Benjamin Lavine, Co-Head of Investments
3D/L Capital Management
It might seem odd to pen a piece on social reconnecting following news reports over this past weekend of a mutated form of the coronavirus surfacing out of the United Kingdom resulting in a Phase 4 lockdown imposed on the city of London and travel bans to and from the UK. Despite the new variant believed to be more infectious, initial market fears were partially alleviated following statements from British scientists that “there is no evidence so far that the new variant causes more serious infections or will neutralize the [COVID-19] vaccines.” However, the chasm between renewed economic / social lockdowns in response to 2nd and 3rd wave infections and the mass rollout of vaccines just deepened even if time length of such chasm has narrowed following emergency approvals of the Pfizer/BioNTech and Moderna vaccines.
We were initially inspired to pen this piece following an evening (virtual) gathering of our local CFA Society. As we enjoyed our delivered meal kits and virtually marveled over each other’s homemade gingerbread houses, we also shared our dream travel destinations once we (hopefully) move past the pandemic. To our mild surprise, rather than hearing responses of desires to travel to faraway exotic locales or family theme parks, many pined to reconnect with their families and loved ones, whom they have not seen since the March lockdown, regardless if said destination was Duluth, MN during the dead of winter.
These virtual forums revealed a bubbling sentiment of social reconnections ready to burst at the seams. A longing for a return to normalcy, with social reconnections at the very core of these desires. And a floodgate of social re-engagement waiting to be unleashed, not just for us to return to our pre-COVID consumption patterns.
However, as we wrote about in our November 2020 Market Commentary: A K-Shaped Recovery, the market continues to favor pandemic ‘winners’ such as technology and consumer discretionary companies with business models designed to keep us apart rather than bring us together. Ground Zero is the explosion of Special Purpose Acquisition Companies or SPACs with blank checks to acquire speculative growth technology companies (Figure 1).
Figure 1 – K-Shaped Fever Captured by Explosion in SPAC Fundraising
The other leg of the ‘K’ represents those lesser fortunate who have not recovered to the same degree as the ‘winners’, whether traditional retail, travel leisure, urban-based small businesses, which have disproportionately affected the lower wage employment base. And although many of those on the lower ‘K’ leg are expected to be the largest beneficiaries of a vaccine-led recovery (along with being recipients of more pandemic relief spending courtesy of a $900 billion aid package just agreed to in Congress), the markets are behaving as if this K-shaped divergence will only continue well past any post-pandemic normalization.
We keep hearing that COVID has merely accelerated the rise and falls of business models and adoption patterns that were already well underway prior to the pandemic. Yes, we marvel at the technology and internet broadband speeds that have made it possible to bring us together virtually, but the increased preference for consuming our basic needs and entertainment from the cocoons of our shelters are conditioning us to live further in isolation – trends we shouldn’t necessarily embrace even if they were well underway prior to the pandemic. Taken to an extreme, we can imagine all of us living in our own BNL isolation pods as conceptualized by the 2008 Pixar move WALL-E.
So, we would posit that there is a deep desire for social reengagement rather than further distancing, but the market seems to be extrapolating social distancing behaviors well into future, abetted by highly accommodating global central bank monetary policies.
And whether those investment dollars are seeking high priced technology stocks, with decades of profitability and market dominance priced into today’s valuations, it is difficult not to argue that today’s speculative fervor for tomorrow’s social distancing darlings have been fostered by an extremely accommodative US Federal Reserve, committed to keeping rates near zero (Figure 2) and growing its balance sheet (Figure 3) for the foreseeable future, even if inflation were to run a little too hot.
Figure 2 – Fed Dot Plots Put Higher Interest Rates Well Into the Future (At Least Beyond 2024)
Source: Bloomberg as of 12/21/2020
Figure 3 – Fed Balance Sheet Keeps on Growing
Which leads us to discuss the spectacular rise in cryptocurrency (namely Bitcoin) price appreciation that we turn our attention to. Although we’ve reported on the risk-on cyclical measures (a weakening U.S. dollar, rising industrial and agricultural commodities, corporate borrowing costs reaching absolute lows), the exponential rise in cryptocurrency (the exact opposite of a socially-reconnected store of value such as cash and coins), has coincided with the significant ease in financial conditions.
Courtesy of the Bear Traps Report, Figure 4 displays the Goldman Sachs US Financial Conditions Index (Inverted) versus Bitcoin (XBTUSD or Bitcoin priced in US Dollars). At least in 2020, we’ve witnessed a strong connection between Bitcoin pricing (which had dropped to just over $5000 during the depths of the March bear market) and the state of financial conditions (whether the non-existence of market liquidity during the March bear market or the near euphoric levels post-election, vaccine news, and zero interest rates).
Figure 4 – Easy Financial Conditions Appear to Have Helped Grease the Runway for Crypto’s Takeoff
Source: Bloomberg through 12/21/2020
Now, could this be a simple matter of correlation without causation? Regardless of the state of financial conditions, cryptocurrency (namely Bitcoin) advocates envision a new monetary order with crypto supplanting the U.S. dollar (along with precious metals such as gold) as the future store of wealth, even though “number of cryptos with algorithmically-constrained supplies is potentially infinite” when compared to the geological limitations faced by gold miners.
But it’s not difficult to imagine that the ‘chase for yield’ by investors desiring positive nominal investment returns (even if negative on an inflation-adjusted basis) would turn towards speculative investments where the ‘future potential’ encompasses the bulk of the present value, whether cloud-based software companies or electronic stores of value whose quantity is limited by algorithmic mining.
Now, this relationship between financial conditions and crypto-currency may have been, at best, marginally positive prior to the pandemic, but one is hard-pressed not to see a much stronger relationship going forward. Is this emblematic of the post-COVID new normal? Time will tell, especially if we ever do enter regime of tighter financial conditions versus what the market has enjoyed throughout the 2nd half of this year.
Easy financial conditions have also produced a rising debt burden facing corporate zombies (companies earning well below cost of capital or even not enough to cover debt costs) as Figure 5 illustrates. Abetted by zero interest rates, today’s ultra-easy financial climate and investor desperation for any financial asset with a nominal pulse have ultimately expanded the borrowing capacities of both governments and corporations, even if such debt loads prove to be unsustainable over the long run (what the catalyst for that point of unsustainability remains to be seen).
Figure 5– The Growing Debt Load Faced by ‘Zombie’ Companies
So, as we try to bridge that deepening chasm between rising COVID cases and vaccine rollouts, what remains largely unknown is societal behavior in the face of normalization. Some tough questions to consider as we head into 2021, desperate to put 2020 behind us:
- Have we retained enough behavioral muscle memory to help reverse the consumption patterns and interactions resulting from social distancing?
- What will happen to investor behavior should the world seek to mean revert from social distancing – will capital follow society’s desire to re-engage?
- And will easy financial conditions in response to fiscal and monetary stimulus remain just as easy in the face of normalization?
The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes, and opinions of others are assumed to be true and accurate however 3D/L Capital Management does not warrant the accuracy of any of these. There is also no assurance that any of the above are all inclusive or complete.
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Past performance is no guarantee of future results. None of the services offered by 3D/L Capital Management are insured by the FDIC and the reader is reminded that all investments contain risk. The opinions offered above are as of December 21, 2020 and are subject to change as influencing factors change.
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By: Benjamin Lavine