Author: Maneesh Nath
Dated: 4th Apr
2020
'In the middle of difficulty lies
opportunity'.-Albert
Einstein
Due to the COVID-19
Pandemic, US Stock markets, which have been in the longest Bull Run for the
last 11 years, starting in 2009 have seen the steepest decline in its entire
history and have now entered the bear market territory. Just seven weeks ago,
on 12th Feb 2020, Dow Jones Industrial Average (DJIA) reached an all-time high
of 29552 and on 23rd March 2020 created a low of 18592, a sudden decline of
over 35%. Due to this breakdown in the US economy, GDP is now estimated to
decline by 10% in 2020 from the current level of $22 Trillion to 2017 level of
~$20 Trillion, so three years of US economic growth disappeared in few weeks,
leaving millions of Americans unemployed, but that doesn’t mean, the US is not
going to come out of this crisis, it will come out of it and even stronger. The
US Government gets a ~30% share of what the US Inc. produces due to its
taxation power and The Federal Reserve is borrowing from the US future and
injecting it in the economy now to save the present. They have successfully bridged
the gap in the 2008 Credit Crisis led Great Recession and they will be
successful in 2020 too.
The speed with which The
Federal Reserve with the financial backing from Congress and the US Treasury has
intervened this time and got together a $2.3 Trillion stimulus package, a Main
Street Business Lending Program authorized by the Coronavirus Aid, Relief and
Economic Security (CARES) Act, it is nothing short of spectacular. If they had
done nothing but let the entire US economic system collapse, it is like having
an advanced medical treatment option available and not providing it to a
patient and denying him any chance of survival.
Over the last 25 years, US
GDP has grown at 4% from $7.5 Trillion in 1995 to $22 Trillion in Feb 2020. If
we use a conservative estimate of half of that growth (i.e. 2%) for the next 40
years, the US GDP has the potential to reach ~ $50 Trillion by 2060. So, this estimate
gives FED the confidence to borrow from the future and bridge the gap today.
With a Debt/GDP of 150%, US Debt can easily sustain from the current level of
$25 Trillion to $75 Trillion by 2050, so the FED balance sheet has additional
capacity to borrow over $50 Trillion over the next 40 years before the debt
becomes hard to service. With this kind of massive borrowing capacity, the US
dollar and US Treasury Bill look like a safe haven to the investors. These are
the calculations that the FED has done before going all-in to save the economy.
In the distant future, will it be necessary to inflate the debt to those levels?
No, but if a crisis occurs, can the FED borrow a few trillion dollars from the
future to save the economy which has taken over two centuries to come to this
stage, and show bright prospects over the next 40 years, the answer is a clear
Yes.
Now let’s see, what the
markets looked like 25 years ago in March 1995, S&P 500: 500 (vs. 2750 in
03/2020) So, ~ 6X in 25 years (Annualized Rate of 7%). If we use the past 25
years of Annualized Rate and project it for the next 30 years, the S&P 500
has the potential to reach ~ 20,000 by 2050. So, this is the target which the
long-term investors (who are panicking now) should focus on and stay invested.
US GDP 25 years ago in
March 1995: $7.5 Trillion, 3X in 25 years.
US GDP 50 years ago in
March 1970: $1.0 Trillion, 22X in 50 years.
US GDP 100 years ago in
March 1920: $84 billion, 260X in 100 years.
US GDP 200 years ago in
March 1820: ~$1 billion, 22,000X in 200 years.
The US rose from roughly 1
Billion dollars in GDP two hundred years ago to well over $22 Trillion in 2020,
this growth happened due to the meritocratic system and collective efforts of
the most enterprising and hardest working people on the planet. Other countries
who didn't follow this path, their living standard might not have improved at
the same rate as it did for the US. The US from its early days created a system
through which they leveraged its resources, got together the best people from
around the world in a way to become the superpower in a hundred and fifty
years. That first cycle even encouraged more developments and growth due to
which the US has reached the unparalleled economic status in the world. Now the
US is currently engulfed with several problems like a health crisis, economic
crisis, energy crisis all at the same time. Before one gets pessimistic about
the US economic prospects, one thing which needs to be kept in mind is that the
US has endured several catastrophic events in the past two centuries and has always
found a way to come out of it.
