Macro Minute: GDP Deep Dive

Last week, just before the end of the month, we got the Second Quarter Advance GDP Estimate from the US Bureau of Economic Affairs (BEA). The quarter-over-quarter annualized number for real GDP printed a disappointing -0.9%, compared to a median expectation of +0.4%, but still better than the 1Q number of -1.6%. 

GDP releases are very important events for markets. Companies use them to help make investment decisions, hiring plans, and forecast sales growth. Investment managers use them to refine their trading strategies. The White House and Federal Reserve both use GDP as a barometer for the effect of their policy choices. 

These numbers are especially important for turning points in the economy. For some (but not the National Bureau of Economic Relations – the US agency responsible for classifying recessions), two consecutive quarters of negative real GDP growth is defined as a recession. If we took the early GDP releases at face value, this would imply that we are in a recession today, dating back to the first quarter. For all the above reasons, it is worth digging into how the BEA derives this number and how reliable the early releases are.

One of the tasks of the BEA is to calculate US GDP, measured as the total price tag in dollars of all goods and services made in the country for a given period. It is the sum value of all cars, new homes, lawnmowers, electric transformers, golf clubs, soybeans, barbeque grills, medical fees, computers, haircuts, hot dogs, and anything else sold in the US or exported during the period. When calculating current (or nominal-dollar) GDP, the agency adds the value of all goods and services in current dollars. But this herculean task does not end there, because what matters for most people is the real growth in the economy. And so, after tallying up everything in current dollars, the agency has to then make adjustments to try and come up with an estimate of the value of what was actually produced in the economy (e.g., ex-inflation). 

Imagine an economy that only produces two things, potato chips and mobile phones. Suppose that the economy is selling $1.1 million of goods this year, an improvement of 10% compared to the $1 million from last year. That $1.1 million number represents the nominal GDP for the economy this year. But that number does not tell us how much of that 10% increase is due to more goods being sold and how much derives from price increases. 

If last year there were 50,000 bags of chips sold for $10 and 500 mobile phones for $1,000, and this year there were 55,000 bags of chips and 550 mobile phones sold for the same price as last year, the economy had real growth of 10% and zero percent inflation. 

Alternatively, if this year the economy sold the same number of chips and mobile phones as last year but did so at a price of $11 and $1,100, respectively, the economy had zero real growth and 10% inflation. 

However, things are not so simple, for the methodology is designed not only to remove price inflation but also to adjust for the quality of the goods being sold. Let’s assume that this year the economy sold 55,000 bags of chips for $10, and 550 phones for $1,000 (the same as the first example). But in this example, the bags of chips sold this year only contain 40 chips versus the 50 chips in each sold last year, and the mobile phones sold this year have better computational power and an extra camera versus last year’s. In this case, the agency would have to account for those changes by calculating a positive price increase for the potato chips and a negative one for the mobile phones, even though the number consumers saw on the price tag did not change. Now imagine that the BEA must do this not just for all the goods sold in the US economy, but also for every service provided, and to deliver an advance estimate one month after the end of a quarter. 

Which brings us to the question, how reliable are early GDP estimates? The answer is… it depends. Each revision incorporates more and better data and is believed to be a better estimate of the true value of GDP. For example, comprehensive data accounts for only 25.5% of advance estimates and 36.8% of second estimates, but it accounts for 96.7% of what we can call “final” estimates[1].

To assess the reliability of the GDP estimates we can look at revision patterns to understand if there is a bias in these revisions and how large they can be. To assess bias, we calculate Mean Revision (MR) where components tend to be offsetting and a large positive or negative number would indicate bias. To understand how large revisions can be, we calculate the Mean Absolute Revision (MAR) and the standard deviations, which are both complementary measures of the distribution for the revisions around their mean. We calculate these revision metrics for the Advance release that comes out one month after the end of a quarter, comparing with both, the Second releases (two months after the end of a quarter) and what we here call the “final” estimates (also called, comprehensive revisions, which are released approximately five years after the advance release).

What we find is that inflation has a meaningful impact on reliability. More specifically, it creates a pronounced bias for advance releases in underestimating real GDP growth. This makes intuitive sense. The task of calculating real GDP becomes even more challenging during inflationary environments. Looking at the numbers, we find that in periods of low inflation [3,4], bias is virtually inexistent with MRs for Second and Final at +0.10% and -0.01%, respectively. While during periods when US CPI is above 7%, MRs are +0.40% and +0.80%, respectively. That means that, on average, in high-inflation environments, Advance GDP numbers are underestimated materially. It is also important to note that MARs and standard deviations are essentially unchanged from one environment to another. This means that the size of revisions is similar in both circumstances. 

To clarify the point, let’s look at last week’s 2Q 2022 GDP Advance release of -0.9%. We can say that the second estimate will be between -1.5% and +0.4%, while the final estimate will be between -2.6% and 2.4%, with 90 percent confidence. This distinction between inflationary and non-inflationary environments is important because if we used the low-inflation scenario numbers, we would say that the second estimate would be between -1.9% and +0.2%, while the final estimate would be between    -3.6% and +1.7%, with 90 percent confidence. [5]

One way to increase the reliability of activity numbers is to look at the average of GDP and GDI. In theory, GDP and GDI should be equal, but in practice, GDP and GDI differ because they are constructed using different sources of information – both are imperfect in different ways. If both GDP and GDI are interpreted as the sums of unobserved, true economic activity and measurement errors, it is possible to infer that the weighted average series of the two is a more reliable measure of activity than either GDP or GDI alone, assuming some of the measurement errors are averaged out.

