By Byron Wien
|In spite of the coronavirus, we decided to move forward with the Benchmark Lunches this year. For the past several decades I have been organizing four Friday lunches for serious investors who have homes in Eastern Long Island. Usually, I have 25-30 participants at each one. This year I knew bringing 25-30 attendees together in person was impractical. Accordingly, I planned five lunches to be held via Zoom because I expected that there would be a lot of interest and wanted to make them easily accessible. The group included the usual assortment of hedge fund, private equity and real estate leaders, some academics, former government officials and economy and market observers. The Zoom format, which I moderated with an agenda customized to the makeup of each lunch, worked well. Some attendees found the arrangement even better than the physical lunch format because there were no servers or side conversations to distract from the conversation. The physical lunches do give participants a chance to network and interact, however, and everyone hoped we could go back to meeting in person next year.|
The general tone of the sessions was one of optimism tempered by uncertainty. Only a small number thought we would be back to something like the normalcy of 2019 by next year. Most thought we would get there by 2022, but there was a dispersion of opinion on what “normal” would look like. Everyone agreed that two factors would be necessary. First, we would need to develop, test, manufacture and administer an effective vaccine. Second, while the economy was still struggling, government assistance in the form of fiscal stimulus and monetary expansion would be needed to provide support to the millions of people who lost their jobs during the recession. It would take a while for the economy to develop natural momentum on its own. In any case, there would be some permanent changes, as there were after 9/11, that are unforeseeable at this time.
On the vaccine, there was considerable optimism. Many companies are working to develop one, and several are conducting clinical trials and manufacturing doses in anticipation of regulatory approval. These processes are underway in Europe and Asia, as well as the United States. Many expected an effective vaccine to be available for essential workers by the end of this year. They thought the general public could be receiving it by the second half of 2021, and by the middle of 2022 most people who wanted the vaccine could have it. There was considerable controversy over how long the vaccine would last and whether booster shots would be required annually or more frequently to maintain immunity. There was also disagreement on the willingness of the public to get the shots. Only 40% of Americans obtain ordinary flu shots. The feeling was that well over half the population would need to get Covid-19 inoculations for people to feel reasonably safe taking public transportation, eating indoors in restaurants and going to movies, theaters and sports events. There was widespread agreement that the medical profession has learned a lot about the disease. As a result, more people contracting Covid-19 can be treated effectively enough to mitigate long-term health problems, and hold down the number of related deaths.
On the economic devastation wrought by the disease there was a wider range of views. Most agreed that the unemployment rate would remain high – perhaps 10% – but were impressed by the current rate of recovery. The manufacturing and housing sectors have shown strength, both helped by low interest rates. As an example of the bounce-back in manufacturing, U.S. domestic auto production increased by 200% from May to June and has recovered to nearly two-thirds of pre-Covid levels. Around the world, purchasing managers indexes were above 50 in most industrialized countries, indicating expansion. Still, thousands of small businesses have closed during the recession; many will never reopen because their owners have gone bankrupt or chosen to retire.
Large portions of the economy are in serious trouble. The hospitality segment – including hotels, restaurants, resorts and cruise lines – will take a long time to recover. The airline industry may suffer from secular change. The use of Zoom and other such tools has demonstrated that certain business functions can be accomplished effectively remotely. If you are selling something or investing in a business, there is no substitute for being present in person, however, and relationships are hard to build remotely. We all like to travel for pleasure and to see friends and relatives, so airline and other travel businesses will come back, but it may take a few years for that to happen.
The experience of working remotely is likely to have a secular impact. Many of us have found working at home can be extremely efficient. We can dress casually, avoid the hassle of commuting, and use the time saved for deeper thought and contemplation. On the other hand, we all like interacting with colleagues, mentoring junior people and cross-fertilizing ideas in group meetings. We look forward to going back to the office, but perhaps not every day as we did before. This will also have an impact on group meetings outside the office and conventions. Less office space may be needed, although lower density could also be a countervailing factor.
