The long Easter break allows a moment of calm and reflection for all faiths. To take a step back and contemplate the enormity of the crisis we are facing and living through together. It was the most extraordinary sight this week to see Andrea Bocelli sing Amazing Grace, entirely alone outside the Duomo in Milan, amid streets usually thronging with people. And to cut away to similarly empty streets in Rome, Paris and London. There have been real hardships due to COVID19, real pain and traumatic loss. Loved ones lost alone in hospital, surrounded by tubes and plastic, remote from the people closest to them in their dying moments. It is a pandemic layered with biblical undertones. The scars will be felt for years, decades, and generations to come.

This week, we would like to spend some time trying to assess the longer-term effects of this crisis. On society, ordinary people, governments and those governing, day to day life, investment markets and outcomes. But first let us share an update on where we find ourselves in progression of the virus, markets and South Africa.

THE MARKETSSouth Africa has mirrored the recovery in global equity markets that commenced on 24th March 2020. From its low, the JSE All Share Index is up fully 30%, to leave it 19% off its previous high, having been down 38% at worst. The Old Mutual Balanced Fund is down 9% year-to-date, having been off 25% at worst. Globally, the market recovery has been led by a few critical factors, as noted in a previous week’s newsletter; factors to tick off to get to a robust market rally:

1. A peak in daily cases reported of the virus in most major countries, led by Italy and Spain, and now peaking in the US and the UK. This has always been the critical leading indicator, and means markets can begin to look forward to an end to the crisis. An important side note is that daily cases in Sweden (no lockdown) look to have peaked.

17 APRIL 2020

Daily New Cases in Sweden

2. Associated planned measures to ease lockdowns in a gradual phased exit approach. This has been led by smaller countries in Europe. Austria opened certain shops again this week. In Spain, factory and construction workers are returning to work and in Italy (outside of Lombardy), shops selling books, stationary and children's clothing are reopening in certain areas. School children will return to pre-school this week in Denmark. Wuhan of course lifted its lockdown last week.

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3. A recognition of the scale of the drawdown in economies and corporate earnings, with US EPS now forecast to be down north of 30% year-on-year in 2020. Once this is discounted in the market, participants can look forward to a recovery and ‘look through’ the dip in earnings. Market commentators will in due course be talking about market valuations based on full year 2021 earnings, as a new normalised level.

4. An appreciation that the scale of support from global authorities will be sufficient to get us through the crisis, and support economies back into full working mode. Two examples. One, under the US fiscal support program, short term unemployment benefit amounts to $600 per week, an equivalent of $25/hour for an assumed 40 hours of work. The highest minimum wage in America is $13.50/hour. Two, 90% of US households earn less than $99 000 per annum. In each of these each adult will receive a cheque for $1 200 and each child $500. Just two examples pertaining to individuals where the bridge looks effective. It is also worth noting that 80% of registered unemployment claims in the US are of a temporary nature, allowing people to rejoin the firm they left.

If there isn’t a second wave of infections, we feel the market recovery is justified, and whilst further near-term gains may now prove limited given the scale of market moves already seen, we feel we are on firmer ground.

THE VIRUSAs noted, crucially the virus has, or is peaking in most major nations. We have assessed this at length in previous papers, and we are relieved that the forecast has proved correct, from a market, economy, and human point of view. Concerns will remain around the possibility of second waves, and the reopening of economic activity and normal life will need to be well measured and accompanied by much more intensive testing programs. However, both are likely so optimism is justified. And again, the enormous research and testing of anti-virals suggests that a more enduring avenue of exit from this virus will be forthcoming.

South Africa remains a conundrum as to the virus progression, and it was heartening to see such a detailed address of the issues by our Health Minister in a televised broadcast this week. The lack of expected exponential progression was put down to an early and mandatory lockdown, that had resulted in much more limited local transmission than some other countries. However, vigilance was seen to be key, to prevent simply a delayed exponential curve, and this progression will be critical for the health of our nation.

Daily New Cases in South Africa

WHAT MIGHT BE THE LONGER-TERM IMPACTS OF THIS CRISIS?We will address four key areas here.

1. Economic

2. Geopolitical

3. Political

4. Societal

1. EconomicWhat is clearly emerging from this crisis is that governments will be much more indebted than just a few short months ago. Could this be the last chapter of the Super Debt Cycle, that has played out since the debt liberalisation of the Thatcher and Reagan years? The playbook goes something like this.