In short, calculating GDP is a mammoth undertaking, early estimates of real GDP tend to underestimate growth in inflationary environments, and you are better off taking a holistic view of the economy when data is as volatile as it is today. 

P.S. We talked a lot about real GDP, but we should not neglect nominal GDP. Historically, S&P earnings growth tended to stay in line with nominal GDP. And that is how corporate sales, revenues, and profits are recorded. In the second quarter of 2022, nominal GDP in the US was approximately +7.9% QoQ annualized.  

P.P.S. For a depiction of how and when GDP revisions and their vintages are made and maintained by the BEA, please see below.

[1]  Comprehensive revisions are performed every five years and include major updates to classifications and definitions for the entire GDP time series – for more information, please see the endnote

[2] Holdren, Alyssa – Gross Domestic Product and Gross Domestic Income – Revisions and Source Data (June 2014)

[3] Fixler, Francisco, Kanal – The Revisions to Gross Domestic Product, Gross Domestic Income, and Their Major Components (June 2021)

[4] Using 1996-2018 period used in above paper, when US CPI inflation averaged 2.2%

[5] Revisions follow a normal distribution and therefore we can calculate the combined probability that the true value of real GDP growth in the 1Q and 2Q was below zero, i.e., two consecutive quarters of negative GDP growth. P (2Q < 0% | 1Q < 0%) = 36%.

Macro Minute: Flip or Flop

With so much talk about a recession lately, it is hard not to look for clues in housing numbers. This past week, we had numbers for US housing starts and building permits. While homes only directly account for roughly 5% of GDP, related goods and services can account for nearly 20%. Aside from 2001, the US has never gone through a recession when housing is doing well. Conversely, the US has never emerged from a recession without the help of housing (2009 being the exception with a rebound while housing was stagnant). Fort these reasons, it comes as no surprise that so much attention is given to the release of housing data.

Housing starts record how much new residential construction occurred in the preceding month, while building permits track the issuance of construction permits. The number for both releases is reported in number of units, with the latest number for housing starts and building permits disappointing the Bloomberg median survey at 1.549 million and 1.695 million, respectively. But how disappointing are these numbers, if at all?

First, let’s look at housing starts. The month-over-month number came in at -14.4%, and comparing the latest release with the same time last year, the number of starts contracted by -3.5%; however, these numbers are very volatile and prone to significant revisions. When looking at the rate of change of the 12-month moving average in May versus the previous month, we encounter only a -0.28% contraction, and when comparing the average with the same period last year, we find a growth of +9.5%. Building permits decreased by -7% MoM and increased +0.2% compared to last year. Using the same 12-month moving average to smooth volatility, the rates of change from the previous month and last year are +0.2% and +6.4%, respectively. We can see some deceleration, but we are still at very healthy levels compared to the past.

One thing to keep in mind is that looking at housing starts and building permit numbers only gives us an idea of the real component of the economy. But for prices and company earnings, it is Nominal GDP that matters. Therefore, we have constructed a nominal index for housing starts and building permits using the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index. When looking at that number, we see some deceleration, but in aggregate both starts and permits are still running at very high growth rates.

We cannot draw firm conclusions from a single piece of evidence, but what a closer look at housing starts and building permits shows is that the probability of recession may not be as high as one perceives from reading headlines.

Macro Minute: Speak Harshly and Carry a Small Stick

In the early 1900s, President Theodore Roosevelt was known for the aphorism “Speak Softly and Carry a Big Stick.” The idea behind this adage is that it is the availability of raw power, not the use of it, that makes for effective diplomacy. In the case of Roosevelt, that policy worked very well. His two terms in office had been almost completely without conflict. “He has managed, without so much as firing one American pistol, to elevate his country to the giddy heights of world power.” – Literary Digest, December 22, 1906

Possibly empowered by the policy success almost 100 years earlier, in the early 2000s, the Fed decided to embark on a policy of forward guidance. Forward guidance is the act of communicating to the public the future course of monetary policy, namely, the path of interest rates. Said guidance, which along with the control of short-term interest rates and quantitative easing, had the aim of controlling the interest rate curve without so much as “firing one American pistol.” In hindsight, it worked. Forward guidance not only kept interest rates low through the expectations channel, but also helped dampen interest rate volatility (and along with that, equity and fx volatility).

However, the deflationary forces that provided the Fed with the availability of raw power began to dissipate around 2015. Raw power allows the Fed to introduce QE and rate hikes without needing to backtrack. This was ultimately eliminated once Covid incited a degree of globally coordinated fiscal and monetary policy never seen before. Since then, the Fed has flipped Roosevelt’s policy on its head. Today, the Fed is using FOMC press conferences and governors’ speeches to speak harshly on inflation. But when the time to act comes, we believe that the Fed does not have the same firepower as before. On one hand, it cannot materially tighten financial conditions without causing an enormous problem for the refinancing of historically high levels of debt (both corporate and government). On the other hand, with inflation rampant, it cannot continue to serve as a backstop to financial markets.

