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The Super-Spreader

Third Quarter 2020

Have you seen the new Tom Hanks’ movie “Greyhound”, that’s streaming on TV?

The movie brings to its audience in vivid fashion, context on the considerable challenges the U.S. and its allies had to overcome from the formidable Nazi military threat on the Atlantic front during World War II.

The daunting challenges from the other side of the world, by the Japanese Empire in the Pacific theatre were discussed in our April Perspective, The Alphabet Debate and Midway .

Why so much focus on this period? We believe that valuable perspective relevant to today’s investing environment can be gleaned from it.

From being the hunted to becoming the hunter…

If betting markets had existed at the time the U.S. entered World War II, the Japanese Empire and Nazi Germany would likely have been the odds-on favorites to prevail.

The Battle of the Atlantic, which is the backdrop for “Greyhound”, played a critical role in helping the U.S. overcome the unfavorable early-War odds.

The movie is set in early 1942, just months after the U.S. entered WWII. Hanks plays the role of a U.S. commander in charge of a naval destroyer. His ship, the Greyhound, is charged with protecting a convoy of merchant ships carrying vital supplies across the Atlantic Ocean.

The excellent book, Loonshots, offers additional insights into the Battle of the Atlantic. Here are some key excerpts from the book:

‘Four days after Pearl Harbor (December 7, 1941), Hitler declared war on the United States. He unleashed Vice Admiral Karl Doenitz, his commander in charge of U-boat submarines, to fire at will on U.S. ships in the Atlantic.’1

‘The U.S. had no recent experience fighting submarines. One German U-boat officer wrote, “We were passing the silhouettes of ships recognizable in every detail … they were formally presented to us on a plate: please help yourselves!”’

‘In his war memoirs, Winston Churchill described the Allies’ ability to protect their fleets as “hopelessly inadequate … week by week the scale of this massacre grew.” Allied shipping losses reached staggering (proportions) in 1942. By early 1943, food supplies to Britain had dwindled to two-thirds of normal levels.’

‘The (British) government was forced to ration basic goods. No oil meant no planes, no ships, no transport. No ability to resist the German machine.’

‘In early March 1943, German codebreakers deciphered Allied transmissions indicating two large convoys…within 48 hours, the U-boats sank 20 ships without suffering a single loss.’

‘In Berlin, U-boat commander Doenitz and his staff celebrated: they had inflicted the largest single maritime loss of the war’.

’It would be their last celebration. (That same) month U.S. Army Air Force B-24 Liberator bombers became equipped with two new devices. The first was a powerful microwave radar…the second was pulsed radio signals.’

‘The new radar could detect the periscopes of surfaced submarines, day or night, through clouds or fog. Pulsed radio signals enabled a pilot to calculate his location on the (Atlantic Ocean) grid without alerting an enemy ship.’

‘(With the aid of this equipment) Allied planes and ships sank 41 U-boats in May of 1943, more in one month than in any of the first three years of the war. Doenitz received messages from U-boat commanders across the Atlantic: they were being continuously chased underwater by bombers, with losses mounting.’

U-boats had gone from the hunters to the hunted. “We had lost the Battle of the Atlantic,” Doenitz wrote.’

‘U-boats never again threatened passage of a convoy. The lanes were cleared for an Allied invasion of Europe.’2

A little perspective can be the difference between spiraling into dark despair and clawing your way back to the light…

–Dan Crenshaw, U.S. Representative and Navy SEAL blinded in Afghanistan

The U.S. was initially poorly prepared to confront the then-modern military might of Japan and Germany. But the U.S. transitioned relatively quickly from being “the hunted” to becoming “the hunter”.

How did this transition come about?

The war effort acted as super-spreader of adaptation across the economy and society.

From Rosie the Riveter on the home-front to a total makeover within the military mindsight, the U.S. massively adapted to the realities of World War II. (For those interested, Loonshots, provides insightful detail on the key individuals driving adaptation within the military).

In our estimation, the adaptation process reflected a combination of:

  • Free minds that powered human ingenuity
  • A market-based economic system that fostered innovation
  • A generally supportive social, cultural, legal and political backdrop

These ingredients were, and we believe still are, the “secret sauce” underlying the growth-adaptation process and the resiliency of the U.S. economy.

Not only is this secret sauce relatively unique within the global context, it remains largely misunderstood and under-appreciated by many, both domestically and around the world.

Stock markets are less “about” the here and now and more about what’s likely ahead.

In the spring of 1942, the U.S. stock market ended a multi-year slide. Investor Barton Biggs called it a “bottom for the ages”. Prices rose sharply (in excess of 25% compounded annually) from that point to the war’s end in 1945. (See Chart 1 on the following page).

It’s important to note that the rise in the stock market occurred even as three more years of terrible battles and discouraging setbacks were to be endured.

Stock prices also rose despite flat corporate earnings growth during the 1942-45 period.3 Instead, stock prices rose, and stock valuations significantly expanded, well in anticipation of the strong fundamentals (corporate earnings growth).

