Uptimo Investment Theme-Post Covid19

“Every Pandemic in history has changed the world. Pandemics are like rivers. They alter national borders. They interrupt national alliances. They restructure internal political systems. There’s something about each one tough that is unique, and it goes way beyond the number of death and casualties” Dr. Larry Brilliant

Covid-19 is one of those events which brings changes in social, geopolitical, and economic relations. Things which used to take years to happen, are now occurring in a course of weeks:

  • The Fed was buying more than US$1 million in financial assets every second at the peak of pandemic
  • Global carbon emission falls by ~8% this year. This is roughly equal to the level India emits per year.
  • It took Netflix 7 years to reach 50 million users, Disney+ 5 months, and House party app just one month as people were stayed at home.
  • Hertz rental-car fleet, the second largest in the U.S. behind Enterprise, is selling one-third of its car(150,000 fleet) rents in US to adapt to post-Covid travel pattern
  • This is the good one: Sir Isaac Newton discovered gravity during great Plague of 1666 when he had to respect social distancing, so can we expect to hear about new discoveries anytime soon?

The current pandemic has accelerated already-in-progress secular shifts in global economy. Investors should take into account this changes in their asset allocation process. In this report we try to highlight some trends that will define different sectors aftermath of Covid-19.

 

1. Digitalization & Telecommunication

Ten years of companies migration to cloud could make an amiable infrastructure for rapid consumer digitalization ( e-commerce, working from home, online communication). Tech companies have a lot of highly attractive features (low leverage, short product cycles, used to deflation, scale, consolidation, employs relatively few people, higher recurring revenues) as well as offering growth against a backstop of no overinvestment. Telecommunication and all its supply chain will benefit as the sustainable and reliable connectivity will be even in more demand.

Cybersecurity will be indivisible ingredient of all this digitalization changes. As individual and institutional communication become more IT-based, the management of this venue suits more attention. We believe that while VPNs have been widely used for home working during the pandemic, these will be phase out gradually due to their inefficiencies and replaced by cloud-based connectivity and security software with zero trust network access. Identity governance, and cloud-based security engagement will be more in demand not to mention national security concerns due to more cyber-attack by adversaries.

Digitalization and automatization, what we call 4.0 in manufacturing, Proptech in real estate, and Contech in construction, will be the most important driving force of the next decade. This will be propelled by the lack of workers in developed countries, increasing costs for materials and important down pressures on selling price. The only way businesses will be able to survive will be to increase their efficiency through digitalization and automatization. This means it will require a lot of cash on hand to make the required investment.

While the global economy is dealing with a spike in unemployment and many companies are scrambling to raise money in the bond market, Technology companies are benefiting from changing consumer habits formed during the lockdown. In addition, Technology companies have fortress like balance sheets that are allowing them to reinvest in their business during this downturn.

2.    Infrastructure expenditure by governments

Developed countries (US, UK, Germany and Canada specifically) has used most of their bullet in the monetary front to stimulus their economies. As the real rate hovering near negative territory and Covid accelerated job erosion in disrupted sectors, the only game left in the town is to boost infrastructure spending to secure job market and improve productivity. When we look through broader economic lenses the huge government deficit will be a dent on future productivity growth in developed countries. Higher debt means more interest payment and without higher efficiency or/and more innovation the societies must sacrifice future growth by stuck in paying interest or will be left with huge currency devaluation and capital outflow. Having said that, we believe authorities will invest in infrastructure projects (connectivity, health care, sustainable energies, and education) to back innovation and efficiency.

In the short-run the unprecedented relief packages injected into the economies around the world make us adding the probability of levying higher taxes on the corporate sector and the wealthy (via a wealth tax on property) like situation after WWI and WWII. However, due to much easier mobility of capital now versus world war eras, authorities cannot increase taxes that much.

3- Less Globalization

For several decades, businesses in developed markets moved production offshore to countries with lower labor costs. China’s manufacturing value-added share reached ~25% globally from just 3% in 1990. Moreover, new inventory management systems (e.g. ‘just-in-time’) allowed companies to significantly reduce their working capital. The combination of the two also made supply chains significantly more complex and vulnerable to external shocks.

Replacing labor with automation, thanks to robots,  and elevated wages in some of emerging countries, as they getting richer, lead companies with high added value products to think onshoring their operations. We believe that President Trump’s policies were only an accelerator to this transformation. We doubt this process will be dramatic, however semiconductors and health care companies will be the first to move. Trade war between US and China and Covid accelerate this process as the companies realized how vulnerable are their supply chains. (e.g. medical device chaos during pandemic or Apple problem to secure its chips from China and Taiwan)

This is a trend which will have secular effect on transportation, warehouses, energy, and somehow job markets in the world. We are bullish on automation and robotic solutions, warehouse and inventory real estate and short haul transportation facilities ( we won’t be surprised seeing drone delivery for specific goods in the next 12 months).