Going forward we believe that the Fed will speak harshly of inflation, but will consistently be behind the curve, possibly un-anchoring inflation expectations and the long end of the interest rates curve.

Macro Minute: US Labor Participation

This week, we will once again touch briefly on labor force participation and attempt to make sense of the US Employment Situation Report from Friday.


US labor force participation has been the subject of much discussion lately. Beginning in the 1960s when more women entered the workforce, it has steadily risen, moving from 59.1% to 66.9% by the year 2000. Since then, it has drifted lower and settled near 63% pre-Covid. A drop of almost 4% on the labor participation rate is equivalent to around 10 million jobs. At first glance this seems negative, but we find that most of this was due to strong levels of enrollment in post-secondary education among those aged 16 to 24. This trend began in the late 1980s, and accelerated into the 2000s, hence a deluge of social science majors and a dearth of truck drivers.

Turning to today, let’s analyze some of the most common arguments for explaining the slow recovery of the labor force participation rate.

(1) Self-employment is keeping labor participation low – One way to try to test for that, is to track the difference between the household and the establishment employment data. The household employment figure captures the self-employed, farm workers and domestic help, something the BLS payrolls survey doesn’t do. Here what we find is that household employment suffered more than payrolls during 2020, and still hasn’t recovered to pre-covid levels.

2) Women have been kept out of the labor force because of childcare – There is some indication this may be true. We saw nearly the same number of exits from the labor force for men and women in 2020 (3.9mm & 4.2mm in April ’20, respectively). Those aged 25-34 were the second most affected at the time, accounting for more than 1mm women exiting the labor force. By September 2021, there were still 550k less women aged 25-34 in the labor force than in January 2020, the largest discrepancy across all age brackets. With schools reopening, that number was cut in almost half to 283k in November.

(3) Retirement is keeping people out of the labor force – It is hard to see that clearly in the data. The age group 55 and over (55-64 & 65 and over), suffered the least in both genders and have the least amount of people out of the labor force (when compared to January 2020 levels). Today there is 100k more men 65 and over in the labor force than at the peak in January 2020.

Macro Minute: Fiscal Cliff vs. Excess Savings

Looking ahead to 2022, much has been written about the pending fiscal cliff and its impact on Real GDP Growth. As the impact of fiscal stimulus dissipates and the federal government mulls tax increases, analysts expect fiscal impulse to shift from positive to negative next year.

Figure 1: Effect of Fiscal Policy on Real GDP Growth (3Q CMA) [Source: Goldman Sachs]

In our estimation, given the levels of excess personal savings reached in the past 20 months, we believe there is enough pent-up savings to compensate for the forthcoming negative fiscal impact on GDP. Using seasonally adjusted personal income minus personal consumption expenditures as a proxy for personal savings, we find that from April 2020 through September 2021, Americans generated over $2.8 trillion in excess savings, amounting to approximately 12% of GDP. That compares with approximately 4% of fiscal drag projected for 2022.

Macro Minute: What’s going on in the US Labor Market?

With job openings, participation rate, and unemployment central to the current discourse on markets, the topic of this month’s memo is the United States labor force.  

Focusing on the four largest sectors (which add up to more than 60% of payrolls and job openings in the US economy), we can see that wage inflation is a pattern that predates the onset of covid. In other words, wage inflation is not simply a result of covid supply shocks, it is based on fundamentals in the economy, and therefore it is not transitory. 

1 – Trade, Transportation & Utilities (19% of total Payrolls, 18% of total Job Openings)  In 2018, demand for work (job openings) started to grow much faster than supply (using payrolls as a proxy). As a result, average hourly earnings growth for this sector has surged from an average of 2.25% percent in 2018 to over 4% today (and 3.35% pre-covid). 

2 – Education & Health Services (16% of total Payrolls, 18% of total Job Openings) Hereto the story is very similar, but it started even earlier. In 2014, demand for work accelerated faster than supply of workers, driving an increase in earnings from 1.5% to 3.4% today (and 2.5% pre-covid).

3 – Professional & Business Services (14% of total Payrolls, 18% of total Job Openings) In Professional & Business Services, we saw two waves. The first in 2014 and the second in 2018, causing an increase in earnings from 1.5% to 2.3% in the first wave, and from 2.3% to 4% today (and 3.3% pre-covid).

4 – Leisure & Hospitality (10% of total Payrolls, 14% of total Job Openings) Leisure & Hospitality is the only sector in the top 4 that has gone through two opposite cycles since 2014. The first was with the demand for work growing faster than supply starting in 2014, increasing earnings growth from 1% to 4% in 2017. The second cycle took place starting in 2018, with labor supply growing faster than demand, and earnings growth falling to 3.5%. Today we are back at 4% growth, last seen entering 2018. It is worth noting that today, the demand for work in this sector is at historical highs while supply is back near the levels of 2010.

Labor Supply Shock

The last point has to do with the temporary labor supply shock that happened due to covid. Comparing jobless claims numbers between states that ended extra unemployment benefits before the September 6th deadline and those that adhered to the target, we see that the states that finished earlier have a much more accelerated and consistent contraction in claims across latter weeks. With this in mind, we expect some of this labor supply shock to normalize as we get farther from the deadline. However, when we look at the pre-covid trend, we believe that this will not be enough to avoid wage inflation.