Chart 1: Japan’s failure to deliver a knock-out punch to the U.S. military in the Battles of the Coral Sea and Midway helped set the stage for a stock market “bottom for the ages”.

A line graph showing the Dow Jones Industrial Average from years 1941 through 1944 and key World War 2 events.

With both Japan (Battles of the Coral Sea and Midway) and Germany (Hitler’s Operation Barbarbossa invasion of Russia failed) suffering their first major setbacks of the war, stock investors in 1942 began to “sense” the tide was turning against the Nazis and the Japanese Empire. Markets also “saw” the U.S. was gaining precious time to gather strength through adaptation.

Though starting from way-behind militarily, and bumbling about, the U.S. adapted mightily to the demands of World War II.

COVID-19 is an adaptation super-spreader

Fast forward to the present. COVID-19 is proving to be a super-spreader in terms of mass adaptation and dissemination of digital technology throughout the economy.

For the past few years, we’ve been discussing our portfolio investments in context of our “ear-to-the-ground” research approach that was hearing recurring themes of exciting prospects from managements of what are proving to be some of the world’s most innovative companies.

The themes revolved around promising developments in digital capabilities like cloud computing, big data analysis, genetic research, life-cycle tools, computational biology, material science, 3-D printing, simulation software, artificial intelligence, machine learning, 5G telecommunications, edge computing, digital twins and the internet of things (“IOT”), as well as digital payment systems—whew—and these are just some of the “biggies” that come to mind.

In addition, the digital infrastructure created from these developments has increasingly become available via software-as-a-service subscriptions. This typically requires relatively modest cash outlays for users and reduces or eliminates the need for large hardware investments.

One result of all this? The ability to test and bring to life new ideas, innovations and problem-solving solutions has become increasingly “democratized”. And the ability for cross-pollination of ideas among more minds has been enabled like never before.

For example, a small biotech company can now have access to technology research platforms that once only large pharmaceutical companies could afford. More new and novel idea “recipes” are being tested as a result.

Meanwhile, an entrepreneur with a good idea for most any new product or service can quickly gain national and international market exposure selling through Amazon or Shopify and advertising on Google, Amazon or Facebook.

To paraphrase economist Diedre McCloskey; “our economic progress occurs not by piling brick on brick, or bank balance on bank balance. It occurs by piling idea on idea.”

Author Steven Johnson offers some powerful examples of what can happen by piling idea on idea.4

From artisan glassblowing came the field of optics. Optics led to the creation of eyeglasses which in turn, enabled more people to read and think about the ideas flowing from Gutenberg’s printing presses.

Optics also spurred astronomy which created a new understanding of the earth and the cosmos. Optics also enabled the microscope and the discovery of microorganisms that paved the way for scientific and medical advances that continue to today. New ideas in glass blowing also spawned fiber optics and our present communication systems.

Speaking of the present; you may have noticed large “quilts” of collaborative innovation being “sewn” together via partnerships among companies and their innovations. For instance, Microsoft is partnering with Adobe, PTC, Ansys and Rockwell Automation. PTC is in additional partnerships with Ansys and Rockwell Automation. PayPal is partnering with Visa and Mastercard.

Ideas piling on ideas, indeed!

When firms share resources through collaborative innovation, significant value can be created for both parties as well as the economies in which such collaborations take place.

–Klaus Schwab, The Fourth Industrial Revolution, World Economic Forum, 2016

All of this was congealing before COVID-19. Now it and massive adaption are being super-spread throughout the economy.

Consider the following:

  • The race for efficacious vaccines is indeed amazing—as the vaccine timeline graphic below (created by economist Brian Wesbury) suggests.

    How and when any of the many vaccine trials underway pan out is anybody’s guess, but we believe the odds favor a vaccine being discovered in “record time”. COVID-19 the hunter, is being hunted.

  • A graphic showing how many global SARS-CoV-2 vaccines are in the various testing phases to limited availability to approved as of September 30, 2020.

  • Some amazing tools from the life-sciences industry are emerging to support and accelerate the drug discovery process well beyond COVID-19. (Thanks in part to portfolio companies Danaher and Illumina, by the way).

    The vaccine race includes several unique molecular and genetic-based approaches enabled by digital life-science infrastructure. Even if these approaches don’t lead to COVID-19-specific vaccines, researchers indicate the knowledge gained from the efforts may well trigger important advances and potential cures of various cancers and other serious diseases.

    Many in the medical field are remarking that COVID-19 has set off a new energy across medical R&D.5

  • Medical staffs have quickly adapted COVID-19 therapies to improve care. Treatment “ideas” that provide relief rapidly spread among care facilities. This has helped mitigate fatality rates as measured virus incidence rises (Chart 2 below).
    Chart 2
    Source: Economist Brian Wesbury

    A combination chart showing daily and 7-day moving averages of both covid-19 tests and death beginning in February 26, 2020 and ending September 30, 2020.