4-Real Estate

Historically real estate as a hard asset benefits from extended period of low rate, let alone the negative one. Long period of low interest rate, quantitative easing and interfering of central banks in corporate credit market have increased asset prices and widen inequality in societies. Massive relief packages (7trillion just in US) left governments with huge deficit which should be finally financed through taxes and inflation. Investors should be very selective for their investment in housing market and avoid negative cashflow investments as they are abundant in big cities for speculative purposes. On top of these macro factors, we are thinking about lasting impact of Covid-19 on real estate:

  • Probability of tax increase in wealth. Although this happened after WWI and WWII, we do not expect any change in the magnitude this time around, because even a small tax increase can change the flow of money due to mobility of capital in developed markets. Having said that, we suggest less exposure to high end property market.
  • Long-term risk of elevated adoption of working from home could put pressure on office real estate. Facebook, Microsoft, Google, Citibank, to name a few, are planning for permanent work from home mandate.

Office prices have surged over the past decade, thanks to demand from institutional investors, and are now higher relative to property income assets. Office owners also tend to have more debt, in part because banks have been willing to lend more against assets, they deemed safe.  The recent trouble in the sector belies office buildings’ reputation as a safe holding because they are mostly leased to long-term tenants. But as the economy shrinks and businesses shutter we wonder if companies will be able to pay their rents in short term and whether they will continue renting offices at pre-Covid scale if they adapt to working from home. The office selloff indicates that trouble in commercial real estate is spreading beyond hotels and retail properties and now threatens much of the $16 trillion U.S. commercial real-estate market and the $4.5 trillion in mortgage debt secured by it. Working from home and less commuting to big cities, can also have impact on residential markets in big cities with overvalued prices, cities like Toronto, London, Paris, Vancouver, New York, and San Francisco. ( MoveBuddha, a research location website, says that searches for places in NY City’s suburbs are up almost 250% compared with this time last year.)

  • Increased inequality and ongoing structural change in workforce market result less affordability and more support for rental markets especially in lower tier cities.
  • The elderly population continues supporting rental market even more in developed countries. As baby boomers reach to their 60s, they prefer renting vs. owning for less headache and having more liquid assets at hand for their retirement. It is a ~15 years period before they move to senior housings. However, we expect lengthening of this period due to uncertainty around senior housing capability in combating contagious risks following Covid-19. The current pressure on Senior housings’ stocks vs. at-the-house treatment’s solutions is a clear reflection of the fact.
  • Agri-farms: Panic-purchases, lockdowns, restriction on travel and export/import, and governments food reserving for national securities signals the challenges agriculture supply chain will face. This could support more local production, which will support agriculture lands. We expect investment acceleration by institutions in agri-business and land improvements. Land and water will be the main definers of strategic advantage in this filed, of which Canada is in rich position. Implementing technologies can tackle Canadian high energy consumption rate in agriculture
  • Data centers, cellular towers, and logistic warehouses were some of the strongest growth trends before the Covid crisis and are benefiting from expanding digital economy and e-commerce. Looking forward, with introduction of 5G, global cheap satellite internet, and increasing penetration of smartphones, we do believe these group of investments continue to deliver outperformance.
  • Political stability, friendly immigration policies, abundance of natural resources, lower cost of living vs most of other developed countries, and robust job market are the factors bringing talented immigrants to Canada in the next decades, which is a big contributor to real estate sector. We want to reiterate again that Canadian real estate is a heterogeneous market with huge difference between west and east, small and big cities requiring active selection.

    5- Healthcare

    Covid-19 will amplify the importance of global healthcare and its social role. Right now, 10% of global GDP is spent on healthcare, of which 25% is wasted. This can be seen as the highest expenders in health care do not have the lower disease rate or longer life expectancy. Therefore, we are expecting huge investments on more efficient systems that focusing on value-based outcome, preventive care, and greater use of technology. In the US we are expecting to see increased debate about universal healthcare coverage as it is the only developed country does not have such a system. We are bullish on value-based health care, mobile medical, and medical analytics solutions.

In a more secular trend, developed economies are suffering from low productivity which is partially caused by elder population who stopped working because of physical incapabilities. Living longer should accompanied with longer productivity to have sustainable economic and social systems. Therefore, the need for a massive revolution in biological research applied to medical care. A range of diseases must be eliminated, such as Parkinson, Alzheimer, and brain disorders which are render the elderly non-contributors on the economy. Successful global laboratory collaboration that we are observing right now to combat Covid-19 will facilitate this development.

 

Uptimo Investment Research

May 2020

https://uptimo.ca/

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