Special Report – A Changing Paradigm

As an investment philosophy, we believe that the best way to deliver above-market returns is to find something cheap, take a position, and hold it for the long term. We tend to avoid market timing and “short-term” investments.

Looking across asset classes, we find that many equities are overpriced on a historic basis by virtually every metric and expect future returns to be much lower than in the past decade, save for a couple of undervalued sectors like energy and materials. When the stock market is on fire, as it has been almost non-stop since 2008, investors ignore companies that specialize in raw materials and other goods. With investors too distracted by their ever-increasing portfolio of technology companies, there was a loss of interest in investing any money in increasing the productive capacity of raw materials, agricultural products, and other hard assets.

In real estate, housing around the world is already too expensive to represent a compelling investment. In the US alone, the S&P Case-Shiller Home Price Index sits a lofty 26 percent above its 2006 peak, with a 17 percent increase year-over-year for the nine US Census divisions. To put this in context, housing prices have been rising more than 5 percent above inflation for the past decade.

Products like copper and lumber seem expensive but as an asset class, commodities are the cheapest. When you factor in inflation, even after the recent run up in prices, most commodities are trading closer to their historical lows. We will further explore this asset class in detail in future reports.

Figure 1: Inflation-Adjusted Commodity Prices

Bonds have never been this expensive in history and are clearly in a bubble. As we write this letter, 10-year real yields in the United States are at their historical lows of -1.2 percent. With the Fed’s new inflation targeting policy of slightly above 2 percent, real rates could still theoretically go down to somewhere slightly below negative 2 percent, assuming the Fed cannot reduce nominal interest rates meaningfully below zero. However, for that to be true one needs to accept that we are living through some type of global secular stagnation[1] process, from the demand or the supply side.

Herein, we hope to show that such a scenario is extremely unlikely. First, we believe it highly probable that the environment of slower growth and inflation from the past few decades has more to do with a series of temporary “headwinds” arising mostly from consecutive deleveraging processes caused by the fact that almost all recent crises were balance sheet crises, and therefore deflationary. Secondly, we argue that even if we were living through secular stagnation before, we are not anymore. The underlying forces in play for the past few decades began reversing around 2015, and the Covid crisis created a catalyst for an acceleration of these forces.

If you wish to receive a full copy of this report, including our directional views across asset classes, please contact ir@norburypartners.com.


[1] Secular stagnation is defined as a prolonged period of low growth. While prolonged and low are not further specified, many economists define low as an average annual real output growth rate of no more than one to 1.5%, and prolonged as covering at least several business cycles. The term secular does not require stagnation to persist forever.

Special Report – US Elections: Part 3

To conclude this series of Special Reports examining the 2020 United States election, we want to take a closer look at one of President-Elect Biden’s cabinet picks, what the selection could mean for sustainability and fiscal policy, and developments at the Fed regarding climate change. Part 1 detailed our probabilistic approach to predicting a Biden win, while Part 2 dug into his policy platform, fiscal approach, and where we could see bipartisan support (hint: tech antitrust).

Election Outcome

As a quick refresher, let us first level-set on how things have shaken out since November 3. In a pattern many analysts suspected would occur, Republican voters turned out en masse for in-person voting on Election Day, giving President Trump and other Republicans early leads at the polls, but as mail-in votes were counted across the country, President-Elect Biden edged into the lead in a handful of key states and two runoffs were set for the Georgia senate races. President Trump contested the election results in many states, but elections were certified, and electoral votes cast by each of the battleground states in question (Georgia, Pennsylvania, Wisconsin, Michigan, and Arizona), guaranteeing a Biden presidency.

In Georgia, two hotly contested senate races determined the final composition of the Senate. At the caucus level, the final tally now shows 50 Republicans and 50 Democrats, with both Messrs. Warnock and Ossoff defeating Republican incumbents. We wrote in our final update to investors on October 27 that there was a 66.1% chance of a Blue Wave in D.C., including the scenario in which we have arrived. A surprise double Democrat win has given the incoming administration (with the vice-presidential tiebreaker) the ability to freely legislate. Caucus moderates, like Independent Angus King from Maine, and centrist Democrats from states with more practical, fiscally conservative electorates will be critically important to the passing of any legislation and are likely to serve as a dampening mechanism against some of the more extreme agenda items coming from the party’s fringes. However, we do expect this split to result in a streamlined nomination process for executive branch members and judges – expediting the rate at which we expect to see implementation of the President-Elect’s policy platform.

President-Elect Biden’s Cabinet

Partisan gridlock aside, the executive branch is expected to leverage its powers to advance its policy agenda, thus rendering the members of Cabinet ever more important. As is tradition in the Cabinet Room of the White House, the President and Vice President sit at the middle of a long table, opposite one another, with the members of Cabinet (e.g., department heads) organized around the table according to the date the department was established (and de facto, by importance). To the right of the President, and first ranking department head, sits the Secretary of State. And to the right of the Vice President sits the second ranking department head, the Secretary of Treasury.