We had a number of major real estate investors at the various sessions. Most were optimistic that if their properties were well financed, they could wait the recession out and recover as they had in the past. Some were looking to buy properties at distressed prices. Most said that office tenants were paying their rent, despite the fact that most employees were working remotely. All acknowledged that their retail tenants were in serious trouble and that the damage in the retail sector was likely to be permanent, as we have seen with the bankruptcies of Lord & Taylor, Neiman Marcus and Brooks Brothers. The United States has been over-stored. One of the real estate executives shared the startling statistic that the U.S. has over 50 square feet of retail space per capita, nearly three times the amount of the next highest, Canada. Countries in Europe are in the single digits. It was their view that the retail sector will need to shed nearly one-third of its current physical space. The impact on cultural institutions was likely to be huge. Any venue that attracts tourists will see declines, and those that involve people being seated close to one another will see a drop in local visitors as well. Charitable giving is being directed to social services and healthcare rather than arts organizations.
The people attending the lunches were all doing so from the comfort of their homes (for many of them, a second home). They all had occupations that enabled them to work remotely. They all had savings and a net worth that would allow them to maintain their lifestyle, even if their income suffered for several years. As a result, they have been able to insulate themselves from adversity. According to a June 2020 BLS study, around 40% of American workers have the ability to work remotely, but the other 60% have to be present physically to perform their duties, whether in hospitals, factories, service businesses or transportation. It’s the latter group of people who are not as comfortable and probably less optimistic about the outlook. They will be less willing to spend money on non-essentials. When coupled with the country’s high level of unemployment (non-spenders) and the large number working remotely (reduced spending because of less mobility), there is no mystery as to why the United States economy has only retraced about one quarter of its way back to its 2019 level. For that reason, any view that we will be back to 2019 levels of GDP by 2022 may be too optimistic. Despite the challenges and the ongoing need for government support, the group did not think that a Universal Basic Income program was likely to be implemented.
We also have to think about the impact of social unrest on consumer behavior. If cities remain unstable, those who live in them will be less likely to leave their homes. There will also be a cost to adapting offices to post-pandemic conditions. Employees may need to have their temperatures checked, ventilation systems will need to be upgraded, and regular thorough cleaning will be required. One former state official spoke about the impact of the virus on state and local governments. Sales tax and income tax revenues will be down, and the cost of operating state and local government will increase. While the federal government will have to provide up to a trillion dollars in fiscal support, whether Washington will be willing to appropriate those funds is an open question.
In the last session we discussed the effect of the virus on younger people. Most agreed that remote learning was much less effective than classroom instruction and varied depending upon income disparities. Physical schooling also provides the benefits of social interaction. Kids learn from each other and they develop collaborative skills that are important in life and the workplace. Even before the onset of the pandemic, graduates of our education system found that when they left school, the job market was tight. To some extent, this has been true since the last recession. It seems now that career opportunities may be limited for a generation. What are the long-term ramifications of that on society?
We discussed the effects of enormous fiscal and monetary stimulus on the financial markets. So far, there has been little impact on interest rates or inflation. Most in our group were skeptical that Modern Monetary Theory would allow governments to print money indefinitely. In any event, as long as real growth is higher than the inflation rate, we can probably continue our current revitalizing efforts. The U.S. dollar has already declined about 10% this year and that may be the first sign of trouble. It also may indicate that Europe and Asia have done a better job of controlling the virus and are recovering more favorably. The combination of social unrest, enormous fiscal and monetary stimulus, poor discipline in limiting the spread of the virus, gridlock in Washington and avoidance of international involvement may have diminished America's standing among nations in the world. The prospect of a sweep in November with both the presidency and the Senate moving to the Democrats and a less business-friendly environment in Congress may also have had an influence on the dollar. Even so, most participants expected interest rates and inflation to stay low for the next several years. The choice of Kamala Harris was viewed as a positive to the Biden campaign because she is not an extreme progressive.
