by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Our latest Confluence of Ideas podcast episode is now available, titled “The 2020 Election: Part 2.”  In our “2020 Geopolitical Outlook,” we named the 2020 U.S. election as a key event.  Our recent five-part Weekly Geopolitical Report series examined this issue in more detail.  This is the second of three podcast episodes that will look at the 2020 election.  In this episode, we discuss the issue of inequality and the rise of populism, the impact of social media, and the current problems of extreme partisanship and political legitimacy.

As usual in recent weeks, the financial markets today reflect a tug-of-war between coronavirus optimism, and renewed outbreaks and lockdowns in a growing list of countries, states and localities.  As described below, the renewed outbreaks and lockdowns seem to be winning of late, helping reverse an initial uptrend in the stock market yesterday.  Just as important, we also review several indications that relations are continuing to worsen between China and the Western democracies, which is a further threat to global risk assets.

COVID-19:  Official data show confirmed cases have risen to 13,127,030 worldwide, with 573,664 deaths and 7,280,515 recoveries.  In the United States, confirmed cases rose to 3,364,704, with 135,615 deaths and 1,031,939 recoveries.  Here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• Responding to the recent surge of infections in California, state officials ordered an immediate lockdown on indoor activities at restaurants, bars, museums, zoos and movie theaters.  In addition, the main school districts in Los Angeles and San Diego said they would start the school year solely online.  Separately, Oregon Governor Kate Brown ordered a ban on most indoor social gatherings of more than 10 people, and said the state would require people to wear masks outside when they can’t properly social distance.
  • Coupled with renewed lockdowns in other areas, these measures underscore the risk of renewed economic damage from the resurgence in infections in the South and West.  Even though this round of infections has mostly affected the younger, healthier victims that typically handle the disease better, intensive-care capacity is already being stretched to the limit in some areas and the first hints of a resurgence in deaths is already visible.
  • If those trends continue, more state and local governments are likely to reimpose their lockdowns to protect the most vulnerable – a move that would probably lead to another retreat in equity prices.
• Compounding the negative news from the U.S., the Walt Disney Company (DIS, 116.22) said it is reclosing its Hong Kong Disneyland theme park, just a month after it reopened, because of a resurgence of infections in the city.  The closure comes as Hong Kong officials said all activities such as large social gatherings, dining in at restaurants and going to the gym would be temporarily suspended.
• The British government said face masks will be required for anyone entering retail stores in England beginning on July 24, on top of the existing requirement to wear a mask on public transport.  Cabinet Office Minister Michael Gove had said on Sunday that masks should not be made mandatory, but the government overruled him on grounds that “there is growing evidence that wearing a face covering in an enclosed space helps protect individuals and those around them from coronavirus.”  The decision brings England in line with Scotland, Germany, Italy and several other European countries and locales.
• In South Africa, a sharp resurgence of coronavirus cases has forced the government to reimpose its lockdowns, including a ban on alcohol sales and a curfew.
• Economic reports from Europe and Asia today show continued deep economic scarring from the virus lockdowns (see data below), including an annualized drop of 41.2% in Singapore’s second quarter GDP.
• If you’re looking for more evidence that some things will never be the same after the virus crisis, recent polling shows that a large percentage of Japanese commuters don’t want to go back to the office and submit themselves again to the nightmare known as Japanese public transport.  The reporting highlights the risk that many office complexes around the world could end up being less utilized and less valuable going forward.

Foreign Policy Response

• Germany continues to show surprisingly strong support for the European Commission’s proposed €750 billion coronavirus recovery package, which is expected to include a large program of joint, mutualized EU debt.  Chancellor Merkel yesterday insisted the package had to be “massive.”  In fact, she insisted that, “Europe wants to stick together in this difficult time,” illustrating Germany’s fresh sense of leadership in the EU as the U.S. pulls back from its traditional role as global hegemon.