1980s – liberalisation of debt provision to individuals led by free market reforms in the UK and US – financial firms were freed to lend multiples of their deposit base to consumers in a free spending world where for the first-time consumers could run up credit card bills and purchase houses with associated debt at multiples of their annual income. Asset prices soared, banks and consumers became highly levered.

The end came with the house price crash in the UK in 1989-91 with negative equity for many (where your house mortgage exceeds the now depressed value of your home).

1990s – liberalisation of corporate borrowing via the debt markets; shareholders rule and companies lever up to engineer equity values higher through share buy backs, and higher return on levered stub equity.

The end came with the DotCom bubble of 1999 and crash of 2000/01.

2000s – a super levered version of the 1980s, led this time by the US. Massive debt provision to force feed house purchases largely by those with no means of repaying the debt. Tranching and multiple syndication of debt structures, levered and sold on to pension funds, other banks and hedge funds. Massive levering of bank balance sheets (up to 60x).

The end came with the Global Financial Crisis (GFC) of 2008/09 – massive deleveraging as house prices fell and consumers were unable to repay their interest or debt. Collapse of banks, and massive government bail outs of entire banking systems.

2010s – recovery from the GFC, rebuilding of bank balance sheets, tighter regulation, less leverage, meaning banks in much better shape going into this latest crisis. Corporates still increasing leverage, consumers less so. Governments still running with debt raised to bail out the system in the GFC.

The end came with an entirely exogenous event, the Covid-19 virus.

Hopefully you can see the thread here of debt being passed on from consumers, to corporates, then to banks, then to government – where it has stayed. So, governments have entered this latest crisis, that requires unprecedented amounts of fiscal support, in perilous shape. Total global debt to GDP rose to 322% towards the end of last year (up from 230% in 2018), a total worldwide debt of $250 trillion. Here are some key nations’ ratios of government debt to GDP:

Japan 240%

Italy 135%

United States 110%

European Union 82%

United Kingdom 81%

South Africa 63%

These figures are before the latest crisis and associated stimulus packages. It is forecasted that the UK will borrow £273bn this fiscal year, up £218bn from £55bn.

There is now nowhere else for this debt to go in the final stage of the merry-go-round of the 40-year post-Cold War Super Debt Cycle. Governments therefore have a number of options open to them to manage their debt load.

1. Increase taxes

2. Reduce government spending

3. Run with higher debt burdens and the likely associated higher rate of interest required by investors

None of these are palatable, or even realistic given likely circumstances in the near term (and the typical five-year political cycle).

Which leaves one, very risky option - monetise government debt. This describes the purchase of government debt by central banks, purchases that are never withdrawn from the market. Since the central bank prints money to effect the purchase, the system is left with an increase in the money supply. Note that this is different from conventional QE (practiced to date) where central bank purchases of government debt are ultimately sold back to the market thereby withdrawing the incremental money supply commensurately.

If the money printed is sufficient to offset the contraction in the money supply caused by a fall in economic activity the overall effect is neutral. If it is an excess then money supply expands. This is what makes such a course of action extremely risky and potentially highly inflationary. When the printing presses are allowed to run, it generally spells trouble (Germany, Zimbabwe, Hungary, Venezuela). If conducted judicially it may have a chance of working, however a risky prospect.

It is certainly true that governments would also wish to see inflation somewhat higher as this would reduce their debt burden in real terms (inflate it away). And a post-virus world may also play to that narrative, as the 20-year trend towards increased globalisation falters further, as corporates and consumers look more to local supply chains and provision of local goods. The US was somewhat alarmed that 80% of its antibiotics are sourced from China. Expect things like that to change.

And it is globalisation that has been a major driving force in keeping inflation low for the past 20 years (that and technological change). Cheap imported goods from China,

Vietnam and elsewhere. Again, expect this to change. Indeed, very early signs this month in Asia is that inflation is starting to increase post-virus.

2. GeopoliticalUS versus China. The big game now firmly in play. The simplistic version posits that China emerges the clear winner post-virus. An early adopter, it has emerged "clean" of the virus and is already back at 80-90% working mode. It will however be subject to abject short term, and potentially subdued long-term trade flows. Its economy has to grow north of 5% per annum just to absorb local rural migrants into the cities. The promise of a larger middle class and aspiration for all must be maintained. A descent into some form of social unrest/dissent or even bifurcation is the stuff of President Xi Jinping’s worst nightmares. It is estimated that up to 50m Chinese may now be unemployed. It is imperative that this is solved quickly. Hence it is a sure bet that massive Chinese stimulus is on its way and soon. They have spent a modest 3% of GDP so far, expect double that.

