Bedrock’s Newsletter for Friday 29th of May, 2020
29 May 2020


 Friday, 29th of May 2020


“An investment in knowledge pays the best interest.”

– Benjamin Franklin


Equities have motored higher this week as investor optimism about a possible near-term vaccine builds, and major economies continue to open-up with no dangerous second spike in cases yet. The S&P 500 Index has finally broken through 3000, a level last seen in early March, while the STOXX 600 Index is up >3% amid European outperformance of the US for the second consecutive week – a rare feat. Within DM indexes, there has also been a significant rotation from ‘growth’ into traditional ‘value’ sectors, which tends to occur when economic confidence spikes and interest rate expectations shift higher. Financials have led the rally, up +8.9% for the week (according to the MSCI World Financials Index), while Tech is up just +0.8% (according to the MSCI World Technology Index). Energy stocks also participated in the rotation early in the week, up +3.9% by the Wednesday close. However, they have since fallen back after Putin suggested that he might be reluctant to pursue oil production cuts beyond their present July expiry. This may be a negotiating ploy, but it underscores the present state of flux in energy geopolitics.


The strength of the equity market rally has been impressive. Despite economic data pointing to a deep recession from which trade and some sectors (e.g., airlines) are likely to take years to recover, investors have managed to look through this near-term disruption. The panacea, of course, was the monetary and fiscal bazooka deployed by central banks and governments around the world; and more is on its way. For example, this week Japan announced a further $1.1tn in fiscal stimulus for households and companies, raising the total value of the country’s fiscal relief package to $2.2tn. This is equivalent to 40% of GDP, making it the largest globally. (The Japanese are always ahead of the curve on stimulus). Meanwhile, the EU Commission has also finally proposed creating a €750bn EU-wide recovery fund this week, with €500bn dispersed as grants and €250bn as loans. The debt will be repaid through higher EU budget contributions in future. The so-called Frugal Four – i.e., Denmark, Austria, Sweden, and the Netherlands – are not keen, but if they can at least avoid debt mutualisation then they are likely to cave in eventually now that Germany has switched teams. Across the pond, and eager not to be outdone by politicians from the Old World, Senate Majority Leader Mitch McConnel signalled this week that the US fiscal response (huge as it is) could also be expanded in the future. And why not? Everyone is doing big government now – and Wall Street loves it! Who cares about the consequences for bondholders or the inflationary legacy of these decisions anyway? That is so 2019. And you can always buy gold… we suggest you do.


One big beneficiary of the market rally since late March has been the Swiss National Bank (SNB), which has been buying lots of US equities throughout the crisis using spare dollars from its vast FX reserves. In order to prevent the Swiss franc – which is a safe haven bought by investors at times of stress – from exploding higher in the past few months, the SNB has been printing francs, selling them for foreign currency (which puts downwards pressure on the franc), and investing a portion of this foreign currency in foreign assets, including equities, of the same denomination. The central bank’s FX reserves are now worth some CHF 800bn, which is more than the total GDP of Switzerland. That is some balance sheet! Curiously, in addition to being responsible for Swiss monetary policy, the SNB is also a profit-making institution – and one that has made a fortune from its foreign equity holdings. One area of focus in Q2 has been large-cap technology stocks such as Microsoft and Apple, but AT&T is still the SNB’s largest holding. On Wednesday, the SNB announced that, if necessary, it would cut rates beyond today’s level of -0.75% and intervene further in FX markets to weaken the franc. Maybe time to rotate the book too?


Despite the risk-on mood elsewhere, returns for the MSCI EM Index have been fairly muted this week as US-China tensions over Hong Kong continue to spook Asian markets. To be sure, there has been significant dispersion across the EM universe, with some indices like the Brazilian IBOVESPA (up >10% in USD after similar gains last week) and the Indian S&P BSE SENSEX index (up >5% in USD) rallying hard. However, the war of words between China and the US risks overshadowing large gains in these markets in most EM portfolios given the weight attached to Chinese, Korean, and Taiwanese stocks in the benchmark index. The two great powers have been clashing for some time over China’s lack of transparency about the early outbreak in Wuhan, as well as their treatment of Muslims in Xinjiang, for which Congress voted to impose targeted sanctions this week. However, Xi Jinping’s decision to impose a controversial national security law on Hong Kong (a version of which the Hong Kong Chief Executive was forced to withdraw late last year after months of sometimes violent protests) could be the final straw. President Trump will host a press conference on China later today. The US is in the midst of a presidential election campaign where competition with China is a hot button issue, so the Donald is unlikely to strike a conciliatory tone. Instead, he is likely to confirm what trade privileges Hong Kong is set to lose in the wake of Secretary Pompeo’s decision to certify to Congress that the territory is no longer autonomous from China. This is bad news for Hong Kong’s economy, but it is unlikely to move officials in Beijing. Neither is a joint letter from US, UK, and Australian foreign ministries condemning the law. For the Chinese Communist Party, Western condemnation is the inevitable cost of integrating a territory seized from the Mainland during the Century of Humiliation. That foreign powers again want to dismember China by fomenting rebellion and meddling in its internal security is nothing new in their view. Sadly, this clash of narratives and values shows no sign of abating. Rather, it looks set to deepen. From a portfolio standpoint, this is one reason we favour keeping our hedges in place for now. It seems doubly prudent when you consider the uncertain near-term fundamental picture and the 35% rally in the S&P 500 Index since the March 23 bottom.