United States-China:  In a major shift away from the previous U.S. policy of not taking sides in territorial disputes where it is not involved, Secretary of State Pompeo said the United States has formally rejected a range of Chinese territorial claims against its neighbors in the South China Sea.  In his statement, Pompeo characterized the decision as an effort to uphold international law against what he called a “might makes right” campaign by China to coerce and intimidate its Southeast Asian neighbors into ceding their interests.  Although it wasn’t immediately clear what the practical implications of the policy shift will be, there is a high risk that the move will exacerbate U.S.-China tensions in trade, technology, human rights and other areas.  At the extreme, the move could also raise the risk of military confrontation with China at some point down the road, so it is a decided negative for equities and bears close watching.

China-United Kingdom:  Buckling to U.S. pressure, the U.K. did an about-face and banned Chinese telecom giant Huawei (002502.SZ, 3.07) from the country’s 5G communications network.  The company will be banned from supplying new equipment to Britain’s 5G networks from December 31, while existing Huawei equipment must be stripped from 5G networks by 2027.  The move, which aims to prevent Huawei’s equipment from being used for Chinese spying or influence operations, illustrates the growing global pushback against China’s political, economic and technological rise.  Not only does that pushback portend a potential conflict with China at some point in the future, but it also has the potential to crimp Chinese economic growth and the success of its firms as they attempt to expand overseas.  As noted above, the pushback is therefore a growing risk for global risk assets.

China-Hong Kong-United Kingdom:  The British government estimated about 200,000 residents of Hong Kong could apply for special “British National Overseas” passports and emigrate to the U.K. under Foreign Secretary Raab’s offer last month.  That’s far below the 3,000,000 or so who are eligible for the passports, but even that level of emigration would likely anger Beijing and further strain relations between China and the West.

United States:  A fire in port has caused major damage to the USS Bonhomme Richard, one of the Navy‘s few amphibious assault ships capable of conducting offensive operations like an aircraft carrier.  According to officials, the damage is so severe that it may be impractical to repair.  If the ship is lost, it would significantly reduce U.S. ability to project power around the world for an extended period.

European Union:  The European Commission is reportedly planning to clamp down on the sweetheart tax deals that some smaller countries have offered to multinational firms.  Crucially, unlike ordinary tax legislation in the EU, the initiative would only require the backing of a qualified majority of the EU’s 27 member states rather than unanimous support of all countries.  That would limit any government’s ability to wield a veto, although the measure would also need approval from the European parliament.

View PDF

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  Global equity markets are higher this morning.  There is a good deal of foreign news today, including Poland’s election news and Turkey’s controversial move to change a museum into a mosque.  China will be next in line, followed by our update of the pandemic news.  We will close with policy and economic/market news. Here are the details:

Foreign news:

• The preliminary results from Poland’s runoff election show that the Law and Justice Party incumbent Andrzej Duda has squeezed out a narrow victory, although his opponent, Rafal Trzaskowski, has not yet conceded, saying the election is still too close to call. Final totals are expected tomorrow.  The Law and Justice Party is right-wing populist and has strained relations with the EU.  The narrowness of the victory suggests Poland is closely divided; voting distribution shows that the incumbent party dominated the eastern parts of Poland, whereas the centrist parties do better in the western areas.
• Turkish President Erdogan’s government won a court case to convert the Hagia Sophia from a museum to a mosque. The facility was originally the premier church of Eastern Orthodoxy but was converted to a mosque by the Ottoman empire.  After creating modern-secular Turkey after WWI, Ataturk made the facility a museum.  The action is not sitting well among the Orthodox.
• The EU is in preparing for critical talks over the €750 B aid package that would include a Eurobond. The frugal nations are pushing for fewer grants and reforms as part of the package; this is a non-starter.  If the EU is unable to make this work, it would be a major setback.  However, we think that Germany has too much at stake; one key problem in Europe is that export growth remains sluggish, which is hurting Berlin.  Thus, the support package will likely help Germany too, so we expect Chancellor Merkel to eventually drive the program forward.
• In Russia, widespread protests have emerged in the Far Eastern regions over Putin’s decision to oust a popular, but apparently corrupt, governor. Unlike protests in the major cities east of the Urals, these protestors are not those calling for more democracy but are, instead, tied to a particular person.
  • The Netherlands is bringing Russia to court over the downing of flight MH17.