Mrs. Janet Yellen, the nominee for Secretary of Treasury, needs no introduction. In her acceptance speech, the former Fed chair pointed to five issues as part of her agenda within the Biden administration: (1) inequality, (2) stagnant wages for non-college graduates, (3) communities that have lost industry with no new jobs to replace it, (4) racial disparities in pay, jobs, housing, food security, and small business lending, and (5) a gender disparity keeping women out of the workforce. While opinions differ on how to interpret the data to either support or refute those positions, one thing is clear, Janet Yellen, who as Fed Chairwoman said it was in fact “her job” to discuss economic inequality before Congress, will be attempting to address income inequality in America that may likely be as bad, if not worse, than it was after the Gilded Age preceding the Great Depression.

The Secretary of Treasury is the lead go-between for the executive branch and Congress on matters of fiscal policy and budgetary spending. Yellen can be described as a progressive Keynesian, believing that government intervention should be utilized as necessary to restore full employment and demand. She is a stated supporter of broader unemployment benefits and has been characterized in the media as “pro-labor.” As Fed Chair, her monetary policy toolset was limited to interest rate control and quantitative easing – as she navigated the post-crisis period, she maintained low interest rates, encouraging employment but consequently also causing asset price inflation which in many ways exacerbated the inequality issue.

Stepping into her new role, Mrs. Yellen will have a wholly different set of levers to pull. With a second wave of Covid-19 spreading and vaccine rollouts being less successful than forecast, there is a good chance that as part of the follow-on coronavirus relief package to come after Inauguration Day, we see her reinstate the expanded unemployment benefits that expired last summer. She has also come out in favor of fiscal support for state and local governments, a contested view on Capitol Hill. She recognizes these entities as important employers, and notes that if they are not helped, there will be large layoffs and more difficult to solve problems in the future. It is important to remember that state and local governments are required to maintain balanced budgets and cannot raise money selling treasury securities like the federal government, meaning in times of low revenue (e.g., low sales tax revenue, low metro ridership), states and municipalities are required to cut costs (e.g., jobs, subway service). Abroad, she will be central to negotiating America’s position in trade deals, and as a believer in globalization, will likely be a measured, stark contrast to the outgoing administration. Finally, she has stated a desire to leave the system more guarded – the New York Times characterized it as, “putting training wheels on capitalism.” An example is her support for budgetary stabilizers, which would kick in when the economy declined and do not require Congress to vote and pass a fiscal package but would automatically increase unemployment benefits.

Given her background, we expect the Federal Reserve Bank and executive branch to be far more in sync, and for Mrs. Yellen, who has gone on record discussing how recent asset inflation has not carried over to working people, to be instrumental in shaping the country’s fiscal agenda.

Federal Reserve Joins NGFS

Last month, the Federal Reserve officially joined the Network of Central Banks and Supervisors for Greening the Financial System, a collection of central banks meant to exchange ideas and best practices to account for environment and climate risk in the financial sector. The Fed has recently began paying more attention to climate change and can thank former Chair Yellen for being the first Chair to begin examining the impact of broader economic and global issues on the financial sector. In April 2019, Mark Carney, former Governor of Bank of England and Chair of the NGFS, penned an open letter detailing four recommendations from the coalition’s first report seeking to translate commitments into action: (1) integrate monitoring of climate-related financial risks into day-to-day supervisory work, financial stability monitoring, and board risk management, (2) integrate sustainability into central bank portfolio management, (3) collaborate to bridge the data gaps to enhance the assessment of climate-related risks, and (4) build in-house capacity and share knowledge with other stakeholders on management of climate related financial risks. For a myriad of reasons, particularly given our investment strategy, it is both exciting and encouraging that the Federal Reserve is participating in the organization.

Together at the Group of 30, Yellen and Carney wrote that governments should treat climate change and fighting global warming like monetary policy, because both require considerable long-term decisions that can be undermined by short-term partisan pressures. Carney is pushing for all listed companies to report on their exposure to climate risks for by 2023 and substantiated his reasoning in a recent talk at the Dallas Fed. As governor of the BoE, he oversaw the insurance industry and noted that those who oversee property and casualty insurance, in addition to reinsurance, are keenly focused on climate change. Over the past decade they are consistently repricing coverage because, “what was once the tail has become the central scenario in terms of extreme weather events.” He went further to echo a sentiment we share, that it was necessary for the BoE to get involved in climate change because it was prudent responsibility. Ultimately they recommended a change to capital ratios for banks based off who they lent to – banks would be required to maintain greater reserves for lending to brown industries versus green. While on the surface this may seem partisan, it is important to recognize the following – as society slowly starts to more seriously consider these issues, climate policy will be stricter and banks could end up with very large stranded assets. As such, Carney believes that banks need to be stress tested for vulnerabilities associated with climate change in the same way they are tested for exogenous shocks after the 2008 crisis.   