Not everyone thought a Biden victory was a sure thing. People often lie to pollsters. Many are concerned that personal safety issues will cause people to vote for the candidate who is likely to be tougher on crime and more focused on maintaining safety in the cities. There are also those who will want someone in the White House who promises neither to raise taxes nor impose regulations that are harmful to business. All of these are reasonable considerations, but Biden has a considerable lead at this point and he will be hard to beat. Some worried that he is a less effective debater than Trump and prone to gaffes. If his performance were poor, his prospects could weaken. There was also the observation that the country as a whole has shifted to the left. Racial injustice, inequality and environmental considerations are more important to the American electorate then they have ever been before. There was a great deal of enthusiasm in the 1960s after the Voters Rights Act and the Civil Rights Act, but half a century later, recent events have made clear that the progress that was made during that era was insufficient. Those attending the lunches expect more change in the next few years, because support for reform is so widespread at this time.
We discussed the global significance of a strained relationship between the United States and China. Everyone agreed that it was not good to have the two largest economies in the world in conflict with each other, but some saw it as an inevitable outgrowth of the long-term shift towards nationalism and away from globalization. Most were concerned that China's policy towards Hong Kong and its military operations in the South China Sea would result in an increase in the U.S. defense budget, but knowledgeable observers said Phase One trade negotiations were moving forward and our imports from and exports to China continue. A Phase Two deal seems to be off the table for now. China is a major manufacturer of generic drugs and medical equipment. Cooperation on vaccines and aid to the developing world may provide the bases for some constructive discussion. China has also proven to be a low-cost producer of quality goods in many areas. Bringing that production home or relocating it will be difficult, costly and time-consuming, but this endeavor is at least partially underway.
We spent some time talking about energy. During the worldwide recession induced by Covid-19 lockdowns, oil demand fell 25 million barrels a day, an amount four times greater than the drop experienced during the Global Financial Crisis. The situation has improved as people resume using their cars. Notably, China is consuming more oil today than it did a year ago. Jet fuel is the biggest factor in the decline in oil demand. This dynamic is unlikely to change for some time, as people won't feel comfortable flying again until they get a vaccine. The United States has accumulated a huge excess inventory of a million barrels of oil which will have to be worked off. Shale production will be down because it is mostly unprofitable at current price levels, so U.S. output will remain depressed at 700,000 barrels/day, down from a peak run rate of 2 million. OPEC will be the world leader in production. Prices won't exceed $50 a barrel for West Texas Intermediate until 2022 when the economy gets back to something close to normal, but there are opportunities in well-financed producers for patient investors. Global exploration will be deferred for a while. Political conditions in the Middle East will be more unstable until the price of crude recovers.
We discussed the opportunities for wealth creation at all of the sessions. Everyone agreed that monetary expansion by the Federal Reserve has been a strong contributor to the positive performance of the equity market. There is a profound difference between the price of financial assets and the performance of the real economy. The FAANG stocks, some healthcare stocks and Microsoft have driven the market close to new highs. Most stocks in the S&P 500 have not participated in the rally, and energy and hospitality-related stocks have suffered. There was a general feeling that growth will be key to performance and that innovative companies would continue to do well, but prices have reached a point where it is time for them to rest for a while. There will be interesting initial public offerings of companies that are forcing change in their industries, and these should be studied carefully. Strong consumer brands held by well-financed international companies have pricing power and will be able to grow earnings as the world economy recovers. With interest rates low and some companies available for sale at depressed prices, private equity should continue to find opportunities. Many participants expected a high level of restructuring, merger and acquisition activity. Investors are hungry for yield. High yield bonds for companies that will survive the current stress and do better when the economy recovers are attractive, but even these yields have declined substantially. Finally, airlines, transportation and hospitality have performed poorly, and some represent good value for patient investors who can tolerate the risk as a part of their portfolio. Only a few participants in the lunches were buying gold, despite its dizzying rise this year. Very low interest rates contributed to gold’s attractiveness. Several investors were positive on biotech and money management.
I titled last year's essay “Plenty to Worry About, but Not Much to Do.” I certainly did not foresee what was coming. Some trends that were developing before the virus, like the importance of a more flexible lifestyle in the workplace, e-commerce and tele-medicine, will be accelerated. For the optimistic and the patient, there is plenty to do now.