Friday, 21st of August 2020
“The stock market is filled with individuals who know the price of everything, but the value of nothing.”
– Philip Fisher
Equities have seen mixed performance this week as concerns over US trade policy and the ‘phase one’ US-China trade deal resurfaced, and many European countries saw a sharp spike in cases of covid-19. Despite these troubling headlines, however, the S&P 500 Index finally broke through to reach a new all-time high on Tuesday when it reached 3389 for the first time ever. This new record close officially brings the 2020 bear market in US equities (the shortest in history) to an end. With much of the country still wallowing amidst a major coronavirus outbreak, no indication that a proven vaccine will be available until at least Q1 next year, and corporate America now facing its biggest test in decades after the economically-disastrous lockdown in Q2, the trajectory of the blue-chip index appears to defy reason.
To be sure, many large index constituents, such as Facebook, Microsoft, Google, Apple, and Amazon, have been left largely unscathed by the pandemic – and some are even set to benefit from the growth of online services and sales during the lockdown months. But the health of the US economy cannot be deduced from the market cap of Big Tech, and growth of market share is not the same as growth of the total market. Even the most innovative technology companies ultimately rely on honest dollars earned by the employees of cyclical industries and cash-strapped small businesses to earn their crust. These households are still experiencing a rate of unemployment not seen since the early 1980s, and the pace of the US jobs recovery appears to be slowing (initial claims for unemployment benefit jumped >1m this past week). The heartland is hurting, even if equity investors are not. That Tesla just hit $2000 per share, making the company more valuable than Walmart, when it only announced its fourth consecutive quarter of positive earnings in July, tells you all you need to know about stretched valuations.
Although the disconnect between surging stock markets and struggling economies is unprecedented, the explanation is pretty clear; namely, the vast fiscal and monetary stimulus provided by governments and central banks around the world. In an effort to boost demand and reduce the cost of (equity and debt) capital for companies burdened by coronavirus-related restrictions, the authorities have cut rates, launched aggressive QE programmes, and socialised balance sheet risks so we can all share in the immiseration of society (and shift much of the burden on to those yet to be born). The dampening of the immediate economic downturn has created the illusion that the real economy has been rescued from the crisis, as well as a technical environment in most markets that supports gains and limits losses. But, while such measures were necessary to stabilise the economy, there is no free lunch, and the stimulus will need to be rolled back eventually. The tightening of policy in the wake of the virus could usher in a period of slow economic growth and weak returns for equities (that is, if an instant correction can be avoided when the shift in policy becomes clear). Yet, such a reversal is clearly still some way off.
The principal risks to the outlook today are hardening protectionist rhetoric from President Trump and the further deterioration in US-China relations ahead of the US Presidential election in November. The campaign season kicked off in earnest on Thursday when Joe Biden officially secured the Democratic nomination, chose Kamala Harris as his running mate, and promised to deliver America from a ‘season of darkness’ under the incumbent. The Donald also finally accepted the Republican nomination and hit out at sleepy Joe for his liberal position on immigration and trade. What seems obvious is that Trump will be stressing anti-China and protectionist policies to win support in the big swing states of the post-industrial Midwest. He has already pledged to introduce a system of corporate tax credits and tariffs to encourage American companies to move supply chains back onshore, cancelled trade talks with China which were planned for last weekend, and suggested that he may yet pull out of the phase one deal that the US and China struck last year. Meanwhile, his Administration has placed further restrictions on Huawei to reduce its access to chips, suggested that university endowments may want to divest from Chinese stocks ahead of their potential de-listing from domestic exchanges, and suspended the US extradition treaty with Hong Kong. There are many more weeks between now and the 3rd of November – plenty of time for a spiral of recriminations to develop. Volatility is to be expected.
One way to benefit from rising political risk in the US (and hedge long equities exposure) is by investing in precious metals. This has been, and remains, a high conviction position for us. Gold has soared this year (+27.3%), as ultra-loose monetary and fiscal policy, recessionary economic conditions, geopolitical uncertainty, and a weaker dollar have created a near-perfect environment for the yellow metal. Gold and Silver have both dropped from their mid-August highs, as profit-taking drives some consolidation. However, we expect this correction to be short-lived. Moreover, the coup in Mali this week – which is the world’s fourth-largest gold producer – adds a further impetus for prices to rise. All roads lead to gold.