From Great Reopening to Another Not So Great Reclosing: As of the beginning of July - a time when much of the country was expecting to be well on the road back to normal - 13 states had begun to alter their statewide reopening plans due to rapidly rising case numbers observed within the final few weeks of June. After several weeks (and months in some cases) of lockdowns and stay-at-home orders, many Americans were looking forward to the prospects of returning to some version of the pre-COVID norm. Chief among those looking forward to a return to normal have perhaps been businesses (particularly those dependent on customers walking into a physical location) which were, of course, severely impacted in the second quarter as commerce came to a screeching halt for many. With confirmed cases jumping from 1.8 million on June 1st to 2.7 million on July 1st, concerns and speculation are running rampant over what to do about the increasing likelihood of overtaxing the resources of the healthcare systems in many regions and how best to respond.
Our Takeaways: Upon a state by state review of case data, what appears to be occurring for many states can be more accurately described not as a “second wave” but as an exponential tsunami. While initial “hotspots” such as New York and New Jersey fueled the majority of cases over the past 6-8 weeks, other states are just now beginning to increasingly contribute to a greater degree to daily case numbers as the virus continues its pervasive march from community to community.
The reason we believe it is not correct to classify this as a “second wave” is that, for many states, this is their first real experience with a significant surge of confirmed cases. In fact, there are very few instances in the data collected so far of what could be considered a double sigmoid function which would better demonstrate the instance of a “second wave.” The narrative surrounding this, in our opinion, is partially driven by both the media’s and the general public’s tendency to draw what are often poor/misunderstood comparisons among and between different geographies.
Actual performance in handling the virus aside, it does not make logical sense to treat and interpret data regarding total cases over time and geographical spread the same way in the United States as, say, Italy for example. These two countries represent dramatically different numbers/densities of population over vastly different scales of geography. Moreover, there are a variety of cultural, demographic, and societal differences that make summing up each country's respective “handling” of the virus response and interpreting those results in the context of a headline or news broadcast chyron particularly challenging. However, and for reasons that we will touch on further in the final “Our Takeaways” section of this letter, the result - at least in the United States - has been for states to pause, pivot from, or in some cases outright reverse their reopening plans.
Judging from the states that have successfully flattened the exponential growth of cases to something that roughly resembles a sigmoid function, it takes about 5-8 weeks to do so. Now, assuming no further setbacks or true resurgences in places that had previously flattened, we appear to be 2-4 weeks into the process for states such as South Carolina, Texas, and Arizona which are still presenting exponential function shapes in their case data.
Perhaps what is most concerning of all is that other highly populous states, such as California and Florida, appear to only be a week or two into what could be their transition from a roughly linear to a roughly exponential rate of growth. This will surely add many more cases on an absolute basis, and create further pressure for more restrictive or regressive policy.
Lest We Forget China: This year started off with optimism around the framework for a trade deal between the U.S. and China. We were supposed to see how, and if, each side might begin to make efforts towards a more mutually beneficial trade partnership. Instead, what we have today is a global pandemic that has thrown a wrench in the mechanisms of global trade. Washington and Beijing have traded some pointed words over the potential origins of the novel coronavirus, but otherwise the focus of the financial press has been on the domestic response to the virus. That is until the end of June when two major developments occurred. First, White House trade advisor Peter Navarro expressed in no uncertain terms during an interview with Fox News that the trade deal with China is “over,” but then put out a statement later in the evening walking back that term and clarifying it had nothing to do with the Phase 1 trade deal. Only that he was speaking to the “lack of trust we now have of the Chinese Communist Party.” The second major development was China’s passing of a national security law focused on Hong Kong. Of particular contention has been the broad definitions for crimes such as terrorism and sedation, both of which carry harsh sentences and even up to life in prison. The global reception of the law has been mixed with battle lines drawn where you would expect them to be. At a recent UN Human Rights Council in Geneva, 53 countries presented themselves as being supportive of the new law while 27 were opposing. Unsurprisingly, all 27 countries opposed to the new law are considered “free” according to Freedom House’s global ratings and include countries such as the United Kingdom, Japan, and Australia. Meanwhile, the 53 countries in favor are at varying degrees of “partially free” to “not free” and include countries such as North Korea, Saudi Arabia, and Syria.
Our Takeaways: Beginning with comments on China in general, it has surprised us (given where we were going into 2020) that there could be any story - the election included - that could cause the current state of play between the U.S. and China to fall so far into the background. Yet, here we are.
The first development, Navarro’s apparent dismissal of the Phase 1 trade deal and then subsequent comments walking his statement back, reminded many members of the financial press that the concerns around the sustainability of that agreement are still very much alive. The night of his comments, Dow futures dropped about 400 points prior to his subsequent statement “clarifying” what he had told Fox News. Ultimately, the severity of the drop was likely trimmed not by the speed of Navarro’s retraction, but the speed of the drop itself, particularly given it was late in the after-hours, made many take notice and prepare to take advantage of mispricing opportunities. More importantly than what is now being considered a misstep in phrasing related to the trade deal is the rhetoric that was doubled down on in the subsequent statement from Navarro after his interview.