China news:

• In retaliation for the U.S. sanctioning Chinese officials over the Uighurs, Beijing has sanctioned several U.S. officials, mostly member of Congress. This action was expected and the fact that no major members of the administration were targeted suggests this was a measured response.
• Despite the recent National Security Law crackdown, primaries held by pro-democracy parties saw a massive turnout, a snub to the Xi regime.
• The U.K. is taking steps to reduce their use of Huawei (002502, CNY 3.09) equipment in 5G networks and supporting a broader ban by the “Five-Eyes” network. The latter will almost certainly require the creating of equipment alternatives which will need government investment support.
• We are seeing improving industrial metals prices, which is attributed to expectations of Chinese stimulus. Although we do expect authorities in China to inject fiscal and monetary stimulus, it is likely that it will be much less than what we saw coming out of the 2007-09 downturn.

COVID-19:   The number of reported cases is 12,932,640 with 569,666 deaths and 7,139,672 recoveries.   In the U.S., there are 3,304,942 confirmed cases with 135,205 deaths and 1,006,326 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases across nations using similar scaling metrics.  All but seven states have a reproduction rate over 1.0, meaning that the virus is spreading at an increasing rate.

Virology:

• As the number of cases in the U.S. rise, we are seeing new evidence that households are returning to earlier sheltering behavior; we are seeing a rise in canned soup and flour sales.
• In the race to develop a vaccine, a couple of concerns have emerged. First, a recent U.K. study suggests antibodies against the virus from those who have been exposed dissipate in about three months.  Thus, COVID-19 is acting much like common colds and influenza, in that a single infection doesn’t grant long term immunity.  This may mean that high-risk groups will need to be vaccinated on a regular cycle and that the disease may be a plague upon humanity until it mutates into a less virulent form.  Second, lost in the raging debate over reopening schools is how the virus affects children.  It appears that most children are only mildly affected by the disease, but there are rare cases of MIS-C, which is similar to Kawasaki disease.  MIS-C seems to be an immune response issue, meaning that (a) it isn’t the pathogen but the body’s reaction that the problem and, (b) vaccination may actually increase the risk of trigging this response.
• Researchers are not only working to create a vaccine but are also taking steps to insure it is safe. There is a response, known as “disease enhancement,” where a vaccinated person comes down with a severe case of the disease.  Given the already elevated level of vaccine fear, a vaccine that triggers cases of the disease would be a real problem, as it may discourage people from accepting the vaccine and thus reduce the odds of building herd immunity.
• One of the hopes was that COVID-19 would dissipate under warm summer weather. After fall, flu and colds have a season and that is fall and winter.  However, summer hasn’t slowed the spread of the virus and researchers have been investigating to see why.  The key reason seems to be that there simply isn’t enough herd immunity yet to allow summer to reduce infections.  A secondary reason is that the virus seems to spread best indoors; in the summer, as temps rise in the south (it’s 94^o at 5:00 am Phoenix…yes, it’s a “dry heat” but the forecast calls for 111^o today) people tend to move indoors.  Note that in northern parts of the country, cases have fallen, perhaps because it isn’t as hot, and people are not congregating inside.
• Now, some good news and some bad news.
• The good news is that Italian researchers believe that the virus may be mutating into a less virulent form, noting that more people are seeing asymptomatic infections and complex cases in Italy have declined. The debate among scientists is raging, but it would not be unusual for a coronavirus to mutate in this fashion.
• Kazakhstan is reporting an ‘unknown pneumonia’ that is deadlier than COVID-19 and appears to be spreading. It is not clear if it is a coronavirus or something else, but the country has implemented a lockdown.

