Inside Track February 2021

  • Virus variants are stealing a march on vaccination efforts. Linear thinking will always fail to pick up the financial (and other) impact of macro events. With inequality firmly on policy makers’ radars, the value of social capital is being increasingly recognised. Investors and financial institutions are now recognising climate risk. For value creation don’t underestimate human ingenuity.
  • The longer the pandemic lasts, the greater the damage it will inflict – economically, politically, and socially. The whole world is engaged in a race between the various COVID variants and the vaccination campaigns, and so far, the pandemic is winning. Israel is a sobering example. Despite the world’s fastest vaccination campaign (already 30%+ of the population) combined with a harsh lockdown, Israel’s infection rate barely declined (from 10.2% to 9% in January), forcing the country to close its international borders. If the variants give COVID the ability to always be one step ahead of the efforts to contain it, a rapid vaccine-driven global recovery looks more and more like a pipe dream.
  • Financial investors underestimate non-economic risks– underappreciating the extent to which the economic crisis and dislocations spurred by COVID are bound to have a profound impact on social and political stability. This is attributable to linear thinking about phenomena that generally manifest themselves in terms of “cascading effects”. An example to prove the point: an increase in the level of unemployment by 1 percentage point tends to increase the share of votes for far-right or far-left parties by 2 or 3 percentage points (not 1!). For this reason, shocks and crises tend to favour extremism and radical policies like capital control.
  • A simple rule-of-thumb for investors and other decision-makers is this: when and because events cascade, things tend to happen faster and with greater magnitude than we thinkor predicted. This holds for both complex living systems like societies (with political upheaval and social turmoil often taking us by surprise when it shouldn’t) and natural ecosystems (global warming happening much faster than we thought just a few years ago). We can take a cue from Hemingway’s The Sun also Rises. How did you get bankrupt? Two ways: gradually then suddenly.
  • The US having flirted with the abyss is proof of this. Who would have imagined a year ago that an undeclared coup d’état would be attempted in the country that exemplified for so long the ideal of liberal democracy? US institutions have withstood the shock, but as one prominent thinker observed on 6 January: “If the post-American era has a start date, it is almost certainly today” (R. Haas). What lies ahead for investors? (1) US stability is now an open question; (2) Domestic right-wing extremism will increase, which is bad for confidence and economic growth; (3) Globally, governments have learnt that the societal backlash against perceived inequalities and injustice is by far the greatest danger.
  • The US homegrown insurgency, riots in the Netherlands, and even to an extent the GameStop saga are disparate phenomena that share one commonality: It is already erupting in some places and bubbling below the surface in many more. The mob storming the Capitol is reminiscent of the Beer Hall Putsch (1923), but more generally there are rumblings of resentment in many countries. This doesn’t mean massive unrest will happen, but it could.
  • As a result, concerns about social and political stability have forged a new consensus among policy-makers: the greatest danger lies in doing too little (austerity) rather than too much (i.e. unprecedented monetary and fiscal stimulus measures). The mindset of the economic profession has also shifted, with a flurry of research papers pointing to the vital importance of social capital. Notions like trust, state capacity, community-building, social cohesion, and social values like empathy and altruism are now seen as a prerequisite for prosperity and welfare.
  • By now, the pernicious effect of COVID on inequalities of wealth, income, opportunity, race, gender and geography is well understood and a cause for considerable concern among policy-makers. In addition, another form of inequality is evolving from a weak to a very loud signal in terms of its impact: intergenerational inequality. A flurry of anecdotal evidence combined with analysis of the discourse on social media shows that anger vis-à-vis the baby boomers “who had it all” is growing. As generational tensions rise, the boomers may be asked/forced to surrender part of their defined or contribution benefit schemes.
  • The dominant narrative about China’s growth(“the only major economy currently growing”) is misleading. China’s GDP rose by 6.5% in Q4 2020 only because the authorities decide it would. In their bid to reach this target, China’s government has moved in areas that previously, for the purpose of rebalancing growth, they were keen to abandon industrial production, real estate, and net exports. Meanwhile, consumption – which the authorities wanted to expand – is still lagging. This is not sustainable, and excess lending (particularly local government debt) must now be reined in.
  • Climate risk is an investment risk. Larry Fink (CEO of BlackRock – $8.6tr of AUM) said it in his annual letter to CEOs, adding: “the more your firms are seen to embrace climate transition and the opportunities it brings, the more the market will reward you with higher valuations”. Put differently, this means that companies whose business model doesn’t fit a net-zero economy face trouble. 2021 will be yet another inflection point for ESG strategies. Take divestment. Once the preserve of religious investors and vocal students, it is about to become mainstream for large pension and institutional funds. Even some banks are joining in!
  • Human ingenuity is such that we can reconcile a somber macro-outlook with a great deal of hope at the micro-level (no dichotomy here). With a new focus on social and natural capital, many new activities and industries are about to flourish, generating growth and employment in the process. Some examples: co-working (double-digit growth), pets(a $100bn industry in the US, growing at 5% per year), immersion in nature (walking, forest-bathing, and ski-touring are exploding). A striking example of ingenuity and value creation: a Japanese who is successfully renting himself out “to do nothing” for $96 per assignment.The Inside Track February 2021