Bedrock’s Newsletter for Friday 4th June, 2021

“If all the economists were laid end to end, they’d never reach a conclusion.”
 
— George Bernard Shaw

Friday 4th June, 2021

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May was another solid month for risk assets, as investor optimism and shedloads of liquidity courtesy of our lavish central bankers continued to spur the recovery in most markets. Commodities have been the standout performer in recent months as economies begin to re-open in full, consumers stumble out onto the streets once more, manufacturing and construction roar back to life, and the resulting pricing pressures drive a flight to real assets and other inflation-hedges among wary investors. May was no exception to this general trend, with cyclical commodities like oil (WTI: +4.3%; Brent: +3.1%) and copper (+4.4%) making strong gains during the month. However, the best performing assets were actually gold and silver, which have a rather looser relationship with economic growth. The former climbed +7.8% in May (rising above $1900/oz at one point), while the latter soared +8.1% (despite the Reddit army having abandoned the cause some time ago); after a tough Q1 for precious metals, we believe that gold and silver have now certainly turned the corner, particularly if the fading of the bitcoin boom persists. After all, there remain very real risks to the outlook, such as mounting US-China tensions over the origins of covid-19, infectious new variants of the virus being discovered on an almost weekly basis, razor-thin credit spreads on both IG and HY bonds, and toppy equity markets as we enter seasonally thin trading conditions this summer. Having at least one long volatility asset in a diversified portfolio seems smart.
 
However, despite the multitude of risks to the outlook, the global economy does seem to be in ok shape right now given the horrors of winter; and we see no reason to bank the year-to-date gains by selling out of positions ahead of the summer lull. Although today’s non-farm payroll data in the US fell short of expectations, survey data shows strong underlying growth. Indeed, the May composite PMI printed at 68.7 this week in what was its best reading since the series began in 2009. Meanwhile, composite PMI data for the Eurozone (which came in at 57.1) has also been upbeat, suggesting that the Old World is finally rebounding too after a slow start to vaccination in the spring. And, across the channel, the UK is now almost completely free from the shackles of the pandemic, recording just a handful of daily deaths. In Asia, as well, there are some obvious bright spots, with China’s economy, in particular, continuing to motor ahead (as ever). That being said, most of Latin America and Emerging Asia are still in the grip of the coronavirus and related restrictions, and the situation is hardly improving across the board.
 
Precisely how the global economy escaped a systemic 2008-style crisis due to covid-19 will be debated for many years to come. But there is no doubt that the new technologies that facilitated remote working, combined with massive fiscal and monetary support played an outsized role. The latter has shifted much of the cost burden of the pandemic onto future generations, who will be labouring under huge debts and the distortions that negative rates and QE are causing for many years to come. Lucky them… The question for policymakers today, however, is when to reverse gear and get back to something close to ‘normal’. Creative destruction is vital for any capitalist economy to be successful, and this means letting unprofitable businesses fail and redundant jobs disappear. This has not been happening since the start of the pandemic given the blanket support that was provided to struggling companies. The longer these policies remain in place, the greater the structural damage done to the economy – and the less prepared we will be for the next crisis (not if, but when, it comes).
 
Yet moving too early risks tipping the banks, the financial markets, and much of the real economy over the edge at a time when they are just picking themselves back up. If you believe some commentators, a sudden surge of inflation may yet force the Fed and the ECB to act (and producer prices are soaring in some sectors already) but our inkling is that any such pressures will be temporary, and policymakers will be slow to change tack as a result. This is particularly likely in Europe where stagnant growth and QE infinity were the norm even before covid-19 reared its ugly head. The aftershocks of the pandemic are likely to reverberate for a long time to come in our view and the coronavirus (and the policy response to it) will do much to define the investment landscape over the next few years at least. What this means first and foremost is that rates (in Europe in particular) are unlikely to rise anytime soon. We do not buy into the argument that we are at some sort of inflection point for rates that will cause a shift in relative prices across markets (resulting in, for example, value beating growth stocks for the next decade). Once the immediate rebound has taken place we are almost certainly in for more of the same: low rates, weak growth, and immovable debts. Sorry to disappoint. The ‘change of environment’ narrative is rather less convincing than the ‘worse environment’ one since the pandemic has essentially exacerbated all the structural problems we had before. It has not resulted in greater dynamism or a clearing out of zombie firms. Luckily for us, stimulus seems to matter at least as much as fundamentals for investors!