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COVID-19 Risk sector on revenue and EBITA

What a First Recession feels like for a 1990s Working Adult

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I was talking to my boss and realised that in the 2008 Great Financial Crisis, I was 15 — in Secondary 3.

I had not studied economics yet.

But more importantly, this will be the first recession I will face as a working adult.

Some friends were retrenched, they were fresh out of school for less than 3 years.

So should we be worried when options run out?

Like Rudolf Abel, in the movie Bridge of Spies, I’d muse “Would it help?”

With this perspective in mind, I’d like to talk more about actionables.

And some thoughts regarding a playbook for the recovery into a new bull run.

These are my takeaways — a culmination of conversations over the dinner table, coffee discussions and meetings with friends and fellow investors.

1. Economy

There are 2 points which distinguish this COVID-19 period from the 2008 GFC and SARS.

  1. COVID-19 affects consumers more than GFC-08. Ultimately, consumers spend less now because their health is at risk to go out and spend, not just only due to lesser asset values in their holdings or a shortfall of income.
  2. COVID-10 has infected 40k+ persons to date, 5x the number of SARS, with more dead than SARS in a shorter duration. SARS was limited only within Asia and not affecting the West

The Keynesian theory is simple.

Consumption is the self-fulfilling prophecy on growth or recession.

If you keep on consuming despite bad times, the economy will still carry on well.

It is true that Aggregate Demand (AD) can be boosted by other components of GDP, but consumption still holds the greatest sway.

G (govt) /I (investment) expenditure is a temporary measure to boost C (consumption).

At this juncture, I want to introduce a model (IS-LM for the initiated).

I hope I do my Profs proud by showing I can explain this to even my grandmother. I’ve made this as easy to follow.

There are 2 main markets in the economy.

  • The goods market
  • The money (local currency) market

The Goods Market

Source: Policonomics

The goods market is where we buy and sell our products and services.

  • The higher the interest rates, the less we invest, and thus we produce lesser (lesser output).
  • The line is sloping downwards since when the interest rate is high, the output is low

The Money Market

Source: Policonomics

The money market is where the central bank buys and sells cash at a price (interest rate) that allows consumers to use in exchange for goods and services

  • When output increases (more production of goods & services), demand for money increases, which raises interest rates
  • Upward sloping since more output = higher interest rates

Putting both curves together, the intersection of both curves will give us

  • market interest rate
  • output


Source: Policonomics

Before jumping into more details, here are two types of policies we need to know. Think of various types of government policies as tools that the government can use to impact the economy.

The government can choose between a fiscal policy or monetary policy to achieve certain outcome in the economy. Each policy comes with various pros and cons.

  • Fiscal policy from the government will cause your goods market line to shift right as output increases.
  • Monetary policy from the government will cause your money market line to shift right. The government increases the number of dollars in the market. This causes interest rates to decrease (since the interest rate is the price of demand and supply of money), thus increasing output, as lower interest rates imply increasing investments.

The lines on these graphs are drawn in an X, perfectly symmetrical.

However, their angles can shift.

In Econo-speak, that is called elasticity. Elasticity refers to how sensitive your output is with any change of input.

  • If I move by 1 step, and you move 0.5 steps, you are insensitive or inelastic.
  • If you move 3 steps, you are more elastic.

Consumer spending is inelastic mainly due to virus concerns. Social distancing, reduction of discretionary purchases like houses and cars, reduction of incomes due to unemployment.

Here’s what’s happening to the world now, which is that both lines are inelastic and insensitive to what monetary policies (Fed fund rates cuts) and fiscal policies (The US Congress agreeing to US$2 trillion stimulus).

1. Consumer spending is inelastic.

This means that the IS line is inelastic. Regardless of what happens to decreasing interest rates, consumers will not spend more.

  • Mainly due to virus concerns. People are not only afraid of their jobs, but their lives.
  • I was talking to a friend recently and we said that it could be a case where consumer discretionary spending goes online. However, it will be near impossible to expect the same expenditure. It will take time for big-ticket items like houses, cars, eating out etc. to be fully replaced by online resolves.
  • And if the consumer market which is a method of calculating GDP as a consumption-based approach, this will definitely affect production. In this approach, any stimulus by the government does little to increase consumer spending. That means that even if the G gives you S$1,000 more today to spend, you may not spend it all to effect the stimulus they intend.
  • Thus, 1) social distancing, 2) although staple purchases like groceries remain, 3) discretionary purchases like houses and cars are reduced, 4) incomes are reduced
  • No matter how good the interest rate is now, you’re not going to buy a new house. You’ve got to see the house and showflat to make a purchase. It could be that these VR things will now take off, but that seems unlikely.

