Dear Friend:

As we write this, there have been close to 12,000,000 confirmed cases of COVID-19 in the world and over 540,000 worldwide deaths due to the virus. Through it all, our commitment to the well being and care of our clients, and our extended Noesis family, has remained resolute. As you know we have staff and clients located all around the globe, and we asked some of our remote colleagues, and those with ties to remote areas, to let us know the situation outside of Boca Raton, Florida.

From Christian, who was born in Germany and has family there:

“Germany restarted public life with slight regional variances in the middle of May. Gradually stores of all sizes, restaurants, hotels, cinemas, museums and so forth reopened. At the same time the German soccer league, Bundeliga, continued its matches albeit without visitors. By now the complete school system, from preschool to high school, is open at a reduced schedule and smaller events are allowed again. Face masks are mandatory in stores and public transportation. Contact tracing, an important tool to contain local outbreaks, is supported by a recently released app. Besides a few confined flare-ups, the overall infection rate is under control and life is slowly returning to normal.”

From Shihfang, who was born in Taiwan and has family there:

“Taiwan had SARS in 2003, so the government and the people are quite experienced in dealing with the virus. Taiwan has been clear of domestic infection for over two months now, and the society is fully open except border control for foreigners.”

From our colleagues (Michiel, Huub, Rein & Carola) at Noesis B.V. in Holland:

“In the Netherlands the number of Covid-19 deaths dropped below ten a day in early May and the number of new cases has dropped below 100 in late June despite a huge increase in the number of tests. More than 90% of the deceased were over 65. Most measures taken as part of the ‘intelligent’ lockdown have ended. Restaurants, schools and public transport now operate within Covid-19 rules. Many people have started planning vacations, albeit in many cases closer to home than usual. During the lockdown – contrary to many other European countries – major segments of the economy continued to operate, this included most of the construction sector.”

 From Adriana, who was born in Paraguay (South America) and works there:

“Paraguay has been one of the countries with the fewest cases in South America. There are 2,190 cases confirmed total, with only 16 deaths and 1,080 people that have recovered safely. The government implemented a full quarantine since the 20th of March, followed by a “smart quarantine” system with four phases, starting with phase 1 on May 4th; we are currently on phase 3. All international borders are closed to travel and all persons arriving must remain in isolation at a government facility or designated hotel for 14 days, regardless of whether symptoms are present. Non-residents of Paraguay are not permitted to transit. Wearing a face mask when in public is required during visits to supermarkets, stores, pharmacies, gas stations, or any other place where people gather. All travelers must wear a mask to board public buses. Additionally, a nightly curfew is in effect.”

 From Bruno, who was born in Madrid, Spain and works there:

“The health system collapsed in Madrid. With 600 ICU beds, there were more than 1,500 patients in the ICU, based on increasing hospital capacities to 250%, as well as 13 hotels and 1,000 beds in IFEMA (the fairground in Madrid). Protective measures such as prohibiting layoffs and 75% governmental wage support were implemented. There has been very little collaboration in transferring patients from one community to another.”

The Economy – Sequential Improvement & Unprecedented Stimulus

Spring and summer have arrived in the Northern Hemisphere and with it came the gradual reopening of economies as COVID-19 infection numbers declined in many countries. Earlier we shared a snapshot from some of our colleagues. The swift actions by central banks and governments during March showed positive effects. Monetary stimulus led to a rebound across capital markets and fiscal stimulus supported households and businesses in the real economy. We can observe sequential improvements in the U.S. labor market with better than expected payroll gains and unemployment rates in May and June. Manufacturing activities are rebounding globally, while specific service industries such as travel or live entertainment are slower to normalize as virus control is more difficult.

At the time of our last quarter letter, direct fiscal stimulus, excluding any loans and loan guarantees, represented around 7% of the U.S. Gross Domestic Product (GDP), around 2% of the four largest Euro economies, and approximately 5% of China’s GDP. Since then, these numbers have been rising.

In the U.S., several relief programs are expiring soon which might lead to a fiscal cliff in the summer months. Lawmakers are currently working to avoid this. In particular, small businesses received payroll support for an eight-week period under the Paycheck Protection Program (PPP) which ended for most between mid-June to early-July. Congress might provide further help, but more targeted to the hardest-hit businesses. Furthermore, the extra jobless benefit of $600 per week is expiring at the end of July. In industries such as leisure, hospitality, and retail the raised unemployment benefits exceed the average weekly earnings. Congress might extend the payment at least at a reduced amount. Additional measures considered by Congress could be another round of stimulus payment to households and more fiscal relief for states. Economists from Goldman Sachs estimate the total of these new fiscal measures to be around $1.5 trillion or another 7% of U.S. GDP.