  • Telemedicine has emerged and spread, providing more safety and convenience for many needing medical care.
  • Adaptation and the adoption of digital technology are not just occurring in the medical domain. Several surveys estimate over 40% of U.S. employees are working from home. Many companies have discovered and adopted new digital tools that enable connected, coordinated and collaborative work on-line.
  • Businesses of all sizes are adapting to find new ways to fulfill customer needs. “Curb-side pickup”, on-line ordering and shopping, home delivery of goods, on-line delivery of education, entertainment and other services are among the adaptations being tested in the marketplace. As is the case with favorable COVID-19 treatments; approaches that prove popular quickly spread across industries.
  • Vacationers are adapting. “Virtual travel” is being rolled out on various platforms. Meanwhile, vacationers wanting the “real thing” have pivoted from plane travel to cars or RVs and “road trips”. Reports indicate campgrounds and parks across the country are packed. RVs have become rolling (and digitally connected) home offices.
  • Even trick or treating is adapting. Halloween candy sales are a big deal for Mars Wrigley. The company is experimenting with digital trick-or-treating that allows kids to virtually go “door to door” visiting friends and family across the country collecting Mars Wrigley candy credits that can be exchanged for the real thing. (More M&M peanuts please!)
  • “Sheltering in place” and fear of handling cash in the COVID-19 era has accelerated the adoption of digital payment technology across the world. In addition:

    ‘The so-called silver tech generation—older Americans (are) going cashless for the first time, as COVID-19 changes habits. PayPal says that this demographic is now its fastest growing user base, with considerably larger transactions sizes and purchasing power than younger generations. As more on-line purchasing, or when in-person transactions occur it’s more likely via contactless methods.’6

“Habit-breaking hurricane”

The rapid adjustment of business models, working practices and technology super-spreading are triggering a “habit-breaking hurricane”.

Each technology revolution involves profound changes in people, organizations and skills in a sort of habit-breaking hurricane.

–Economist Carlota Perez, Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages, Edward Edgar Publishing, 2012

  • New ways of conducting business and meeting customer needs replacing old, less-efficient habits. PLUS
  • More technology being diffused throughout the economy. EQUALS
  • Favorable implications for greater efficiencies, higher productivity growth, wage gains, economic resiliency and recovery.
  • The pre-COVID-19 economy was in good shape

    Our assessment of the economy before the COVID-19 recession was that it was in good shape. Accumulated excesses (too much inflation and/or debt) that typically precede “normal” recessions were largely absent. Unemployment was at 50+ year lows. The banking system was very well capitalized.

    With the solid foundation underlying the pre-COVID-19 economic expansion and the super-spreader impacts we’ve discussed, we expect the current recovery to have staying power.

    Consider that retail sales have demonstrated resilience and have already recovered despite still high unemployment.

    Chart 3: U.S. retail sales are back in growth mode.
    Source: numbernomics.com. Horizontal axis in $billions

    A bar chart showing US retail sales levels from 2007 through mid-2020 and how the level has recovered to an all time high after America shutdown due to the COVID crisis.

    Housing is strong as robust demand meets tight supply. Since the housing bust of 2008-09, the supply of new homes has lagged well behind the population-driven demand for homes. Adding fuel to the demand side of the equation, the “Gen X” and the “Gen Y” demographic cohorts are on the move to the suburbs. (So much for the widespread fear that they were all going to live in their parents’ basement).

    The prospects underlying retail sales and housing should also prove resilient as consumers have accumulated, in unusual fashion, “large buffers of savings”. The highly regarded academic economist Emi Nakamura explains in the news summary below.

    Star economist Emi Nakanmura says an unusual feature of the COVID-19 downturn could make a big difference when restrictions on spending go away. “During a recession, it’s not typical that people are building up these quite large buffers of savings. Not only at the very top of the income distribution, but actually down into the median of the income distribution, one sees accumulation of savings.”

    –Nakanmura Bloomberg New, October 6, 2020

    We are not saying, of course, that everything in the economy is great.

    COVID-19 tragedy and the fallout from the mandated economic shutdowns is not over. Adaptation requires time. The clock will, unfortunately, continue to run out for some businesses. Unemployment remains high, although progress is occurring. The “psyche” of many remains stressed out as fear, uncertainty and doubt (“FUD”) about nearly everything remains prevalent.

    But…just as three more years of tragedy of war followed 1942’s “bottom for the ages”, the stock market is looking ahead. The silver lining in the dark cloud of COVID-19—super-spreading adaptation and diffusing productivity enhancing technologies throughout the economy—may well deliver surprisingly sunnier skies in the not-too-distant future.

    Sources & Notes

    1 Loonshots , Safi Bahcall, St. Martin’s Publishing Group, copyright 2019
    2 Loonshots , Safi Bahcall, St. Martin’s Publishing Group, copyright 2019
    3 Yale Professor Robert Shiller’s corporate earnings database. http://www.econ.yale.edu/~shiller/data
    4 Steven Johnson, How We Got to Now, Penguin Publishing, 2014
    5 See for example, What if creating a coronavirus vaccine that saved the world from the COVID-19 pandemic was just your opening act? Investors’ Business Daily, September 21, 2020, and Barron’s, The Pandemic Speeds Up the Health-Care Revolution, September 25, 2020
    6 Barron’s, How Covid Killed Cash, September 21, 2020