Covid-19 is a consumption driven recession, or the lack thereof rather.

2. Liquidity trap.

This happens when interest rates fall so low, that people do not see the return on holding debt, and rather hold on cash instead.

This scenario is depicted with an inelastic LM line.

In this case, if monetary policy is done to shift the LM curve outwards, output remains similar because people have no incentive to buy debt and the amount of money remains the same.

Source: https://web.mit.edu/

Thus this explains why despite 2 fed fund rate cuts, the market still did not respond likewise, and despite a US$2t stimulus agreed to by the US Congress, we do not see the futures increase as much, only +170.

2. Credit

I decided to cover credit rather than venture capital or private equity because this is where the discussion gets interesting. Most private equity and real estate use credit as well to leverage their investments so any credit discussion will be pertinent to VC/PE.

In the case of venture capital, the case is quite clear.

  • Tough for funds that have not received capital commitments into their bank accounts
  • Tough also for startups who have not received cash from investors. The entire equity game is at a standstill due to the various margin calls and uncertainty on revenues.
  • I covered on the consumers in the Economy portion
  • Would cover more on the businesses in this case
  • The key issue: Many businesses may go down under due to lack of income to pay for interest on their debt
  • The narrative is simple
  • Due to 1) Virus, 2) Oil prices, 3) VIX affecting businesses
  • Those that will be rated B- corporate ratings will suffer the most pressure and vulnerability
  • Based on
    1) Weak fundamentals
    2) Balance sheet and income statement exposure to industries that virus attacks more
    3) Weak cashflows
    4) Large debt maturities in the coming days
  • Key indicators to look at: 1) Valuation compared to net asset value, 2) Net gearing ratio, 3) Debt to market cap, 4) Interest coverage ratios
  • S&P is predicting a 10% default of spec-grade (usually B- and below) rated companies (GFC was 13%) in the US
  • *Note that the credit rating is a forward-looking indicator of whether someone can repay a credit, much like a futures
Source: S&P Global Ratings
  • Reason for these industries being selected is because this Covid-19 is a consumption-driven recession, or the lack thereof rather.
  • Discretionary purchases such as consumer goods, gaming, leisure, hotels, travel, retail and F&B are not being done as everyone is afraid to go out and also told to stay home
  • Thus, combining this and the above paragraph, look for companies within these industries that exhibit poor credit repayment quality.
  • Cost of NPLs is expected to hit US$100b in total default cost (most from China)
  • We will see the rise of Oaktree, SSG Capital and the rest of these high-yield, distressed debt, special situations players coming into the market and being the buyer

Look for companies in consumption-driven industries — 1) transport, 2) consumer discretionary, 3) Leisure and hotels, 4) Retail & F&B that exhibit poor credit repayment quality

Some other comments that were interesting (by S&P):

  • Countries that can pull through the crisis, reflected in sovereign ratings, will provide investors with critical information on their institutional and social resilience to react to crises, affecting their future FDI (foreign direct investment) flows
  • India NBFCs (nonbank financial companies) were already impacted before this Covid-19 and will not get as far worse. Non-performing assets were already high and can’t have that much deterioration compared to other countries
  • Japan banks are on a positive outlook since the government is fully supporting it

3. Policy

  • We are seeing a U-shaped recovery (there’s L, U, V shapes — just think of love lol I remember Seet Min Kok giving a heart shape in an NUS lecture) similar to AFC and GFC
  • This is a U-shaped instead of V-shaped because the initial shock is so drastic that revenue quality for corporates fall to the point that they stop investing in the short run, and thus unemployment increases
  • S&P is seeing GDP growth with 300bps (3%) taken out of its growth
  • Thus, the S&P 500 drop from peak to now (around 30%+) is not the end. We might be looking at 60%-80% fall (GFC was 56%). This is due to 1) 4–5 months of revenue to firms shaved off, 2) valuation multiples falling from 11x to around 6x. The percentage fall is around 60%-80% if you combine these 2 effects
  • Apart from virus containment, how fast the recovery depends on fiscal and monetary policies that can limit balance sheet and labour market scars (quoting S&P)
  • I covered on consumers earlier under Economy. Many will get retrenched due to a drastic fall in consumption.
  • For consumers, the key is consumption smoothing. It is about making sure they get the credit from the banks, don’t get sacked, thus increasing Keynesian growth.
  • For businesses, they are affected mainly by 1) revenues, 2) interest pressure, 3) exchange rates which affect their balance sheets
  • Especially for the private businesses (SMEs etc. that make up most of the market). They are in the worst position as price takers.

