Black Swans and ‘K Shaped’ Recoveries

Lebanese-American essayist, scholar and mathematical statistician Nassim Taleb developed a theory describing ‘outlier’ events that take people by surprise, have large flow on consequences, and for which people are insufficiently prepared or do not understand prior to them occurring.

He coined the phrase Black Swan event to describe such happenings in reference to the previously unknown existence of black coloured swans prior to the European discovery of Australia.

Why is this relevant to where we are today in society and investment markets?

The current Covid-19 global pandemic is certainly no Black Swan event. Global Pandemics have occurred across recorded history.

Arguably the Black Swan event of 2020 is how Governments around the world have reacted.

Rewind to late 2019. The Australian economy was churning out strong growth numbers. The residential property market was gaining steam after a few years of weakness. Australians could freely travel, meet with family and friends at their leisure and legally operate small and medium enterprises such as restaurants, coffee shops, gyms, hairdressing salons, and high street retail shops without fear of being shut down or restrained from trade without notice.

Fast-forward to September 2020.  The world is starkly different. In the pursuit of crushing Covid-19, many Governments in the developed world have also crushed their economies through population lockdown strategies – with the poster child for this strategy being the Victorian State Government.

Whether as a public health strategy this can (or will) work we will leave for others to offer an opinion on.

What is abundantly clear is that lockdown strategies come at an enormous economic cost.

A cost which so often falls very unfairly at the feet of those who can least afford it – students, young graduates, people early in their careers and small business owners, many of whom have spent years building their passion often taking substantial yet calculated risks like placing the family home on the line as collateral for expanding the business they have put their heart and soul into. These cohorts are substantially overrepresented in the negative fallout from current public policy decisions.

As leading business identity, medical doctor and founding CEO and current Chairman of global biotechnology company CSL – Brian McNamee – stated to the Australian Financial Review in recent weeks:

“the harm to our youth and the broader society is not acknowledged nor would appear to be factored in sufficiently… We’re harming the social contract with our own society and particularly our youth and small businesses”.

A fork in the road

Ever since the economic fallout of managing Covid became clear earlier this year, pundits have assigned various letters of the alphabet to their forecasts for economic recovery. Was it to be the traditional ‘V shaped’ recovery (quick snapback), ‘U shaped’ (a slower bottoming out phase before recovery), or the ‘W’ (a bounce followed by another dip then a sustained recovery).

Our view is that Government and Central Bank policy is resulting in a very clear bifurcation in both the real economy and financial markets.

That is, Government health policy and resulting shutdowns have created a fork in the road with very distinct winners and losers.

This has been highlighted acutely in Victoria with stage 4 lockdowns crippling ‘customer facing’ businesses in hospitality, leisure, and the arts, with those lucky enough to be able to work remotely by leveraging technology remaining (largely) unaffected.

A number of financial market participants (ourselves included) are seeing this public and monetary policy creating a clear delineation amongst societal cohorts – resulting in a ‘K shaped’ economic recovery with those who own assets and hold wealth remaining relatively unaffected and those who do not being severely disadvantaged from the economic fallout.

This will present significant public policy challenges into the future.

Investment themes

The following is a non-exhaustive list of investment themes and considerations currently on our minds when reviewing client strategies and portfolios.

  • Ample cash reserves and liquidity is never a tired strategy – it sounds so very basic and vanilla but recent events are an abrupt reminder that cash reserves and prudent cash flow planning is the life blood of business, and an integral part of a sound personal financial strategy. It is imperative that there are some nuts squirrelled away for the winter.
  • Government policy can turn, and sometimes quickly – business models predicated on niche Government policy or heavily dependent on current regulation can present unwarranted risk (think car novated leasing companies or businesses with a single international trade market).
  • Interest rates are at record lows and much of the risk has shifted to Government balance sheets – with interest rates near zero globally and Governments taking on very large sums of debt to fund social security (e.g. JobKeeper/JobSeeker), Government Bonds with a long duration (term to maturity) are not particularly attractive. Keeping defensive exposures more liquid and shorter in duration is preferable in most circumstances.
  • The run up to Tuesday, November 3 will be volatile – US elections are to be held on this date and the United States of America remains a hotbed of social and economic division. Regardless of the outcome, this election will be among the most divisive in US history due to the ongoing civil unrest in several US States and the stark contrast in policy between Trump and Biden camps. Love him or loathe him – make no mistake – a Trump victory would signal lower taxes and a more pro-business stance. Our outlook for US stocks remains positive whoever wins but markets could be ‘super-charged’ with a Trump second term.
  • Big Tech is here to stay – whilst valuations of many publicly listed big technology and e-commerce companies appear lofty, many will go from strength to strength at the expense of incumbent /old world bricks and mortar businesses. Employers have been forced to acknowledge that staff can work productively from remote locations and eventually all businesses will shift databases and customer management systems to the Cloud. Businesses that win these markets will benefit from scale through expanding customer bases whilst generally maintaining fixed expenses. This demands a premium price multiple in the marketplace.

Samuel Adams and Glen Orbell

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