the covid response, if repurposed for infrastructure and making us carbon neutral would also be transformational.
• Societal Impacts:
  • Pandemic behavior influenced generations: Given this experience, generations ahead would have influenced their behavior to maintain social distances, be cognizant of personal spaces and even the regular dynamics of collaboration with others. Just like 9/11 changed the millennials, covid-19 will change our future generations.
  • Personal & Group vendettas will be acted upon: The rhetoric against blue states, Asian Americans and USPS are some trends we see playing out. I do not expect these trends to change, given how polarized we have become.
  • Worker Benefits/ Retirement Security/ Basic Safetynets and Universal Healthcare can become rallying cries for transformation and betterment of people’s lives.
  • Focus on a clean and sustainable environment, given most people experienced how good a pollution free experience could be given the lockdown.
  • Population density in the developing world will need to be addressed, given it is the fuel for this pandemic
  • Migration and Immigration policies will have to be revisited, given the expectation of massive migrations that would be needed from effects of climate change.
  • Role of corporates: Capitalism will need to adapt, where profits may not be the only objective. While maximization is important, understanding that their image, societal impact and responsibilities and profit extraction would be critical to maintain the ability to continue operating long term. There will also be pressure for multinational corporations to align to nation states and to identify with their biggest markets where they have to operate.
• Behavioral shifts:
  • Polarization, Information &Trust: Given the polarization that we see in society, where we consume our information from will be fractured. There will not be a common set of understanding and agreement or even how we assign trust.
  • What will work: Ultimately most factories will be automated. Even if they come back near shore, these are not bringing back huge employment opportunities. Field work may still need humans, till we have autonomous movement and operation with robots.

What is The New Normal?

• Population Pressure & Food: Presumably 7.8 billion is a lot of people and that puts a lot of pressure on our food supply to feed and care for this population. Consequently there is an increased pressure on meat production (given the preference of most countries to transition to a meat diet as the standard of living goes up) and also on agriculture where large tracts of land has had to be cleared to produce food for such a large population. It appears that we are straining the finite resources of this planet and subsequently having a catastrophic effect on the rest of the species inhabiting this planet. Already humans have been responsible for the extinction of a record number of species. In the short term it does not appear that we are slowing down our population growth and it may only be an external shock as in climate disasters or a shock to the food supply that may arrest this trend.
• Wild Habitat: Under pressure from human encroachment, most wild animals and retreating and species going extinct. Will we give some of these wild habitats back?
• Over fishing & the pressure on marine animals: Will humanity understand and responsibly manage fishing to be sustainable?
• Antibiotic Resistant Bacteria: Factory farms that produce meat and the ideal breeding grounds for bacteria, and given the indiscriminate use of antibiotics for keeping the meat production up, this leads to development of strains of bacteria that are antibiotic resistant. Will we find newer antibiotics or shift away from factory farming of animals for meat?
• Climate Change: Animal and human migrations will result from climate change related catastrophes and disasters. The thawing Tundra is expected to release additional microbes that have not been seen before and could also rival this pandemic.
• Globalization: Will a crisis push globalization to extinction i.e. the specialization of providers for goods and services recedes given our response has been protectionist and to close our borders?  
• Travel, Leisure and Exploration: Will all travel become local? What will be the future of air travel / mass transit? Will telepresence for work translate to experiencing travel and leisure the same way? Seems unthinkable right now, but you never know ….

As always, welcome any feedback, contrarian points of view and a healthy discussion…