On the 23rd of January, while most of us didn’t know it, China locked down the entire province of Wuhan, and the world fundamentally changed. This was the point where it was clear that COVID19 (which didn’t even have its official name until 11 February) was a massive problem and was going to have global human and economic consequences. To quote Lenin “there are decades where nothing happens, and there are weeks when decades happen”.
We live in these times. The implications for social cohesion and geopolitics in the years to come will be profound. The world will get through this, but it will take time. It will take longer than you think. But one thing, as investors, we should be clear about is that the investment world on the other side of this crisis will be fundamentally different to the world we have lived in for the last decade. Rules that used to work, wont. Fundamental beliefs will be upended. For almost every asset in the world, the valuation that applied on 31 December 2019 will no longer apply. It will be lower, we just don’t know how much lower.
I don’t know whether we are heading for a V shaped recovery or a L shaped recovery (or any other letter). I don’t think anyone knows. On the most basic questions, I don’t know whether the outcome of this shock, with its combination of demand and supply side elements, with the policy responses both monetary and fiscal, leads to inflation or deflation (or somehow both). I don’t know whether this leads to a period of high real interest rates, or low real interest rates.
Accepting this fundamental ignorance, it is three months to our next newsletter and the team at Infradebt wanted to share some of the key indicators we will be monitoring over the period ahead that might provide some basic signposts of the direction the world is heading.
Credit spreads. Don’t just watch equity markets as an indicator of the mood of risk assets. Watch credit spreads – they can provide a more reliable indicator of the health of the financial system. For those without access to a Bloomberg/Eikon terminal watch some of the credit exposed ETFs such as JNK or SNRL or AGG. The St Louis FRED provides some excellent real time resources - e.g. https://fred.stlouisfed.org/series/BAMLC0A4CBBB/ - whilst these are US measures they are good proxies for overall financial system health. For those with Bloomberg, watch credit default swaps – both broad indices as well as those of the big four banks (as a proxy for financial market stress).
Bank Shares. This will give an insight into the size and duration of the credit shock.
REITs/Listed Infra. Listed property trusts or REITs provide a window on how the market is perceiving the value of illiquid cash flow generating fixed assets. The listed infrastructure stocks are also worth watching closely. In both cases, by backing out leverage, the listed market can give insights into real time movements in unlevered asset values. This is important for infrastructure, because many recently purchased infrastructure assets will have much higher leverage than the small number of listed infrastructure plays in Australia.
Inflation – look under the hood at sub-components – not just at the headline number. Look at what is happening to implied inflation in inflation linked bond yields.
Currencies – in a world filled with intervention in traditional capital markets, currency movements become an outlet valve for imbalances.
Copper (and other industrial commodities). Gives an insight into length and depth of economic downturn. If we are truly in a V then these should bottom or start to recover first.
Japan. Japan is 30 years ahead of the rest of the world on radical monetary experiments (and demographic challenges). Watch what they do next and how markets react.
Real time traffic/subway ridership/electricity volumes. One of the challenges over the period ahead is that economic statistics will be terribly lagging. There are some interesting new information sources (for example, traffic congestion indices) that will help us see the speed and extent of lockdown conditions easing (see below).