The Navigator provides insight into stock market events with an outlook.
“Stumbling blocks”. It was a difficult year. And the signs of the times indicate that it will not get any easier, at least in the medium term. Which does not mean that the stock market cannot continue to thrive. Imbalances in society are emerging, the debt burden is piling up, and politicians and central banks are doing what they can to keep the wheels of the economy turning. Due to the low interest rates, more and more capital is being forced into risky investments. A dynamic develops, which one day could be brought to a turnaround by a stumbling block.
Market review
The fourth quarter continued the recovery that began in March after the Covid lows. After a consolidation over the late summer, a spirit of optimism returned to the markets – not entirely different from the first quarter, before the correction in March.
2020 was not an easy year. It was no different on the stock market. A standstill in the economy suspends the usual order. In order to avoid mass bankruptcies, the state provides funds for support. This makes sense if it is aid to bridge emergency situations, caused by instructions from the state. If boom-time blossoms are kept alive, or if the aid lasts for a longer period of time (nationalization of the private sector), this is likely to negatively impact future growth.
All of this only occupied the stock market for a short time, the race for returns soon resumed, driven by the additional available capital and debt.
Once again, stoic calm paid off – buy & hold, buy and hold, don’t lose your nerve, as a recipe for success. Adjusting positions in good time can also be worthwhile, but finding the right time is the crux. The markets are currently in an upward trend that has been running for over 10 years. The question is when the turnaround will come. To put it simply, a look at the ratio between total market capitalization (as measured by the Wilshire 5000 Total Market Index) and the gross national product of the U.S.A. may suffice. It shows that the markets are as expensive in this comparison as they have ever been. In addition, in recent years the U.S. economy has grown less strongly than the debt has increased.
However, the high valuations are not great news. If the debts have increased again, they were already at a frighteningly high level for some ten years ago.
However, what seems new is the increasingly common conviction that all of this is less of a problem and that things can continue to go well. Sooner or later, interest rates will rise, either by increasing the velocity of money (inflation) or simply because investors want to be compensated more for defaults. With rising interest rates, the air will escape from the inflated valuations, and corrections are imminent.
Stock markets
At the latest with the fourth quarter, the optimistic mood returned after a consolidation break. Anyone who reduced positions in the first quarter during the correction and then did not trust the situation over the summer could now take heart and get back in. The approvals for vaccines were reason enough for some to buy again. The markets have already risen in price and – due to the increased demand – have started the year-end rally. The fourth quarter was, for example, the strongest quarter of the last two years for the Nikkei or the Hang Seng.
In terms of sectors, the financial sector had a strong last quarter. As one of the sectors that has been lagging the market for years, the discussion about a possible increase in inflation – and thus a steeper yield curve – brought back buying interest.
The energy sector was also able to increase significantly again in the last quarter. The losses from the first quarter could not be made up for in the course of the year. The prospects remain relatively rosy, at least in the short to medium term. The technology sector was the strongest gainer over the year.
A mixture of real economic conditions (lockdown/home office) and growth stocks are still en vogue thanks to cheap money. One observes the inherent dynamic that a strong price development in turn attracts new money. Passive investing also contributes to this.
Stock markets
At the latest with the fourth quarter, the optimistic mood returned after a consolidation break. Anyone who reduced positions in the first quarter during the correction and then did not trust the situation over the summer could now take heart and get back in. The approvals for vaccines were reason enough for some to buy again. The markets have already risen in price and – due to the increased demand – have started the year-end rally. The fourth quarter was, for example, the strongest quarter of the last two years for the Nikkei or the Hang Seng.
In terms of sectors, the financial sector had a strong last quarter. As one of the sectors that has been lagging the market for years, the discussion about a possible increase in inflation – and thus a steeper yield curve – brought back buying interest.
The energy sector was also able to increase significantly again in the last quarter. The losses from the first quarter could not be made up for in the course of the year. The prospects remain relatively rosy, at least in the short to medium term. The technology sector was the strongest gainer over the year.
A mixture of real economic conditions (lockdown/home office) and growth stocks are still en vogue thanks to cheap money. One observes the inherent dynamic that a strong price development in turn attracts new money. Passive investing also contributes to this.
