Since the European Commission enacted a Temporary Framework on 19 March, enabling “Member States to use the full flexibility foreseen under State aid rules to support the economy at this difficult time”, a mind-boggling amount of such aid has been dispensed, of which some 60% pertains to Germany. Beyond detailing the types of grants, subsidies or guarantees that can be afforded to businesses, to help them get through the Covid-19 crisis, the European Commission made clear that “given the limited size of the EU budget, the main response will come from Member States' national budgets”. Which explains why Germany, whose fiscal leeway is unrivalled in Europe, has been so profligate recently, injecting a greater amount of state aid into its own economy than the agreed-upon 750 billion European Recovery Fund will have at its disposal for the entire region. After being a “model” of austerity for many years, to the point of exasperating its EU partners, Germany is now most able to open its purse wide – which seems also to be starting to exasperate some of its EU partners. Incidentally, to those that pointed out the risk of competition being thwarted, the Commission responded that the entire region stands to emerge stronger thanks to German State aid measures.
Source : Bloomberg
Fundamentally speaking, the time is indeed right for Germany, as it would be for every country, to invest massively in its productive system. Outside of Germany, however, because of much more limited means, fiscal spending has been focused just on keeping the economy alive, not on building the future. The Recovery Fund will help in this regard, but it has yet to be implemented because of institutional delays. And as for European Central Bank (ECB) money injections, while they do constitute appreciable support, they are gradually reaching their limits. Upping the size of asset purchases from current levels will prove difficult, unless junk bonds come to be included in the list of acceptable holdings – which would involve making “political” decisions at the ECB level about which individual companies to sustain, at the risk of distorting competition.
Before moving on to the US, a quick update on the UK and on China. Our impression with respect to Brexit developments is that Prime Minister Johnson would actually like to achieve some form of deal with the EU and the public health situation might provide a useful excuse to again extend discussions. So, effectively, a non-issue for now. China, interestingly, seems not to be suffering the same second wave of Covid-19 as the rest of the northern hemisphere. Whatever this can be attributed to (lesser data transparency, greater individual discipline or much more authoritarian testing & tracing), it probably underpins the better GDP and stock market behaviour year-to-date. Chinese A-shares have further accentuated their outperformance since July, buttressing our view to have structural exposure – and take advantage of any dips.
US Elections: Towards A Lame Government
In the US, the outcome of the elections remains very uncertain. The largest-ever volume of mail ballots clearly complicates matters, as does the fact that procedures vary state by state (e.g. different deadlines for voting by post, the possibility in some states for ballots that were refused due to administrative reasons to be corrected several days past the election, specific margins warranting a vote recount, etc.) – not to mention President Trump’s vociferous claims of fraud.
At the time of writing, the most probable result is that Joe Biden becomes the next US leader, and the Republicans retain their Senate majority. But the situation may take weeks to be clarified on the White House front, while the Senate uncertainty could last through mid-January due to the Georgia runoff election(s).
The likelihood of a divided government, with no sharp political turn to the left or right, probably explains the positive immediate stock market reaction. Investor fears, supported by the polls, of a strong “Blue wave” were put to rest. This would have heralded what was widely considered to be a business-unfriendly environment, made of higher taxes, greater regulation, company break-ups and a minimum wage hike.
Still, we would point out that all is not rosy. The lingering uncertainty as to the electoral outcome probably reduces the odds of a large relief package being voted by Congress in the near future. Beyond that, a divided government also means that Joe Biden, assuming he does win the White House race, will find it very difficult to implement his promised green investment program. Indeed, any large infrastructure spending – which, as we just discussed with respect to Germany, is key to ensuring longer term prosperity – will be compromised. Rather, the US productive system risks falling further behind that of its arch-rival China.
And then, of course, there is the risk of civil unrest, as Democrats and Republicans spend the next weeks battling in the courts and the media. How President Trump’s broader entourage and the leading TV channels communicate will be key in this respect – as might also be developments on the Covid-19 pandemic front.