The United States still faces a myriad of threats: the Covid-19 pandemic, a sharp economic downturn, and attacks on its democratic institutions. In 1936, as Roosevelt accepted his party’s nomination in Philadelphia he said, “Governments can err, presidents do make mistakes, but the immortal Dante tells us that divine justice weighs the sins of the cold-blooded and the sins of the warm-hearted in different scales.” It is our belief that recent events have not created an irreversible rupture in the social fabric of this country, and its result will be one of compromise to the exclusion of extremists. Trump’s impeachment process could mark the start of a new era of bipartisan cooperation. Like Roosevelt, the new Democratic president has the opportunity to implement far-reaching reforms through a Green Bipartisan New-New-Deal that will reform the United States infrastructure, increase income distribution and maintain its strategic role in the world for decades to come. Combined with Janet Yellen’s penchant for fighting unemployment and inequality, and the Fed’s increasing posture on climate change, we think that 2021 can be a big year for sustainability and investments that incorporate such thinking. We hope you enjoyed your holiday season; our team is excited for what’s ahead and look forward to you reading our future commentaries.

Sincerely,

The Norbury Partners Team

What A Divided Congress Could Mean For Sustainable Infrastructure Investing

In a fitting end to an already tumultuous year, the 2020 election cycle has (nearly) ended with President-elect Joe Biden announcing members of his cabinet and further refining his platform. One key tenet of his preelection policy agenda was an infrastructure bill with a focus on the renewable sector, but the prospect of a divided government will meaningfully change the size and scope of any legislation passed.

As it stands, there will be 50 Republican senators and 48 Democratic senators, with two seats remaining to be decided in the Georgia runoffs this January. The best historical precedents for these races are the 1992 and 2008 Georgia Senate runoffs, both in presidential election years, which saw a decline in turnout from the general election and the Democrats losing more support than Republicans.

Given the aggregate Republican lead in both races on Election Day, it will be a steep hill for the Democratic Party to climb. Even in a narrowly controlled Democratic Congress, we predict it will be difficult to set pollution limits on greenhouse gases given the producer and consumer states from which certain senators hail. In the face of a divided government, Biden will have to pull on different levers to pursue an infrastructure and clean energy agenda. Following the last two presidents, I expect a healthy amount of regulatory and executive action to be used for achieving policy goals.

A narrow margin in Congress means a less aggressive Clean Energy Standard than Biden campaigned on and may require the inclusion of somewhat forgotten energy industries like nuclear and hydropower. A technology-agnostic clean-energy standard for utilities and the grid would likely include the continued use of natural gas power plants with carbon-capture technology because renewable energy remains intermittent.

From where we stand, improved battery technology can take two paths: First, batteries at the grid level could decrease natural gas dependence by solving the intermittence issues of renewable energy, and second, batteries at the electric vehicle (EV) and home level could increase the dependance on natural gas for the grid as residential consumers consume more electricity. This is all to say that prospects for traditional energy sources are not as bleak as one might think and that the accelerating adoption of EVs might accelerate demand for natural gas in the short to medium term and impact commodity prices.

The government also has massive buying power. We expect the Department of the Interior to be far more active in its pursuit and purchasing of alternative energy sources. Offshore wind and solar are proven technologies with decreasing costs that can be looked to by the administration to “green-ify” the grid without the need for massive fiscal stimulus simply by using the existing government balance sheet.

Some analysts believe that even with a Republican-led Senate, the multibillion-dollar planned spending on the electric grid from President-elect Biden’s “Build Back Better” plan could pass as part of a broader bipartisan stimulus bill focused on jobs and infrastructure next year. Said grid spending could encompass and support energy efficiency and weatherization technology. Grid innovation, in large part, is a necessary complement to the aggressive adoption of EVs while energy efficiency and weatherization legislation will impact builders, owners and retrofitters of both commercial and residential real estate.

In our experience, investors cleanly (forgive the pun) put environmentally innovative energy investments into two buckets: new technologies and process innovation. I believe that the forthcoming Biden innovation will use a mix of executive action and legislation to participate in both buckets, with a divided government forcing a greater emphasis on legacy process innovation than a democratic sweep would have otherwise pursued.

Three of the largest segments we expect the government to invest in are electric vehicles, electric vehicle infrastructure and hydrogen power. Having already discussed the first two, we will focus on hydrogen power: a possible substitute from electric generation in natural gas power plants. New York, Virginia and Ohio recently paid more than $3 billion for three power plants that will initially run on natural gas but be outfitted for using green hydrogen, produced by wind and solar, as collection ramps up. We expect hydrogen storage to be an ever-increasing pillar of the energy complex and look to companies in the space to offer value in the coming decade.

In conclusion, a divided government sets the stage for a smaller, albeit interesting, infrastructure and clean energy agenda that will impact both new inventions and legacy energy tech. We’re interested to watch how the incoming administration navigates all-too-familiar D.C. gridlock, a global pandemic and a recovering economy. A few other industries worth watching are renewable diesel and natural gas, energy efficiency as a service, and energy efficiency in oil fields and digital infrastructure.

Article also submitted to Forbes

Special Report – US Elections: Part 2

If you haven’t had the opportunity to read Part 1 from this series of Special Reports on the United States election, you can find it here. As a refresher, we used a combination of historical and mathematical analysis to arrive at probabilities for a Biden-Harris win and a Blue Wave, defined as a Democrat-controlled House, Senate, and Oval Office. Below, we will begin with a quick update of our election forecasts before moving onto the prospective impact of said forecasts on fiscal policy. We will then more closely examine the high-level and near-term spending implications of former Vice President Biden’s policy agenda on industries and sectors before wrapping up with a look at how a bipartisan push for antitrust legislation might manifest.