Policy news:

• The Treasury and the Fed are having a disagreement about the terms and conditions of the Main Street lending program. The Fed wanted relaxed terms of conditions to encourage borrowing; the Treasury, which would be saddled with losses, has pushed for a more cautious program.  Although the differences make sense given who bears the risk, reluctance to lend is now a concern.
• On July 21, the Senate is expected to hold confirmation hearings on Christopher Waller and Judy Shelton for Fed governor. Although Waller is a shoo-in, Shelton is controversial on both sides of the aisle and may not make it through the process.
• We are again heading toward deadlines for another round of fiscal stimulus. Although the White House and Democrats appear open to more spending, Senate GOP members are less enthused.  There is a risk to the economy (and equities) if no agreement or an inadequate agreement is reached.  However, we would expect the Fed to expand lending if Congress fails to act.  It just isn’t clear how much the Fed can do to directly intervene.   The pace of recovery does appear to be slowing, which should prompt policy action.
• The U.S. is considering $1.3 B of French luxury goods with a 25% tariff in retaliation for a digital tax.

 Market and Economy news:

• OPEC appears to be easing output restrictions. We assume the cartel leadership is signaling it will live with oil prices in a $30/$40 range for the foreseeable future and gambling that this level will prevent a surge in shale production.  We tend to agree with this assessment.
• Last year, Congress passed the Small Business Reorganization Act. The law made it easier for small businesses to go bankrupt using Chapter 11, instead of the more common Chapter 8.  The latter tends to liquidate the business and pay off creditors from the proceeds; the former ends collection efforts and allows the firm to reorganize but tends to mean creditors have to accept less attractive terms.  This new law went into effect in February and we are seeing a rash of bankruptcy filings.  Although some commentators have noted the rise in bankruptcies, suggesting that there is trouble in the economy, it appears that at least some of the actions are due to more attractive terms for borrowers.  The new law gives small business borrowers leverage in negotiations and thus they can extract better terms in negotiations.
• As we have noted, one of the features of the past bull market was a higher level of buybacks and fewer new issues. That situation has changed in this recovery as firms are using “blank-check companies” to facilitate tapping the public markets for liquidity.  This action suggests that firms see the rising stock market as an opportunity, which in the past, has suggested a frothy equity market.  Of course, with the recent aggressive expansion of the Fed’s balance sheet, liquidity is looking for a “home” and equities are one place the funds can go.
• The other may be Chinese government bonds. Chinese local currency bonds are yielding 3.11% for 10-years and the PBOC has controlled the exchange rate successfully for some time.  It is a well-known fact that China’s debt load is extraordinarily large.  Tapping foreign investors may be the last frontier for China to attract funds to eventually resolve the debt overhang.  Thus, in the long run, the risk of these bonds is high, but in the short run, they are very attractive.

View PDF

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

Good morning and happy Friday!  Being Friday, there is a new Asset Allocation Weekly, associated podcast and chartbook, all available for the weekend.  U.S. equity futures and global equities are taking a breather.  Conditions with China continue to deteriorate.  It looks like another round of fiscal spending is on the way.  There are growing worries about the pandemic’s resurgence weakening economic growth and it is also affecting the capital/labor tradeoff.  At the same time, it isn’t all bad news.  Gold and lumber have been doing quite well.  We update foreign news and COVID-19.  Let’s run through the tape:

China news:

• The U.S. has formally sanctioned high-ranking Chinese officials over Xinjiang. Overall, four officials were named, including Chen Quanguo, the CPC secretary of Xinjiang.  Three of the officials will be banned from entering the U.S.; China has not responded yet, but we fully expect retaliation.
  • As an aside, we remain surprised that both sides continue to support the Phase One trade deal. We suspect the arrangement is under threat and have noted that China is well behind its targets.  However, a formal rejection of the deal would have a negative ripple effect on financial markets, leaving it abundantly clear that relations were in trouble.
• The long arm of the dollar is showing its power with relation to Hong Kong. S. and European banks are conducting audits of their clients to see if any are controlled by Chinese or Hong Kong officials that are at risk of being sanctioned.  It is expected that relations with these clients will be severed to avoid losing access to dollar markets.
  • We are seeing a dual system developing in technology. It looks like a dual system of finance may not be far behind.  In terms of finance, China will have a hard time competing with the universality of the dollar and the deep U.S. financial system.
• A recent roundtable discussion noted that Chinese companies listed in the U.S. continue to vary from U.S. auditing standards. It is almost impossible to avoid the risk of non-compliance in passive products, leaving U.S. investors unwittingly exposed to financial reporting issues.
• Iran is cozying up to China; this action will almost certainly add to pressure from U.S. lawmakers to add sanctions on China.

Policy news:

• Treasury Secretary Mnuchin is working with Congress for another stimulus bill. Most of the current measures expire at the end of July.  Expect the bill to adjust the unemployment payments.  The $600 per week flat payout won’t be extended.  We would expect the payment to be a mere replacement of lost income with some additional support for workers in industries hardest hit.  Whenever you make a blanket payout, there will be externalities introduced.  However, it should be remembered that in the initial package, due to the uncertainty, the $600 per week extra cash made sense.  It also makes sense to adjust the program to make it less attractive to stay home.  At the same time, another round of stimulus checks is highly probable.
  • What we will be watching for is if the bill includes help for state and local governments.
  • The White House is looking for a $1.0 trillion package; Congressional Democrats are pushing for a larger bill. We expect one larger than $1.0 trillion as well.

Market and Economy news:

• The meatpacking industry has been hit hard by COVID-19. Workers operate in close quarters, in cold conditions, that seem to allow for the spread of the virus.  In response, the industry is looking to increase automation, which would reduce the number of workers and perhaps allow them to work in less-contained environments.  The pandemic has introduced new trends in the economy, including work-from-home, cashless payments and increased use of store pickup.  What we are seeing in meatpacking is consistent with what we are seeing across the economy.
• The IEA reported that global oil supply fell 2.4 mbpd in June to a nine-year low of 86.9 mbpd. Global consumption fell 16.4 mbpd in Q2.  The IEA is expecting both supply and demand to rise next year, but both are dependent on the path of the post-pandemic recovery.
• In addition to strong equity markets, two commodities have been doing very well, precious metals and lumber. The former is benefiting from low to negative interest rates around the world and the expansion of central bank balance sheets.  The latter is enjoying a boost in demand; as we are stuck at home, we are apparently doing more projects that include lumber.  We are also seeing a surge in homeownership rates as the millennial generation move into their homebuying years.  That will likely lead to an increase in homebuilding that could get supported by telecommuting, which would encourage younger households living in exorbitant tax rate states to consider relocating to lower cost venues.
• Chinese equities have been rising recently, supported by state efforts to encourage stock buying. Authorities in China are apparently worried that things are getting out of hand.  Two state-owned funds sold stocks this week to cool prices.
• In recent years, we have seen steady stock buybacks that have led the S&P 500 divisor to fall, despite a long bull market. Essentially, despite rising equity values, companies tended to withdraw more stocks from the market than were added either by IPOs or by new issuance.  That isn’t what we are seeing now.  Companies are taking advantage of the market strength to issue new shares; the issuance will likely weigh on stocks.  If the divisor rises, it lowers the earnings per share, all else held equal.
• California has belatedly joined an antitrust lawsuit brought by state attorney generals against Google (GOOGL, 1518.66). Since the company is headquartered in the Golden State, there has been reluctance to join the effort.  The fact that California has joined is not good news for the company.

Foreign news:

• The deadline for Brexit is approaching at month’s end and negotiators say “significant divergences” remain between the U.K. and the EU. At the same time, financial firms in both jurisdictions will continue to have access to each other’s infrastructure.  The EU is warning Westminster that border checks for U.K. citizens are likely.  Turkey and the U.K. are close to a free trade agreement.
• The U.S. and U.K. have taken aggressive steps in response to China’s actions on Hong Kong. The EU, so far, has been reluctant to take measures against China, worried about disrupting economic relations.
• The runoff election in Poland will be held this weekend.