In Europe, the European Central Bank (ECB) expanded its asset purchase program by EUR 600 billion to EUR 1.35 trillion and extended the duration. Germany announced an additional fiscal stimulus  of around EUR 130 billion or 4% of its GDP, and the measures include a reduction in value-added tax, one-time payments to families, and investments in digital infrastructure and e-mobility. The European Commission proposed a EUR 750 billion recovery plan consisting of grants and loans with the allocation skewed towards Southern Europe (Italy, Spain). It will be funded through bond issuance by the common bloc, a first for the European Union. The overall size, balance between grants and loans, as well as allocation across countries will be debated in the coming weeks, but expectations are optimistic that the 27 members will come to an agreement.

In China, various monetary measures were implemented such as lower short-term rates, reduced bank reserve ratio, and loan purchases which together total around RMB 3 trillion ($424 billion). On the fiscal side, the government funded infrastructure projects, extended preferred tax rates for regional investments, and reduced the value-added tax. These policies amount to roughly RMB 3.5 trillion ($500 billion), or an additional 3% of China’s GDP.

This fiscal stimulus spending will lead to rising government deficits and public debt levels worldwide. It is projected that debt-to-GDP ratios in developed economies will match levels last seen during World War II and in emerging economies will reach their highest level in history. The long-term effects on growth and inflation are uncertain. Will the U.S. and Western Europe be able to grow out of their debt burdens as they did after WWII?

Kenneth Rogoff, Professor of Economics at Harvard University and former Chief Economist at the International Monetary Fund, researched in 2010 the relation between growth and debt. In a recent interview he had the following to say about the appropriateness of current actions:

“The key point today is that given the magnitude of the challenges we are facing, the gains to borrowing are tremendous, and the growth implications of not borrowing would be a lot greater than any growth implications of borrowing…Losing some growth over the longer term because of high debt is nowhere near the main worry. You should use debt when there is a big payoff, and it is hard to imagine a moment with a bigger payoff than today.”

From Macro to Micro

We are shifting the perspective from macroeconomics to microeconomics and will show how some of our portfolio companies from various industries have fared in the current environment.

In Biopharma, Gilead’s drug Remdesivir was the only proven new therapy by the FDA to fight the coronavirus. Gilead has quickly conducted several clinical trials in different regions to speed up the development of the drug. The company also committed to increasing the capacity to provide the medicine at a reasonable price. Roche provides testing kits for the COVID-19 infection, the antibody, and the infection-triggered hyper inflammation to determine the risk of intubation. All three tests are critical in managing the pandemic and administering the treatment options for patients.

In Medical Equipment, companies with higher exposure to deferrable elective procedures such as Stryker have to wait for patients to return to hospitals. On the other hand, Baxter is benefiting from increased demand for its medication delivery systems, clinical nutrition which is used for patients in intensive care units, and renal replacement therapy which is used for severe COVID-19 patients developing kidney problems.

This time the Banking Industry became part of the solution, instead of being part of the problem like in the Great Financial Crisis, and provided financing and liquidity to businesses. JPMorgan’s corporate clients drew over $50 billion from existing credit lines and were approved for over $25 billion of new credit extensions in March. The bank also gave temporary customer relief in the form of a 90-day grace period for consumer loans. In the recent Fed stress test the capital buffers of all large U.S. banks were sufficient to withstand the scenarios of a V, U, and W shaped economic recovery.

The pandemic has highlighted the importance of several secular trends in the IT Industry – Cloud Computing, 5G, and Artificial Intelligence. Our IT holdings not only have direct participation in these trends, like Google, Qualcomm, and Tencent, but also have exposure to technologies that built the foundation for these secular trends, i.e., advanced chip production and software development.

In the Consumer Sector, home improvement company Lowe’s experienced strong sales in its last quarter driven mainly by essential, virus-related items such as cleaning supplies and refrigerators/freezers. Should the pandemic lead to a migration from urban to suburban areas and rising homeownership, the company is well-positioned with a high suburban store base and Do-It- Yourself exposure. Athletic brand Nike reported at the end of June that around 90% of its owned stores reopened globally. Its digital sale continues to accelerate and grew to 30% of overall sales.

Specialty Chemical Company Ecolab provides water, hygiene, and infection prevention solutions to a broad set of end markets including food, healthcare, industrial, and hospitality. The company should benefit from higher cleaning and sanitizing demand due to increased consumer awareness of hygiene and higher cleaning standards.

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Markets have been driven by declining daily COVID-19 cases and fatalities, monetary and fiscal stimulus, as well as expectations for a relatively smooth economic recovery. The uncertainty remains high and we could expect potential setbacks that might trigger renewed volatility. The second-quarter corporate results and year-over-year comparisons should be bleak as economic life remained closed for at least half of the quarter in large parts of the world. Our companies in aggregate have been holding up well in this epic storm and we are monitoring them closely to assure that they come out strong on the other side. We sold a few holdings when we started to doubt their long-term strength and we will reinvest the cash in new ideas from our shopping list when the opportunity arises.

Sincerely yours,

Research Team