People who are pricing the
markets as the end of the world scenario or are a debt hawk, don’t realize that
the US has prosperity creating a capitalistic ecosystem, rule of law,
infrastructure, and meritocracy in place. Due to this fact, most of the best
companies in the world today are from the US and possess the cutting edge
advanced technology, best education system, healthcare, basically has whatever
it takes for a country to become the greatest economy in the world. It didn’t
happen by chance, it took over two hundred years of collective wisdom, hard
work, planning to fruition to reach the current status.
No country with a significant
population has a per capita GDP of $60,000, that’s because the American workers
consistently create that output, day in and day out. US citizens are the most
prosperous and enjoy the high living standard due to their sheer determination
and grit to overcome any obstacle which may come in their way.
In the time of despair,
one can be overly skeptical and argue that the US economy is based on high debt
and is in bubble territory but one has to treat the US economy as an advanced
financial service institution, where the Debt/Equity ratio (Total Debt/GDP) is
always high. While valuing a company from any other industry, it is always good
to have a Debt/Equity ratio of less than one but for financial services
companies, their books are leveraged and under normal circumstances work fine.
During the 2008 credit
crisis, FED along with European and major Central Banks around the world implemented
Keynesian expansionary monetary policies and stimulated their economy with the
Quantitative Easing (QE); the U.S. Dollar Index (DXY) which tracks the strength
of the dollar against a basket of major currencies in the world has
strengthened by 25% in the past decade. People who are curious about
hyperinflation in the US and worry about the purchasing power of the dollar are
missing one important factor that the US has stayed as a superpower for around
a century now. The US has created the best Institutions in the world, has
top-level intellectual capital doing innovation on a large scale. These
institutions were not developed in a day; it took several hundred years, increasing
the productivity of their workers. The innovation which happened there is the
reason why the world is now able to come together on the US social networks in
the moment of this crisis together.
The productivity of the US
workers has remained on the top over the last seventy years and increased
roughly four folds from $18/hour in 1950 to $67/hour in 2017. Due to the social
distancing measures, the US economy is going to come to a partial halt in this
quarter and then gradually pick up in the second half of 2020 and the US workers
will go on to produce what they did earlier. Due to the uncertainty caused by
the COVID-19 pandemic, high unemployment numbers, weak earnings reports, 2020
US presidential elections, we should expect a lot of volatility in the stock
markets which can easily test the level where it was, say five years ago. At
the time of extreme distress, we need to remember the things which are knowable
and important, that the US can wither this storm and eventually come out of it.
Due to the expansionary
monetary policies, the debt level has now increased but for now, the US can
sail through this crisis and will get it to a manageable level in a decade.
To keep things in
perspective, the total market capitalization of the U.S. stock market is $27 Trillion (2020). (All U.S. based public companies listed
in the New York Stock Exchange, Nasdaq Stock Market and OTCQX U.S. Market.)
As of 2020 U.S. Nominal
GDP: $22 Trillion.
So, Market Cap to GDP in
2020 is (27/22) = 122%
The U.S. Debt is the Sum
of all outstanding debt owed by the federal government. At the end of 2020, the
total debt will be ~ $28 Trillion. (About two-thirds is debt held by the public
and one-third is intra-governmental holdings.)
So, the US Debt to GDP =127% (28/22) will now be in the higher range
similar to Japan which like the US is a prosperous nation with a nominal GDP
per capita of $41,000 despite an aging population demographic, survived low
growth & deflation and now has negative interest rates. In the last twenty
years, despite negative macro-economic trends, Japan’s stock market rose though
modestly with great companies like Toyota Motor Corporation, SoftBank Group, Mitsubishi
UFJ Financial Group, Nippon Telegraph and Telephone, Japan Post Holdings, Sumitomo
Mitsui Financial Group, Sony Corporation, Honda Motor Company, etc. producing
high-quality products & services rewarding its shareholders well.
Currently, the morale of the people in the US is low, but once
this pandemic is over, the economy will also recover as the US has faced difficult
conditions in the past and came out of it every time. To put things into perspective,
the US with 5% of the world’s population contributes $22 Trillion of the world
GDP of $86 Trillion, roughly 25%. Wealth-wise, the US with $106 Trillion,
accounts for 30% of the world’s wealth of $360 Trillion in 2020 (China is
second with $64 Trillion, Japan is third with $24 Trillion and India is at seventh
position with $13 Trillion.) As we can see, China with a GDP of $14 Trillion is
now catching up with the US, but where do you think China and India will export
their products. Just like Europe & Japan did in the past, China & India
will also need access to big markets like the US, so cooperation among the top
economies will lead to a win-win situation for the entire world.