In the follow up statement Navarro said, “I was simply speaking to the lack of trust we now have of the Chinese Communist Party after they lied about the origins of the China virus and foisted a pandemic upon the world.” Beijing traded jabs on this issue when foreign ministry spokesman Zhao Lijian told reporters, “He [Navarro] consistently lies and has no honesty and trustworthiness,” and “China’s stance on the [trade deal] has been consistent and clear.” From this exchange it is hard to come away with a positive assessment as to the state of the deal between the two countries. Data that should prove or disprove China’s adherence with the purchase agreements included in the deal have been hard to come by due to the extent to which COVID-19 has disrupted all aspects of global trade. The only potential positive would be that if either side had no real intention of reaching some kind of agreement, then the expectation would be that such an intention would have been made known.
As for the second China related development, this one appears fraught with more nuance. Without diving into a full history lesson on Hong Kong's origins, in simple terms, to whom it belongs and how it should be governed has been a question for a while. The current media narrative is attempting to paint China as acting like a kind of strongman in the situation by subjecting Hong Kong to oppressive, authoritarian rule. While this contains shades of truth, the anger many Hong Kong citizens are laying at the feet of mainland officials might not be entirely warranted.
Some of this anger appears to stem from economic related frustrations the people are having as circumstances there have become more challenging. Some of this is rooted in Hong Kong’s changing position in the world, particularly in the Pacific region, in the last decade or so. What once served as a major gateway for the West into Eastern markets, the rise of places like Singapore, Japan, and Shanghai have dramatically undercut Hong Kong’s necessity and relevance in global trade and financial markets.
While the political and ethical questions surrounding greater involvement by the central government in Hong Kong’s affairs remain (pending the outcomes and application of this new national security law), the economic motivations of the Party appear logically calculated. Given its weakened state, Hong Kong is ripe for absorption into the mainland economic machine and given the Party’s overt intention of spreading China’s brand of communism, this move seems to be a very likely step for them to take.
A Look Under the Hood: Last month we continued our observation of the jobs numbers, noting with astonishment the return of about 2.5 million jobs to the economy. The headline unemployment rate at that time was 13.3%, a number far lower than the nearly 20% many economists were projecting. Still terrible, but at least better than expected. In the “Our Takeaways” section, we unpacked the potential cause for such a strong rebound positing that the comeback might be policy rather than demand driven. Initial data from June continues to show jobs being added back into the economy, but we will continue to monitor that progress and, more importantly, the proportion of job losses considered “permanent” rather than “temporary,” as this presents a more accurate picture of what the intermediate and long term effects from the business closures will be. With respect to this month, however, we wanted to take a deeper dive into the composition of losses - particularly areas of the economy who have seen declines well in excess of the headline numbers - to get a better understanding of the weak points. Furthermore, by examining sector by sector data, we were hoping to also glean some insights into the health of businesses in those areas and potentially assess their ability to rebound in the coming quarters.
Our Takeaways: Starting with an area that has received a lot of attention, Leisure and Hospitality is unsurprisingly one of the hardest hit parts of the economy in terms of job loss. Going into March, the industry employed about 16.12 million workers. By April, about 7.6 million jobs had been lost (a decline of ~47%). The sector fared slightly better in May, but was still down 6.3 million jobs (~40% off the March high). As bad as these numbers are, the Arts, Entertainment, and Recreation subsector (15% of the total Leisure and Hospitality section prior to COVID-19) was even worse, posting an over 50% decline from March to April, and only recovering about 1% from April to May.
Another sector that has received a lot of attention has been transportation - specially airlines. The transport sector as a whole has actually done well compared to the headline unemployment with sector job losses only hitting about 10%. On the other hand, one big positive for the sector is that transportation and warehousing are grouped together with warehousing doing relatively well given the increased demands placed on supply chains - particularly online focused ones. However, dragging down the transportation sector are the air and ground transportation subsectors. Air, for its part, was down about 15% March to April and experienced further losses in May. Ground transportation has done even worse, posting job losses from March to May of almost 40%. Granted, on an absolute basis these jobs (about 320,000 in total between the two subsectors) represent a smaller proportion of the overall economy than those lost in the Leisure and Hospitality sector, but the magnitude of the loss is telling nonetheless.
Another particularly hard-hit area has been apparel related sub-sectors such as apparel manufacturing (down ~35% March to April and still down ~25% March to May) and apparel sales (down ~60% March to April and still down ~55% March to May). In total, this represents a decline of about 700,000 jobs. One key similarity between all three of these examples is they represent areas of the economy that individuals could, at least in theory, go without and not materially degrade their quality of life. Put another way, none of these businesses are “essential,” and therefore - in our view - provide a good gauge of genuine demand within the economy.
If these areas of the economy fail to add workers back in meaningful numbers, or do so, but then have to resume layoffs en masse, then we will have a clear indication that our current economic situation is not heading in a positive direction. Alternatively, if we see sustainable, demand-driven growth in these areas, we would see that as a positive indicator for the economy writ large.