COVID-19:   The number of reported cases is 12,294,117 with 555,531 deaths and 6,760,631 recoveries.   In the U.S., there are 3,118,168 confirmed cases with 133,291 deaths and 969,111 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases across nations using similar scaling metrics.

Virology:

• The WHO has finally capitulated and confirmed that COVID-19 can spread through droplets suspended in the air. This fact makes large, crowded indoor gatherings particularly dangerous.
• Bolivia’s president has tested positive for the virus.
• A German biotech firm, BioNTech (BNTX, 65.61), says it will likely have a vaccine ready for regulatory approval by year’s end.
• On the topic of vaccines, we are seeing a disturbing trend in vaccine nationalism that could end up causing problems. For example, if a country decides to only support its “national champion” to the exclusion of all others, it could lead to that nation not getting timely vaccine supplies if another nation gets there first.
• The U.S. appears to be inadvertently engaging in the development of herd immunity. By allowing the virus to spread among younger people, more are becoming infected.  If contracting the virus leads to some level of immunity, it might make sense to do so.  However, it still isn’t clear how much immunity an infected person retains.  Another problem is that if a nation decides to go the route of establishing herd immunity, it should put policies in place to protect the most vulnerable; that really hasn’t happened on a national level.
• Iran claims it has used drugs designed for Hepatis C as an antiviral treatment for COVID-19. The two drugs, sofosbuvir and daclatasvir, appear to have reduced symptoms of the virus in three trials with control groups.

View the complete PDF

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

Good morning.  Global equities are higher as Chinese markets continue on a tear.  News on China leads our commentary this morning.  Our usual update of the pandemic follows, along with foreign news, an update on policy, market action and the economy.  The updated Weekly Energy Update is available.  Off to work:

China news:

• China’s foreign minister, Wang Yi, gave a speech this morning suggesting that current relations are at their lowest point since normalization in 1979.
• Since taking power in 2012, Chairman Xi has aggressively consolidated control through a number of measures, including jettisoning informal term limits and purges of enemies. We noted a recent event where leaders close to Xi appeared to be instituting an aggressive crackdown on the legal system through a program of re-education (a long standing favorite tool of communists everywhere).  We are a bit surprised by the ferocity of this response; after all, there has been scant evidence of an independent judiciary for some time in China.  The fact that Xi seems to think these measures are necessary suggests a leader that is still unsure of his position, despite overwhelming evidence he has quelled opposition.  Either (a) Xi is becoming increasingly insecure, or (b) like Mao, he sees these sorts of measures as the way China is to be governed, a situation of constant “revolutionary” turmoil.
• There are reports that the U.S. is considering steps to undermine the Hong Kong dollar’s peg to the U.S. dollar. Hong Kong uses a currency board and issues its own currency based on U.S. dollars held in reserve.  If the U.S. were to deny the Hong Kong currency board access to U.S. dollars, the board could only issue new Hong Kong dollars by allowing the currency to depreciate.  It doesn’t appear that this action is imminent, although the very fact that it is under consideration suggests a deep deterioration of relations between China and the U.S.  Interestingly enough, Hong Kong has been experiencing inflows from abroad, which has required the currency board to intervene to prevent the Hong Kong currency from appreciating.
• The U.S. has put visa restrictions on Chinese officials involved in setting Beijing’s Tibet policy. China has retaliated.
• China is criticizing U.S. fiscal stimulus, fearing a drop in the dollar and calling for a new reserve arrangement. We note the CNY rallied this morning and this market action might be raising concerns in Beijing. This call for another reserve currency isn’t new, but there is a lack of attractive alternatives to the dollar.  We do note, in a recent WGR, we discussed that the potential for a Eurobond might be an attractive vehicle for reserve purposes.
• FBI Director Wray gave a speech at the Hudson Institute where he indicated the Chinese government and the CPC are a threat to U.S. economic and national security.
• It appears that if the U.S. wants to prevent the use of Huawei (002502, CNY 2.86) equipment, it is going to require the building of alternatives. In other words, the U.S. government may need to fund the creation of 5G equipment from firms other than Huawei. Meanwhile, the company is asking the K. to slow its decision on using Huawei’s 5G equipment, fearing it will be ejected from the British market.
• Despite the end of the “one-child policy” and steps to encourage additional births, Chinese couples apparently didn’t get the memo, as births hit a new low in 2019.
• Over the past couple of weeks, we have been reporting on massive flooding in south-central China along the Yangtze River. The sluice gates have been opened at the Three Gorges Dam which will exacerbate flooding downstream.  The current death/missing toll is 119.
• The Institute of International Finance (IFF) estimates that China’s total debt is 317% of GDP at the end of Q1 2020. That is up from 300% in Q4 2019 and the largest quarterly rise in history.  Consumer debt is the fastest growing segment.  Foreign investment in China’s bonds is only 2% of the total; the vast majority of China’s bonds and debt are held internally.  The rise in debt is likely tied to stimulus efforts tied to the economic recovery from the pandemic.  In related news, we note that a Chinese developer has not paid its bondholders.
• Chancellor Merkel has come under criticism for her government’s tepid opposition to China’s actions in Hong Kong. Germany is trying to maintain economic relations with China in a period where Beijing’s actions are making it difficult to keep such ties.
• The new national security law for Hong Kong makes it illegal for anyone to promote democratic reforms or criticize the government. This includes people living outside of China or Hong Kong.  The extensive reach of this law is remarkable; it begs for a global response.
  • Meanwhile, China’s secret police have officially taken up residence in Hong Kong.
  • S. tech firms are trying to decide if they can safely continue to operate in Hong Kong.
• There have been worries that the new security law will undermine Hong Kong’s financial firms. At the same time, Beijing needs Hong Kong’s expertise in this area and we suspect that Chairman Xi will take steps to support the financial firms in Hong Kong while he cracks down on security.  Although we are early in the process, recent listings by Chinese tech firms in Hong Kong suggest that the former colony’s financial prowess will likely be preserved, at least for now.

COVID-19:  The number of reported cases is 12,062,863 with 549,900 deaths and 6,609,462 recoveries.  In the U.S., there are 3,055,144 confirmed cases with 132,309 deaths and 953,420 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases across nations using similar scaling metrics.  Axios has updated its state cases chart.

Virology:

• In the race for a vaccine, the U.S. has committed $2.0 billion to two companies, Novavax (NVAX, 101.44) and Regeneron Pharmaceuticals (REGN, 654.42) who are working on vaccine candidates as part of Operation Warp Speed.
• Testing is being conducted on a drug derived from the blood plasma of former COVID-19 patients. The drug may work for both treatment and as a prophylactic for the disease.
• As testing increases, wait times for test results have increased as well. This development is a problem because a tested person doesn’t know if they should continue their normal activities, assuming a negative test result, or self-quarantine, fearing a positive one.
• Although mask wearing remains controversial, we note a natural experiment that occurred in Germany suggests mask use does reduce the spread of infections.  In March and April, some German states required masks, others did not.  Researchers were able to measure infection differences and conclude that mask wearing reduced inflection spread by 40% compared to areas that didn’t have similar rules.
• Another area of controversy is the debate over airborne transmission. The fact that infections appear tied to events held indoors in close quarters suggests that the virus is probably airborne and can stay in that state for long periods of time.  However, WHO continues to say that the evidence is inconclusive.   If it is established that a prime transmission factor is indoor crowded events, mitigation measures could be adopted, e.g., more outdoor events, crowd spacing, masks, improved ventilation, etc.  But as long as the messaging is inconclusive, mitigation measures will likely not be adopted.
• As hospitalizations rise, the health care system is reporting growing shortages of personal protection equipment.