Just think, what came out
of the 2008 crisis, half-trillion-dollar companies, like Facebook,
trillion-dollar companies like Alphabet, Amazon, and even old companies like
Microsoft, Apple became a trillion-dollar enterprise, why, because of the
ecosystem the US has created in the last century. The US economy works like very
large high-performance machinery, sometimes due to a glitch the machine comes
to a grinding halt but with troubleshooting, it again goes back in full swing
to its full capacity.
The US has an advanced entrepreneurial
ecosystem which is the key reason why US entrepreneurs, like Bill Gates, Steve
Jobs, Jeff Bezos, Larry Page, Sergey Brin, Mark Zuckerberg to name a few,
became so successful. The entrepreneurs who come from outside of the US, like,
Elon Musk also owe part of their success to this ecosystem. It would have been
hard for Elon to achieve so much in such a short period in any other country. In
Dec 2008, both SpaceX and Tesla were facing a serious financial crisis of their
own. NASA gave another opportunity to SpaceX and Tesla investors poured in more
money in the Electric Vehicles (EV) manufacturer. Since then, SpaceX as a
private company has accomplished several successful milestones and Tesla has
produced the finest Electric Vehicles which the world needs. To manufacture a car
like that, it takes an entire ecosystem to support it, consisting of several business
departments, R&D, Design, Engineering & IT, Manufacturing, Sales &
Customer Support, Supply Chain, etc. The US has a vast amount of top-level
talent pool of designers, engineers, programmers, AI developers, data
scientists, business development professionals, etc. This same entrepreneurial ecosystem
will give the US the leading edge in the decades ahead to come. Over time, some
limelight will be taken away from countries like China and India but the US
will be a superpower for the next few decades and till that time, a leveraged
economy can function smoothly and the dollar will not lose its reserve currency
status.
When the dust settles and
the world comes out of this pandemic they will realize this fact and will bring
the US markets back to its all-time high levels. Then also, not all US
companies will reach its historic highs but the best of the best companies will
weather this storm and come out of it with a lot more experience.
People who are talking
about Gold and other precious metals as a safe haven need to understand that gold
as an asset class has underperformed the US stock market over the last century
and it will continue to do so for one basic reason, Gold doesn’t produce
anything, its price is based on fear and greed among its investors. Whereas
when the top brains come together in an entrepreneurial ecosystem and add value
inside a company, for example, Apple, which has its internal ecosystem which
promotes innovation that creates hardware, software & services all to work
together. So, when Apple comes up with products like the iPhone which consumers
all over the world aspire to have, the company’s revenues and profits increase
and the company’s stock price rises and their investors are rewarded several
times over compared to any other asset class.
For average people, who
don’t know how to find companies like Apple at an early stage or are not into
equity portfolio management can find a capable fund manager who can allocate it
on their behalf. If they are not interested in equities at all, they can look
for other asset classes, there is nothing wrong with that, they are just not
going to make high returns after adjusting for inflation on their investments
compared to equities. So, an averaging out buying strategy or increasing their
stakes in the equity portfolio will be a good strategy. Just remember, that if
a $22 Trillion economy can have four US companies with trillion-dollar
valuation, a $50 Trillion economy by 2060 will be able to support at least 25
US companies with Trillion dollar valuation. So, the right question to ask now is
which companies today will reach that level over the next four decades. It is like;
someone in 1980, guessing which companies will reach the trillion-dollar
valuation by 2020, a very tough problem but can be solved by breaking it into a
few stages, decades-long each. So out of the four, only two companies,
Microsoft and Apple (50%) were functional in 1980. Taking a cue from this, it
is fair to say that out of the 25 potential trillion-dollar valuations US
companies, in 2020, 12 companies already exist and 12 companies will be created
in this decade. The quest for the investors should be to spot these companies early
on and stay invested in them through thick and thin.
Maneesh Nath
4th April 2020
References:
http://www.xinhuanet.com/english/2019-09/27/c_138427756.htm
https://www.thebalance.com/open-market-operations-3306121
https://tradingeconomics.com/united-states/interest-rate
https://seekingalpha.com/article/4324254-u-s-dollar-rises-on-continued-flow-of-safe-haven-money
https://tradingeconomics.com/united-states/currency
https://www.nasdaq.com/articles/the-5-largest-economies-in-the-world-and-their-growth-in-2020-2020-01-22
https://www.barrons.com/articles/global-wealth-grows-2-6-to-us-360-trillion-led-by-u-s-and-china-01571681689