The S&P 500 drop from peak to now (around 30%+) is not the end. We might be looking at 60%-80% fall (GFC was 56%). This is due to 1) 4–5 months of revenue to firms shaved off, 2) valuation multiples falling from 11x to around 6x. The percentage fall is around 60%-80% if you combine these 2 effects

4. Actionables

It is an interesting time to be alive. When everyone is panicking around. My Pastor said on the pulpit that man thinks that it is very powerful. But all it takes is just a small virus that it cannot see to put it in its place. Imagine the whole world shutting down because of an enemy you can’t even see with your naked eye.

Not giving investment advice here — but the saying goes that you buy low and sell high. It applies to big real estate investors, and to the common man.

You can make gain from income/dividends but the best gain comes from capital gain/alpha.

The same industries, the same way at looking at which companies applies (refer to the analysis made in 2. Credit)

Of course, a word of caution will be to look at companies that are not under to the point that they will go bankrupt. Once it’s bankrupt, your shares are worthless. You want to find undervalued companies within this space that will eventually survive this COVID-19.

And there’s also those condos within the S$1–S$1.5m price range that was bought 2–3 years ago. With further unemployment, the bank will seize the asset eventually if one is unable to make interest payments and defaults on the mortgage loan eventually.

Of course, most of us do not earn income from stocks only or own businesses. Most are employees earning a wage.

Then the question is simple. Where do you see the future of your industry and job post-COVID? Which places should you go to which are bright post-COVID? Do you have the skills needed to get there? What will you do now to get the skills to get there?

The same fundamentals apply. The question will be access to these opportunities.

Interestingly, I was talking to some friends on what UHNWIs will sell first to cover their losses on capital gain and their margin calls. It will be yachts in Asia.

Unlike the West, Asian scions are not really into their yachts. They are expensive. They require a crew, and maintenance and lots of fees for docking, etc. We will see these coming into the market for cheap. Same applies to those who have 20 cars in their garages.

It is not that these yachts and cars are in bad condition. They just have no choice but to sell it for cashflow.

Thus, if I were to spell it out simply. It is to find opportunities that are considered non-core to the sellers.

The yacht is a non-core asset to many Asians.

Likewise, some companies may be diversified to the point that they actually are not as good in one non-core product/company, and they’ll be happy for you to take out that liability in this Covid-19 period. Of course, it must be said that if the company is in bad condition, it is still not a good buy.

For professional investors, find opportunities that are considered non-core to the sellers.

Find the non-core assets.

BRB while I continue reading on candlesticks and so on for technical analysis 🙂

  • Why the IS-LM model and not the IS-LM-BP (Mundell-Fleming) model? I thought the Mundell-Fleming model overcomplicates this scenario, with the need for explaining the impossible trinity, what is perfect/imperfect capital mobility and bringing the balance of payments and exchange rates into the picture. I think the analysis could be a lot better using BP+ and BP- and showing how the effects occur but to non-econs people this requires a whole economics lesson of its own

Seedly Contributor: Benjamin Wong

Investment Professional @ Alvarium | Board Advisor @ Payboy | Co-founder @ The Mentoring Circle; Atomos Watch Club & Cogito Collective

Benjamin Wong is a private equity investment professional with prior experience in private equity, management consulting, legal and entrepreneurship, covering diverse industries in Asia.

He was previously at Baring Private Equity Asia, Yamato Capital Partners, Kantar Consulting, Shopee, UOB, CMA CGM and EDB. He started his first startup in Junior College focusing on FinTech.

For readers who are interested in keeping up to date with developments in the economy, check out SeedlyRead’s news and perspectives on the economy!

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