Policy news:

• Nearly 60% of Americans have nothing saved for retirement. States are now moving to address this problem by creating programs to strongly encourage companies and individuals to start IRA contributions.
• Recently, Washington issued rules that required foreign college students to take classes in person. This action will either mean that colleges will need to take on campus students to retain and attract foreign students, or continue online classes and lose this source of tuition revenue.  This trend comes along with an anticipated decline in Chinese students due to deteriorating relations.
• Last September (seems so long ago, doesn’t it?) the financial markets were roiled by problems in the repo markets. Although Fed officials still seem to struggle to explain what exactly happened, the response was to flood the non-bank financial system with liquidity.  The balance sheet contraction ended and has expanded with abandon with the onset of the pandemic.  One sign of good news is that the Fed has withdrawn specific repo support due to the lack of demand.  Of course, when one sends the balance sheet to historic highs, one shouldn’t see problems in the short-term funding markets.
• One of the areas of risk to the economy are state and local governments. Unlike the Federal government, the state and local governments don’t issue debt in a currency they control and so their spending is pro-cyclical; it rises and falls with the business cycle.  Due to the downturn in the economy, state and local government spending is showing signs of falling, and if the Federal government fails to intervene, it could undermine Federal stimulus efforts.
• The entire housing payments chain is at risk as well. Renters and homeowners pay rent or mortgages respectively.  These payments flow to landlords or mortgage servicers and these flows eventually end up in mortgage backed securities.  There are government programs that offer protection to bondholders, but little support is available downstream.  Congress continues to discuss another stimulus package; some of the last one did support the housing payments chain.  If additional support isn’t forthcoming, the housing payments chain is at risk.  Interestingly enough, this problem is also a threat to state and local governments, because if this payment chain is broken, property tax payments will likely fall as well.

Foreign news:

• Yesterday, Mexican President Andrés Manuel López Obrador, commonly known as AMLO, made a rare foreign trip to Washington to mark the implementation of USMCA.  Although the relationship between Presidents Trump and AMLO was rocky at first, they have gotten along rather well over time.  Relations between Mexico and the U.S. have improved over the past two years.
• The U.K. Johnson government unveiled a massive fiscal support package to help the economy’s recovery. Much of it is based on funding to subsidize returning workers.
  • Scotland is rejecting Westminster’s food and environmental standards, showing continued divergences within the United Kingdom. Separatism in Scotland has been rising, in part due to disagreements over Brexit.
• Saudi Arabia is planning a summit meeting with Chinese officials. As the U.S. loses interest in the Middle East, the high revenue/low population nations in the Middle East will look for new patrons.
• It appears some European banks inadvertently purchased bonds issued by front companies for organized crime.
• Argentina has improved its offer for restructuring its defaulted bonds, taking the offer to 53.5 cents on the dollar, from 40 cents. The response from creditors was positive.

Market and Economy news:

• Although equity indices continue their impressive run, the equity market internals show that the industry’s most sensitive to reopening—travel, leisure and entertainment—are lagging. The so-called “reopening” trade has been stalling.   High frequency data in states hit by surging cases tends to confirm what is happening in the equity market.
• S. companies are cutting dividends aggressively, the fastest pace since 2009.
• While equities have rallied, precious metals have as well. We also note that industrial metals prices have improved too.  In the China section, we note that debt levels are surging, evidence that monetary stimulus is in place.  Aggressive monetary stimulus globally is a support for precious metals while Chinese stimulus is a boost for industrial metals prices.  Inflows into gold ETFs have been rising lately as investors add the yellow metal to portfolios in light of these factors.
• The Atlanta FRB’s CFO survey suggests that employment will remain below pre-pandemic levels through all of next year. Fed presidents from Atlanta, Boston and Richmond all suggest that the economy may be stalling, which would suggest that policy support from the Fed will likely remain in place.

View the complete PDF