Refreshing Probabilities: Senate Seats Matter
With two weeks left until Election Day, our current forecasts estimate a 91% chance of Mr. Biden winning the presidency and a 69.3% probability of a Blue Wave. Our Blue Wave probability includes all permutations of contested Senate races that would result in a 50-50 split or better for Democrats (given the Vice President holds the tiebreaking vote in the Senate). The probability of Democrats having at least 50 seats is 76%, which drops to 44% for 51 seats, 15% for 52, and quickly converges toward zero as we add more Democrats to the Senate. This is an important distinction to make before discussing fiscal policy because a 50- or 51-person majority will require a legislative agenda that satisfies moderate centrists for Democrats to carry the necessary votes. For this reason, we continue to closely monitor Senate races in states like Iowa and North Carolina that will ultimately decide the balance of power in the Senate, and thereby guide our views on impending fiscal policy and subsequently, our market outlook.


Under current rules, Congress can make changes to taxes and benefits programs with a simple 51-vote majority in the Senate through use of the budget reconciliation process. However, annual spending bills (appropriations) and the establishment of new programs require a filibuster-proof 60 votes to pass the Senate, as do changes to regulatory policy, antitrust law, immigration, and minimum wage. Elimination of the filibuster has been floated by both parties since the turn of the century and will be under consideration in the case of a marginal Blue Wave in order to expedite the passage of Democratic legislation, but is unlikely to be the first bill passed.


Although it would require bipartisan support to reach 60 votes, we view the passage of an infrastructure bill in the second half of next year after another virus relief package as the most probable leg of Blue Wave fiscal policy. Subsequently, we view a broad reconciliation bill covering changes to healthcare and tax increases as likely to follow, needing only 51 votes, but with a lower probability considering the support needed from moderate Democrats in a 50- or 51-Democrat Senate. The last and least probable pillar of Mr. Biden’s legislative agenda is education, which would need to pass with 60 votes and extends from pre-K to university, drawing on former candidate Senator Bernie Sanders’ bill for higher education.


Fiscal Policy for a Blue Wave
Notwithstanding a Covid-19 stimulus package, the Biden-Harris ticket has set forth an aggressive fiscal agenda with estimate gross spending between $9-10 trillion over the next ten years. They intend to offset approximately $5 trillion of this spending through tax increases, budget reappropriations and savings. Our analysis here is focused on gross additional spending over the next decade, how it compares to spending this past decade, and how much of the spending we estimate to occur during Mr. Biden’s first term.


We’ll begin with an examination of spending on infrastructure, research, and development. It is interesting to note that private investment in fixed assets (specifically residential and non-residential buildings, industrial equipment, and transportation equipment) was just over six times that of government investment in infrastructure (mostly transportation) from 2010 to 2019 – in other words, every $1 committed to government infrastructure investment resulted in $6 of investment from the private sector. At this point, it remains unclear if Democrats’ infrastructure and R&D policies will crowd out the private sector, or if they will be additive and result in private sector expansion. Former Vice President Biden’s Build Back Better infrastructure plan contains $2 trillion in funds earmarked mainly for transportation and clean energy infrastructure, but also includes $300 billion for research & development, $300 billion for housing construction, and $100 billion for education-related construction. In aggregate, the Congressional Budget Office estimates the net increase in infrastructure spending will amount closer to $450 billion over 10 years, but expect a Democratic Congress to at the very least pass legislation that boosts infrastructure spending by a few hundred billion over the next 5 years, including tax incentives for renewable energy.


Government investment in non-defense energy, natural resources, environment, and general science research and development totaled $172.6 billion from 2010 to 2020 – this plan pledges an additional $150 billion, or an 87% increase over the next decade, to clean energy research and development. Mr. Biden’ plan also commits $750 billion to affordable housing through expansion of Section 8 and a tax-credit for first-time homebuyers. Last year’s data shows that 33% of homes were purchased by first-time buyers and 4% of United States households are on some type of federal housing assistance. Using this as an approximate basis for private sector spending in these areas, this amounts to a 44.7% increase in spending on first-time homeownership and affordable housing over last decade. Assuming half of the $2 trillion is invested in transportation projects over the next ten years, Mr. Biden’s plan will have committed an additional 39.4% of total investment by state, local, and federal governments this decade. Finally, he has pledged another $150 billion to healthcare, infrastructure, and telecom research and development, which amounts to about 36% of healthcare and transportation R&D in the past decade. Research spending is the most frontloaded of his agenda, with approximately 30% expected to occur within his first term.


Moving on to healthcare, where total spending in the next decade is expected to be approximately $2.8 trillion, not including expanded social security or supplemental security income. Mr. Biden’s healthcare plan includes $300 billion for rural health, mental health, and to aid the opioid crisis. In practice, this means doubling federal funding for Community Health Centers, increasing payments to rural facilities, and expanded funding for mental health services. When compared to aggregate spend on public health activity since 2010, this sums to a 35.5% increase for the next decade. Support for the elderly and those in need of long-term care is expected to increase by $600 billion, an estimated 32% of total public and private spending on senior and elderly living care from 2010 to 2020. The final leg of his plan intends to build on former President Obama’s Affordable Care Act by expanding subsidies and enrolling low-income families in premium-free coverage. The estimate cost of expanded health insurance coverage for Americans is $1.9 trillion, which is only 8.7% of the staggering $21.9 trillion that has been spent on private health insurance, Medicare, and Medicaid in America since 2010. Altogether only about 21% of this spending is expected to occur during the Biden-Harris first term.


