Variant Perception

A Dance with a Depression

Conference call with Simon White

Simon believes that the BoE suggesting a 14% decline in growth is on the optimistic side. For comparison, the Atlanta Fed’s GDPNow Tracker is looking at a 35% decline for Q2 in the US. Variant’s leading indicators are beginning to register the shock - their 6 month indicator in the US has turned down sharply with no sign of an upturn. Feels like markets have priced everything in. Base case for companies is different - some will experience an L shape trajectory towards bankruptcy, U for those that will trickle back to profitability and V for those that can soak up the Fed stimulus and recover quickly. If we see a protracted embrace of social distancing measures, then there is a decent chance we could see depression-like conditions in the US and other countries. Simon discussed how vaccines are extremely difficult to produce. There have only been 17 successful vaccines in history. Rotavirus was identified in 1971 and there was no vaccine until 1993; HIV discovered in 1983 and there is still has no vaccine. Therefore 12 to 18 months to produce a vaccine is far too optimistic. Vaccines are not a high probability event and policymakers are giving a false sense of security and keeping social distancing measures in place. Whilst in the US you can see lockdowns easing and rate of infections falling, this is not the case in Emerging Markets which are easing lockdowns, but are seeing new cases rising.
The over 55’s in the US, which equates to around 40% of spending, are severely reducing their expenditure. Meanwhile, for the younger generation, protracted use of social distancing limits their ability to spend. As a result, this is going to be detrimental for smaller businesses. Companies earning less than $20m annually, can survive with ‘no income’ days for only 27 days on average - 16 days for restaurants. Variant surveys show that up to 50% of companies in the Russell 2000 could go bust; unemployment would reach depression levels (over 25%). Meanwhile, the large investment grade companies are on the receiving end of the fiscal stimulus. This increase in IG and even HY debt could be a tailwind for equities as they will suddenly become under owned. So, you could have this extraordinary situation when there are all these bankruptcies, yet the S&P is at all-time highs. This is not Variant’s base case, but if social distancing measures are not lifted in a timely and orderly way, it could become very real. Lockdowns are very easy to get into, but very difficult to come out of. Investors should therefore have tail hedges in their portfolio such as buying put options in iShares Russell 2000 and selling calls or call spreads in S&P 500. Also, shorting US smaller banks exposed to smaller businesses and commercial real estate. If we look at Europe, Italy’s debt to GDP level is going to get considerably worse; a major strain on the Euro. A cheap way of playing this with positive convexity and limited downside is the Euro Danish peg. The Danish krone has been pegged tightly to the Euro since the seventies, interest rates are very similar, so you can put on forwards for a portfolio tail hedge. Protect from inflation risks by investing in deep, out of the money call options, in gold, gold miners and silver. Libor curve should steepen so put on Euro-Dollar trades. Finally, Simon touched on China and believes there is a massive fiscal package coming, which is likely to be misallocated in infrastructure projects, but will boost commodities.