As to the US, much rides on Trump and his chances of re-election this November. Whilst we expect a V-shaped recovery, clearly there are risks that this does not occur. No US sitting President has ever won re-election with the economy in or even close to recession. Trump’s core followers are riding the economic recovery story – take that away and a Biden victory is possible. If Trump’s approval ratings slip from their current high 40s to below 40, expect aggressive action – and there is no better way to galvanize around a common cause than to identify a common enemy. China, source of the virus that took away our prosperity – Trade Wars, and possibly more aggressive tactics. It could easily get ugly in the near term.

3. PoliticalThe real long-term question is whether China’s political system of communist central control presiding over an intensely capitalist economy wins over pure democracy. Their ability as a command and control regime to suppress the virus was similar to some other countries. North Korea, for example with zero (reported) cases.

The Chinese ability to plan long term infrastructure, R&D (patent filings up 200-fold in 20 years, and this week surpassed the US for the first time) and finance strategic innovation is at present unparalleled – the distinct advantage of no election cycle. It all hangs though on a simple premise of trust and a Faustian trade. Keep us, the people rich and upwardly mobile, and we will trust your regime. If not, we will want a say. This is why the Chinese economic growth figures are of more than passing interest.

It is interesting to assess whether the current rise of populist (and strong) leaders will be accelerated/reinforced post-virus. It is true to say that the more constant and instant information is available, all the more populaces yearn for strong leadership to navigate through the maze of confusion. This, combined with a "left behind"’ dynamic as middle-income wages have stagnated has led to the rise of Trump, Putin, Xi, Erdogan, Modi (and perhaps Boris). The lasting insecurities that will surely accompany people in a post-virus world is likely to indeed

accelerate this trend. There is also the opportunity for strong leaders to firm their grip on events in the coming months and years – given the massive increase in state intervention in all forms of life (and ownership) the crisis has necessitated, leaders have the tools and means to exert an iron grip on society. Orwellian anyone?

4. SocietalIt is said that this virus will split the generations – again the young are being asked to bear the pain (lockdown and workplace) to protect the old (the main victims of COVID19). It is not clear at all that people see it this way at present, as compassion and community are the overriding emotions right now. But as the cold harsh reality emerges and the economic cost is measured, this may become an unfortunate narrative. Similarly, the young would really like a good dose of inflation - to inflate away their high levels of debt (student debt in the US) whilst inflation is the enemy of the lifetime accrued savings of the elderly. It would be unfortunate for such tensions to play out in coming years, and let us hope they do not. One would suspect that the more capitalist a society (US) the worse the effect, compared to say Japan or indeed Italy, where care for the elderly (and co-habitation and active socialising as in Italy specifically) are the norm – part of the reason the virus outbreak was so bad in Italy is that they have much closer proximity to their elders every day.

On the plus side, we have undoubtedly seen greater levels of compassion and community as a result of the crisis. It would be nice to see this continue; we will see, more often than not a return to hectic life takes this time allocation away.

Similarly, we have seen a welcome acceleration of the trend to work from home. This reduces harmful environmental impact and furthermore ease of video calls may make that business trip less obvious. Again, let's hope so. Well-worn habits

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however take time to change. Many will be glad to be back in their workplace; whilst home time is of course precious, we are conditioned to a split existence, and it is often easier to compartmentalise work stress by physical location.

CONCLUSIONWhilst we believe we are past the worst of the COVID-19 crisis, at least globally, material risks remain here in South Africa, that we will need to monitor closely. We remain hopeful that we get through this as one society, together against a common foe.

It is understandable that with so many factors still at play, and with the extension of South Africa’s lockdown, investors are still uneasy despite the encouraging signs shared in this communication. In addition, we are aware that some investors have lost their income over this time and this makes it difficult to constantly hear investment specialists ask them to stay invested. However, investors should remember that as long they do not disinvest, these losses are only on paper. Staying invested gives them time in the market and puts them in a better position to recover the losses once the markets turn, as they seem to be doing at the moment.

Happy investing, and do take care.

Elize and Hywel