Ending with education, where our estimates show aggregate spending in excess of $2.5 trillion over the next decade. Mr. Biden’s plan includes access to free pre-K for all children aged 3-4 through a mixed delivery system combining public schools and private care centers. Additionally, he plans to make the existing tax credit for child and dependent care fully refundable and expand it to cover half of all expenses for one or more children, capped at $8,000 and $16,000 respectively. Biden’s agenda for the Childcare Support & pre-K program is $325 billion over the next decade – which would add 70% to aggregate investment in childcare and pre-K as compared to the previous decade. The largest of the educational spending programs is for higher education, where estimated spending, including free tuition to public universities and colleges for families below $125,000 in income, is $1.6 trillion. This amount of stimulus is equal to 46% of total expenditures by public higher education institutions since 2010 and will grow given the desire to legislate future forgiveness of student loans. In other words, a Blue Wave would result in the federal government covering nearly half of all tuition paid at public higher education institutions in the past decade! Conversely, the additional funding apportioned to support K-12 education in inner cities and for disabled students is a big headline number, $600 billion, but would only represent an increase of about 9% of total public school spending compared to the last 10 years. In total, about 28% of this spending is expected to occur in Mr. Biden’s first term using a 2022 start-date for the education stimulus due to legislative timing.

Former Vice President Biden has laid out an extensive fiscal policy agenda that will be most affected by the Senate results November. We have looked closely at his policies and identified a few key sectors to follow as we begin to position for a Blue Wave: clean energy, homebuilders, industrials, and healthcare.


Implications of Bipartisanship on Anti-Trust

In addition to aggressive fiscal policy, a Democratic White House and Congress might seek substantial changes to antitrust law and, in the process, re-order the mergers and acquisition market for a very long time.


Even with markets slowed by Covid-19, North American M&A activity reached $226.8 billion over 2,205 transactions in Q2 2020 alone. The United States has developed a robust and well understood body of antitrust law to regulate the M&A market and prevent, or at least impede, anticompetitive market concentration of power and the rise of monopolies. This issue has gotten very real attention from the House of Representatives in connection with their investigation concerning whether giant US tech companies have acquired and exercised anticompetitive power in digital and online marketplaces. On October 6, the House Judiciary Committee concluded a 16-month investigation asserting that these large tech companies have very much done so and that there is a “clear and compelling need to strengthen antitrust enforcement.”


The report carries with it the potential, if the recommendations are adopted, to restructure the M&A marketplace as it flips presumptions that have been in place in antitrust law since Standard Oil was broken up as a monopoly in 1911 after the U.S. Government sued it for violations of the Sherman Act. The presumption, under the report, is that companies wishing to merge will have to prove that their mergers or acquisitions are not anticompetitive instead of it being the responsibility of the Government to prove that the mergers or acquisitions are anticompetitive; this is a significant shift. A consequence from this is that we may see many more creative and innovative forms intended to defeat or impede government review – for example, joint ventures where there is no formal combination but in which form the result could still be the same – concentration of market power but now without formal antitrust review.


The Committee also proposes to block all acquisitions of potential rivals and nascent competitors. It suggests that such activity be considered presumptively anticompetitive and thus prohibited. This might have the unanticipated consequence of, in the tech space, deterring startups and innovation as founders lose a natural exit. In the pharmaceutical space, where much of the R&D for truly innovative products is outsourced to startups who are then later acquired, this could have the effect of depriving the world of significant medical treatment research and advancement as drug companies can no longer buy potential competitive bio-tech research firms with interesting advances.


All things considered, the report is a clarion call to Congress to take a leadership role in antitrust policy formulation and enforcement. This would represent a major change in the entire market as professionals who have previously guided antitrust policy and enforcement are replaced by those who are instead governed by a two-year fundraising and election cycle. This is coupled with a significant call to re-invigorate private antitrust enforcement by undoing or eliminating significant amounts of precedent and jurisprudence related to antitrust actions, including lowering the standards by which a court should even evaluate a pleading. This will, if taken up, result in a massive amount of private litigation risk that every merger or acquisition will now have to expect and plan for. It remains to be seen whether the current M&A insurance market or the policies that insurance companies have written for directors and officers will cover the private litigation risks that might be a natural consequence of some of the changes presented in the face of a Blue Wave.


Currently, antitrust law has bipartisan support, and as laid out by the House committee, presents meaningful future risks to the technology sector and could result in systemic market disruption after the election. We are closely following both parties’ rhetoric and the evolution of the House Committee and Supreme Court’s views into and past Election Day as we measure current and future US market risk.


As always, we will continue to monitor markets, polls, and macro data to update our views. We appreciate you taking the time to read part 2 of our series on US Elections. If you have any questions, please don’t hesitate to get in touch with one of us.

Sincerely,

The Norbury Partners Team