Q3 2020 – NS Quarterly Investment Review

“The Fed is following the markets, not the other way round.”
Christopher Wood

 

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. It also assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10-years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at USD 64? Do you realize how ridiculous those basic assumptions are? ….. What were you thinking?”
Scott McNealy of Sun Microsystems, leading tech company of the 1980s

Equity markets recovered further during the third quarter to leave their performance for the year to date at 4.1% in the case of the S&P and 0.3% for the MSCI World, while Europe’s index lagged behind being down 14.3%.

The investment environment remains highly unusual. While the global economy has suffered its largest contraction since the 1930’s, financial markets have rebounded strongly from the March lows courtesy of the extraordinary measures by Governments and Central Banks around the world. This stimulus is the sole reason that they have recovered. To put the scale of the stimulus in perspective the western Central Banks have purchased USD 6 trillion of public and private debt in the last six months, which is four times the amount of all the programmes in the five years following the 2008 crisis. Similarly they have announced USD 13 trillion (and rising) of fiscal stimulus, which is 15% of global GDP, which compares to 2% in the post 2008 period. As a result, we have seen a stark divergence of economies and market performance. However the market has discriminated between sectors according to how the pandemic has affected different companies. Broadly speaking the old economy industrial and retail sectors are pricing in the damage caused by the Covid virus, while the new economy technology sectors are pricing in the benefits of zero interest rates and the shift to digital services that the virus has accelerated. Meanwhile the gigantic liquidity that has been pumped into the system has started to cause some disturbing moves.

Effectively most bond markets have been put into a coma. Citi Private Bank estimates that the global bond market now yields just 1%, even including high-yield and emerging markets. Over USD 15 trillion of global bonds carry a negative yield, meaning that investors pay for the privilege of owning them. The real yield (i.e. inflation adjusted) of the US 30-year bond is -0.5% showing that investors are prepared to lend a dollar today and receive back 86 cents of purchasing power in 2050. In the UK to generate an income of GBP 50,000 from the UK 10-year bond requires an investment of GBP 25 million. For investors who need income life has become extremely difficult.  These paltry rates may have a far greater effect on the world’s wealth in the long run than the Covid virus. More immediately with bond yields so low there is no protection against any return of inflation, so a crucial question is what are the chances of such a return? Even before the pandemic, there were concerns about inflation. De-globalisation, disrupted supply chains, stronger bargaining power for labour via the rise of populist politicians, and the oligopolisation of the large technology companies leading to greater pricing power were all threats to the long period of disinflation that the world has enjoyed since the early 1980’s. The huge monetary and fiscal stimulus this year adds more force to upward pressures on prices. The similar policies taken in 2009 never triggered inflation, but the scale of the current efforts are much larger, and most of the monetary stimulus after 2008 was absorbed by broken banking systems needing to rebuild their balance sheets. This time it is targeted at the general economy, with governments getting more directly involved in the process. The money is being put into the hands of people who need to spend it on wages and supplies, and is being promoted by politicians who have an eye on re-election. This is a much more inflationary cocktail than a decade ago. Still for inflation to rise requires this money to roll around the economy, and that would occur if unemployment starts to decline, and the output gap shrinks.

This abundant liquidity has already leaked into stock markets, with some technology related shares showing signs of bubble-like excess.

 

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Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only.
References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. Notz, Stucki provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document.
This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the Notz Stucki Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer.
Additional information is available on request. © Notz Stucki Group

Quarterly Investment Review

“Policymakers have conjured tons and tons of money out of thin air. As a result, we are now in a situation where never before in history has so much money been chasing so few goods and so few financial assets.””
Charles Gave

In the second quarter equity markets rallied strongly on the back of the abundant liquidity provided by the world’s Central Banks. The MSCI World rose 18.8% during the quarter which left it down 6.6% year to date. Sovereign bond markets were also firm and credit markets continued to recover. Gold rose by almost 13% in the quarter to finish at its highest level since 2012.

As an event the onset of the Covid-19 pandemic may herald the biggest global change since the collapse of the Berlin Wall in 1989. It presents investors with the challenge of weighing up the most dramatic plunge in global economic activity since 1945, against the largest ever monetary and fiscal stimulus. A fog of uncertainty hangs over the world economy. The unique quality of today’s environment is the impossibility of knowing when the pandemic threat will abate (for example will there be a second wave or not), and how businesses and consumers will react until and beyond that point. The likelihood is that the economic recovery will be slow because uncertainty is the enemy of spending and investment. Currently economic activity is only being held together by monumental government support, so on the face of it markets are ahead of themselves, and that is before considering the heightened political tensions and upcoming US elections, with the risks they could bring to globalisation and productivity.

The scale of the shock and response to it has been unprecedented. Once Governments mandated the shutdown of large parts of the economy they had no choice but to provide support. No business is built to survive months of zero revenue, and many businesses such as airlines, hotels, cinemas, cruise ships, retailers and restaurants have had to cope with this. Yet the scale of the support has been breath taking. There have been over 100 interest rates cuts by Central Banks, and Governments have organised in the region of $18 trillion of stimulus. For comparison Gavekal have estimated that the US Government’s response to Covid is four times the inflation-adjusted cost of the Vietnam War. These measures landed on a system that was exhibiting vulnerabilities already. There has been a tremendous build up in non-financial debt in the West, which is also grappling with deteriorating demographics, aggravated by the backlash against globalisation that threatens the free movement of both skilled and unskilled labour to countries that are in shortage. While it is early days some predictions can be made of forthcoming changes. It is likely that supply chains for many goods will be brought closer to home. The crisis left many countries reliant on medical supplies from the other side of the world (China manufactures most of the West’s anti-biotics for example). Relocating supply chains will reduce efficiency because Chinese production represented the low cost and efficient option, but it will become unacceptable for critical items not to be produced locally. Rearranging the current supply ecosystem may take years, and involve significant capital expenditure on equipment and research and development. Companies are also likely to carry more inventory, so as to be better prepared for a second wave, or other crises. Another feature of this crisis is that the impact has fallen disproportionately hard on lower income groups and minorities, increasing wealth inequality. There will be strong calls for more support for these groups. The thrust of all these changes is inflationary; increased government intervention, higher minimum wages, and de-globalisation all represent a dismantling of the anti-inflation bias in place since the 1980’s.

The pandemic has triggered trillions of dollars of emergency spending, and for financial markets the debate is whether this leads to disinflation or inflation. This question has become critical because most markets are priced for continued low inflation, and the current recession and jump in unemployment would be deeply deflationary in normal times.

 

Click here to download the full document.

 

 

 

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only.
References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. Notz, Stucki provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document.
This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the Notz Stucki Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer.
Additional information is available on request. © Notz Stucki Group