Pandemic Framework: For the last several months, we have been analyzing as much data as we can get our hands on related to the virus, the global response to it, the economic impact, and any other relevant information that could be synthesized into developing a framework for thinking about where we are and how things may have shifted as a result of COVID-19. Last month, we gave an early look into how our thinking around this framework was developing in the “Our Takeaways” section related to the recent market rally. In general, we find mental frameworks extremely useful when thinking about, and analyzing, complex systems because a good framework will reduce the cognitive load of working with a variety of interdependent variables without losing the important nuances that are characteristic of complex systems. Ultimately, where we have come to - for now - can be simply stated in an old behavioral economics trope: “incentives matter.” We have mentioned this in each of our notes during the pandemic, but it’s worth repeating: none of us at Gold Sail are medical professionals of any kind, we are intense students of data. Our endeavor in this framework is neither make a public policy prescription nor give any sort of analysis based on a healthcare point of view. It is to simply look at the world through an economic lens and to attempt to make sense of things solely from that perspective.
Our Takeaways: Thinking on our framework began to crystallize when we started drilling down on the question that often underpins a lot of our economic and market related analysis: who benefits from this? Finding answers for this question as it relates to public financial markets (and in particular the recent bull run from the March lows) appears to be relatively straightforward as we outlined in last month's letter, but as it relates to public policy actions (and their effect on the real economy) the analysis can prove more difficult.
For starters, it is not at all apparent who benefits from double digit unemployment, or empty restaurants and bars, or sports arenas/stadiums and concert venues, or closed schools forcing many parents who are also working from home for the first time to also contend with children trying to navigate the complexities of a hastily assembled distance learning curriculum. But we don’t start at any of those points and to do so would be to miss the larger point entirely. Instead, our framework first begins with a catalyst - a narrative shifting event or entity - in this case the novel coronavirus.
Information about this virus was generated initially from two primary sources: China and then Italy, shortly after. China as a source for data is on its face problematic, because (and to borrow a phrase from Epsilon Theory co-founder and CIO, Ben Hunt) everybody knows that everybody knows that data from China is unreliable at best. Italy, as it turns out, is also problematic for reasons we did not find out until recently.
According to the preliminary findings of several studies including those from Los Alamos National Laboratory and the New York Genome Center, the strain of SARS-CoV-2 common in Italy (and now much of the world) is different than the one found in Wuhan, China, and - more importantly - it has been found to be significantly more virulent (i.e. susceptible to transmission) than what is considered the “original” strain. Nevertheless, it was with the grim data we had available back in March that the 24-hour news cycle went to work. Fear, as they say, sells (or at the very least draws eyes and clicks) and thus we find the first instance of incentives mattering.
As a brief aside, we will be using collective nouns such the “media” and the “government,” but are doing so for simplicity's sake. In this day and age, using those nouns in their plain, unadorned forms unfortunately implies certain factional connotations - connotations that are fraught with their own sets of issues and, of which, are not particularly relevant for our framework. The only aspects that we find relevant about these groups as collective nouns is that, regardless of fractional slant or agenda within the respective spheres of influence, these collectives operate mechanistically in terms of processing inputs in a predictable manner for a self-benefiting output. Now, let’s turn back to the media’s output within our framework.
From the media’s steady drip of concern over the virus, we were able to observe the second instance of incentives mattering in U.S. personal savings data preceding the government imposed “lockdowns.” In the initial stages of the reaction to the virus, we held true the assumption that governmental actions were the primary driving force behind the actions of the general public (at least early on). Yet, upon further analysis, we find that the data better supports the notion that the general public was instead drawing upon information being picked up and reported on by the media.
This notion is evidenced by household savings rates beginning to tick up prior to when state and local officials started to publicly suggest they were considering extreme measures similar to what was being witnessed from China’s response. Even for those on the margin who did not believe we could ever experience a similar China-esque lockdown scenario in the United States, most Americans still took steps to better preserve their financial resources - presumably in the face of what appeared to be an unprecedented global spread of a potentially highly lethal virus playing out across news outlets. Turns out, at the end of the day, it is always the desire for self-preservation that wins when presented with grave uncertainties.
So, this leads us to the government (collectively referring to local, state and federal bodies), their reaction(s), and our third example of incentives mattering. Roughly speaking, our framework summarizes governments primary incentive as to give the appearance of providing the greatest benefit to the greatest number of people. This stems primarily from the collective desire/need from the individual components of government (at least in the elective and therefore decision-making capacities) to be re-electable once their designated term has expired. Put another way, there is an overwhelming inertia towards just “doing something” so they and their constituents might at least feel more at ease and have something to point to during the next election cycle. Having also been receiving an increasingly grim diet of information supplied via the media’s apparatus and gauging the concerns of the public, government officials soon began to lean on this backdrop and issue stay-at-home orders, first within cities and then entire states. This in turn, created more for the media to report upon and, therefore, more for the public to consume in a feedback loop of sorts.
Now, with case numbers rapidly increasing in the United States, we anticipate seeing at least one more full cycle through this framework (barring any more significant catalyst that can shift the media’s attention) and a longer path forward towards a full social and economic recovery.
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