Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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December 5, 2020

Vaccine & Solvency Problems, The Everything Trade & “Non”


Now we have them we can look forward to vaccines becoming the next escalation point in our ongoing culture war. As the Brexit divide moves into the background and Kier Starmer looks set to back any deal Boris might put forward, the vaccine divide will take this years great mask divide to a whole new level. Should vaccines been made compulsory? Should we need vaccine passports to get access to public spaces, planes, trains and concert venues? Should children be made to have vaccines to attend school? If we want to travel to certain parts of the world we don’t usually think twice about being vaccinated as required, but to go about our normal daily routine, this is going to be difficult for many people to accept. In fact the more some people feel they are being strong armed into taking a vaccine, the more they are likely to resist. You already get the impression from certain branches of the media that these are just anti-vaxxer crazies who have been put in the “too stupid to matter” category along with Brexiteers and lockdown sceptics. Just because Trump lost, and Boris has tacked to the centre, it is too hasty to dismiss the rise of the foil hatted conspiracists, populists and Q-anon influencers just yet. We have already heard from a few politicians who are keen to be seen publicly taking their jabs. I suspect we might be offered the Great British Jab Off or I’m a Celebrity Get Me Vaccinated as new reality TV fodder for next year. Maybe the Queen’s Christmas message might include special section of her and Phil being vaccinated.


Back in March when the realisation first dawned that we were headed for lockdown the world entered a liquidity crisis. We underwent a mini-rerun of the 08/09 financial crisis. This time the financial world didn’t bring it upon itself. The banks were still slumped on the ropes of post GFC regulation, unable to play a part. Regardless, Central Bankers and governments sprang into action a pulled off a “Draghi”, making clear their ability to underwrite the economy and its short term liquidity needs was limitless. The short term pain of COVID was cushioned. Many people felt better off as a result and more protected from the dangers of a hostile world.


Fast forward to the new post vaccine world of the the Big Reopening Trade and the liquidity crisis has been replaced with a liquidity surfeit. We have seen a rotation trade into old economy favourites and travel and leisure stocks that in aggregate probably has many months to run. But we have also  started to witness a solvency crisis. In the UK we had news this week that both Arcadia and Debenhams have gone into administration. No amount of liquidity will keep these dinosaurs alive. They are simply insolvent. Without COVID both may have limped on for a few more years, but the writing has been on the wall for a while for both companies. Their well known structural shortcomings were compounded by not having the balance sheet flexibility to adapt and survive. Both companies have seen their demise accelerated by greedy former owners who piled excessive debt on top of business models with glaring structural weaknesses.


Modern financial theory (which is now some 50 years old and largely discredited) suggests that the level of debt in a business does not affect its valuation. Common sense and observation of reality tells you that excessive debt kills equity value. This is because it represents a prior call on earnings, representing an existential threat to equity owners. But by not keeping a resilient balance sheet companies also lose out on optionality in periods of radical uncertainty. Debenhams and Arcadia have essentially been asset stripped by previous owners and left with no viable future or ability to adapt.


This week a warning shot was fired in a new solvency crisis for cinema operators. Warner Bros. studios announced that for 2021 they would be launching their new movie releases to their HBO Max streaming platform simultaneously to the cinema chains. Another example where the content owners are turning the screw on the distributors. UK listed Cineworld, as recently 2018 geared itself up  to make a “transformational acquisition” (spoiler alert) of a major US cinema chain Regal. Having managed to wriggle out of its planned follow on acquisition in late 2019 of Canada’s largest cinema chain, Cineworld still went into the COVID lockdown period in a precarious financial position. The lockdown period has arguably changed everything for cinema attendances, maybe temporarily, but probably forever. Whether Cineworld survives 2021 or not, it is structurally flawed and its long term solvency problem has been amplified by an excessively indebted balance sheet.


Interestingly another media company announced this week what could be a technological achievement that surpasses even the recent vaccine developments in terms of its long term beneficial impact on human wellbeing. Google owner Alphabet released details of Deepmind’s new AI offering, Alphafold2. Alphafold2 has solved the protein folding problem. From first principles this technology can now predict the shape of a protein from its sequence of amino acids to an accuracy of a single atom. Proteins and their makeup are the essence of life and the potential consequences of this development, which academics hadn’t expected to be reached for at least another decade, are enormous. Bio engineered proteins that can create plastic eating enzymes and carbon emission digesting molecules move out of science fiction and into science reality. Deepmind has until now been largely regarded as a somewhat frivolous side bet of Alphabet. Let’s see.


Alphabet and Cineworld are both, at heart, media companies. One is ridiculously solvent the other fighting for its survival. Google is so profitable it has been able to fund a portfolio of side bets. When internet search gets disrupted, as it surely will, Alphabet will still have options. Waymo is likely to do for autonomous vehicles what Android did for mobile phones; Deepmind has shown it can do more than win board games; Nest will continue to help our homes become smarter and Google Cloud, Gmail and its derivatives have a future in digital transformation and the new spatial internet. Cineworld, has no plan B.


The companies that are leading this leg of the market rally are the reopen beneficiaries. However, Alphabet, Pinterest and Naked Wine have all recently recorded all time share price highs. The re-rating of the lockdown losers look set to continue for some time. If companies can remain solvent there is a last man standing endowment waiting to be collected. Value will continue to rebound, but the surfeit of liquidity, with little prospect of higher interest rates for the foreseeable future, means that this is not an either or trade. The stock of capital invested in negative return assets (bonds) will continue to seek higher returning alternatives. As the FT pointed out this looks more like an everything trade than just a reopening trade. The way the world works changes and this change has accelerated in the last 11 months. As global advertising recovers more of it will remain online. As people start to travel again they will use Expedia and Airbnb more that traditional travel agents or traditional lodging venues. Both long haul business travel and the daily commute to the central business district are likely to become as rare as department stores and cinemas. These changes will lead to solvency problems, extra liquidity cannot help indefinitely. Being on the wrong side of this trade while carrying too much debt, will be as deadly as ever. The value rebound is not a rerun of the post 2000 dot com crash. Technology is more entrenched across many more sectors of our daily life, and this time they are in the main highly solvent and and in many cases over capitalised with multiple options for alternative futures. The financial casualties will predominate in retail, leisure, and travel, the very sectors that are leading the share price recovery.


Meanwhile, back in politics COVID is (in the UK at least) starting to take a back seat to the concluding episodes of the Brexit negotiations. This is the point at which Emmanuel Macron peeps over the parapet of the Scottish castle and starts telling King Arthur and his knights that he already has a Holy Grail and he never really liked us Engliiiish much anyway (including some extraordinary personal taunts about our parentage). The reality is that he has probably worked out that France, unlike his northern neighbours Germany and the Netherlands, don’t have much to lose from a no deal Brexit and like De Gaulle before him, he might just say “non”. However, if he is seen by other EU members to block a deal on the pretext of the French fishing industry it will only lead to more ructions within the heart of the EU. With Poland and Hungary causing ructions of their own already, I suspect deal or no deal, 2021 will see greater problems for the Eurozone and its stability. The ECB can solve for liquidity, but the solvency of an ever closer union is another matter. In the context of the economic impact of lockdown, a no deal Brexit is now just a mere flesh wound for the UK, but be prepared for £ to test its lows again if this is how things play out.

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