Third Eye Capital
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Toronto, Ontario, M5J 2T3

Drinking From the Firehose (Q2-20)

Drinking From the Firehose (Q2-20)

Sep 08th, 2020

Monetary and fiscal policy coordination has been the most prominent driver of risk-asset performance in the second quarter of this year. This highly supportive backstop to markets will likely continue to push prices up even higher. Investor sentiment has stunningly moved from apocalyptic to euphoric in just three months as epic amounts of liquidity have been poured into an economy with rising unemployment, low inflation and zero-bound interest rates. This liquidity has lifted nearly every asset class, especially equities, which have risen even with sharp declines in per-share earnings reported by many publicly-traded companies. It may be true that stock markets are always anticipatory but current valuations seem to assume a revival in economic activity to pre-pandemic levels by Q2-2021. A rapid discovery of a vaccine, effective treatment options, or even herd-immunity[1] would certainly restore and sustain confidence but scars from consumer bankruptcies, company failures, and credit tightening could be lasting. Households and business are very likely to turn more cautious in a post-COVID world.

Consumers will save more, in our opinion, and firms will invest less. Lost jobs, many of them potentially permanent (in parts of the real estate and travel industries, for example), will increase slack in the labour market and exert downward pressure on wages. We believe the pre-pandemic status quo around certain issues, like teleworking, office space, supply chains, inventory management, online shopping, education, healthcare, and public policy, will be shaken.

The economic outlook is highly uncertain and the number of dead branches on the decision tree for investors is growing. Worries of an economic reopening curtailed by a second wave of COVID-19 infections, and a China-U.S. cold war, will keep volatility high. Risk assets are priced for steady economic progress and reopenings so any disturbance to these expectations could lead to lower valuations. Many investors, policymakers and medical experts believe that a second and more dangerous wave of infections will occur in the fall or winter months (when other coronaviruses tend to spread more readily) after the economy reopens and people become less vigilant about social distancing. A study of the Spanish Flu showed that second peaks frequently followed the sequential start, stop, and restart of nonpharmaceutical interventions.[2] The second influenza wave in 1918 caused much greater mortality world-wide than the wave that preceded it. The independent scientific committee advising the U.K. government, for example, warned in March 2020 that countries with heavy suppression would experience a second peak once such measures were relaxed[3]. There are contrasting views and different political motivations and no one really knows the ultimate truth because COVID-19 is a novel virus. However, at least for now, governments are inclined to reopen sooner than desired by medical experts because the cost of lockdown is too expensive for the economy relative to the risk.

Policymakers will continue their aggressive fiscal and monetary support. With real interest rates unable to decline in any meaningful manner to stimulate private consumption and investment, the onus falls on fiscal policy to fill the hole in demand. Canadian federal aid in response to the pandemic has already been enormous totalling about $330 Billion, or 14% of GDP, most of it to keep workers employed or supplemented in case of layoff.  As the recovery in the labor market slows, households will need further income support. Otherwise, personal spending will collapse and have a ripple effect throughout the economy. The Bank of Canada’s key role will be to ensure that Canada’s large fiscal deficits are funded smoothly and cheaply. The federal government is projecting a record deficit of $343.2 Billion for the current fiscal year ending in March 2021; nearly ten times what the government had predicted in December 2019. Tiff Macklem, the new Governor of the Bank of Canada, has reiterated his predecessor’s commitment to continue large-scale asset purchases until the economic recovery is advanced. The central bank’s balance sheet has more than tripled in size since the onset of the pandemic, reaching approximately 22% of 2019 GDP. The new mantra from the Fed and Bank of Canada may have to change from “lower for longer” to “lower forever”. For investors, the thirst for yield remains unquenchable.

[1] To achieve herd immunity, many people would necessarily die and the pressure on the health care system could be overwhelming. See our commentary in the Q1-2020 Investor Report.
[2] See our commentary in the Q1-2020 Investor Report for a discussion of the Spanish Flu study.
[3] https://www.gov.uk/government/collections/sage-meetings-march-2020



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Instructions for the following sections: Individuals please answer Part A of Sections I and II; Institutions please have an authorized person answer Part B of Sections I and II.

Section I - Accredited Investor Threshold Questions:

Part A - For Individuals:

1. I certify that I have an individual net worth, or my spouse and I have a combined net worth in excess of $1,000,000.

2. I certify that I am highly a sophisticated investor who routinely invests sums of $250,000 or more.

Part B - For Institutions:

1. The submitter certifies that it is a bank, insurance company, registered investment company, business development company, or small business investment company.

2. The submitter certifies that it is a charitable organization, corporation or partnership with assets exceeding $5 million, and that was not formed to invest the Fund.

3. The submitter certifies that it is a corporation, partnership or trust with assets of at least $5 million, that was not formed to invest in the Fund, and whose purchases are directed by a sophisticated person.

4. The undersigned certifies that all of its equity owners are “accredited investors” as defined in United States Securities and Exchange Commission Rule 501(a) and who can satisfy the higher criteria for the same set forth in Section I, Part A above.

Section II - Qualified Purchaser Questions:

Part A - For Individuals:

1. I certify that I own not less than $1,000,000 in securities investments.

Part B - For Institutions:

1. The undersigned certifies that it is a bank, insurance company, registered investment company, business development company, or small business investment company

2. The undersigned certifies that it is a "family owned company" (as defined below) that owns not less than $5,000,000 in securities investments. A "family owned company" is defined as a company that is owned directly or indirectly by or for two or more natural persons who are related as siblings or spouse (including former spouses), or direct lineal descendents by birth or adoption, spouses of such persons, the estate of such persons, or foundations, charitable organizations, or trust established by or for the benefit of such persons

3. The undersigned certifies that it is a trust that was not formed to invest in the Fund, the trustee or decision-making authority of which, and every person contributing assets to the same, is a “Qualified Purchaser” under one of the other definitions of this Section

4. The undersigned certifies that it is a person acting for its own account or for the accounts of other Qualified Purchasers who in the aggregate own and invest on a discretionary basis at least $5,000,000 in securities investments.

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If you have any questions, please contact Chris Vokes, VP of Investor Relations at Third Eye Capital:

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