Interest rates & capital markets
Interest rates were able to recover somewhat from their lows. The yield on 10-year US Treasury bonds rose to just under 1%, after lows of just over half a percent.
The yield curve has normalized compared to the situation in March and – apart from the short-term interest rates – does not present itself too differently than it did a year ago. This is due to lower interest rates at the short end and slightly higher interest rates at the long end. This results in a somewhat steeper yield curve.
With the direct payments from governments to private individuals, the inflation issue has been revived. The economy is also likely to benefit from a catch-up effect when it reopens – which could lead to a short-term increase in inflation and has already been partially taken into account by the market. On the other hand, the deflationary tendencies are still at work and the question arises as to whether the aforementioned measures can break them. Economic crawl typically goes hand in hand with a tightening of lending. Which typically leads to a tightening of the money supply – unless the central banks counteract it. At the latest since the recession at the beginning of the new millennium, one has seen the money supply M2 not come back strongly during recessions or even rise slightly, because the central banks step in to counteract the contraction. This activity was able to absorb a shrinking money supply and thus deflation to some extent, but was too weak to even fuel inflation. As described in the last Navigator report, the central banks are also not equipped to fuel inflation, or it does not correspond to their mandate: this requires the commercial banks and the demand for loans.
With the virus, the economy worldwide has suffered a severe setback. Industrial production in the U.S.A., for example, is currently at the level of 2017. The question therefore arises as to whether the massive measures taken by the central banks are sufficient to withstand increased deflationary pressure. What is new is that governments are directly granting loans or guaranteeing them, which brings additional money into the economy. Voices are being raised that fear inflation, which can no longer be completely dismissed due to the immense scope of the money that has been spoken.
However, one could also pick up the thread of the following argument: Due to the bond purchases of the central banks (US-Fed in this example), the private buyers have fewer bonds available and offer the price high. The institutional money funds recently lost deposits when interest rates fell to low levels. At the same time, interest rates have risen somewhat (when money managers have money outflows, they have to sell interest-bearing investments, which in turn pushes up the yield). Thus, the rising interest rate may be a technical matter and less due to emerging inflation. The coming months will show which force, deflation/disinflation or inflation, will gain the upper hand.
With corporate bonds, one could generally observe a calming. Risk premiums such as with the reduced creditworthiness of a CCC came back significantly after the stress phase in March and also in the annual comparison, the hunt for yield seems to be driving prices up (and thus yields down). The more solid AAA have received a somewhat steeper yield curve like the government bonds.
Market technology
Depending on the geography, the markets were still somewhat battered before the start or in the first phase of the fourth quarter (DAX). After that, however, at the beginning of November or with the US elections, the stock markets were able to make up ground upwards and were generally able to mark new highs since the low prices of March.
The technology stocks still suffered somewhat at the beginning of the fourth quarter, and the high from the beginning of September could not be exceeded. In contrast, the broad-based Russel 2000 Index was able to exceed the old high from the end of August 2018 in mid-November.
After more than two years of negative price development, the Russel has even surpassed the famous Nasdaq in the last quarter and also since its new high in mid-November in terms of positive price development. And in contrast to the Nasdaq 100 Index, the Russel does not show any negative tendencies.
With interest rates, there is a small déjà vu – if you look at the price development of the 10-year US Treasury. Similar to September 2019, yields could reach new lows again after a temporary increase.
Gold has continued its consolidation after the high in August and – possibly – completed it at the end of November. After this consolidation, another high would have to follow to complete the trend.
Gold is also going digital – so one hears. In any case, the “gold standard” of cryptocurrencies, Bitcoin, has been making headlines. A brilliant increase in the last quarter. Technically, a consolidation should follow soon (or could have already started, an overshoot upwards, as seen, cannot be ruled out).
The market capitalization for Bitcoin is still relatively small, which can easily lead to larger price fluctuations (very possible upwards, as not many people own Bitcoins and purchases have recently been made by well-known investors or companies and on the supply side only a few give something away => hodlers).
Compared to gold, Bitcoin has caught up. Whether one should really compare the two with each other is another question.
Outlook
There are always stumbling blocks on the way of the stock market. If the driving forces of the prices are solid enough, the hiker is fit enough, stumbling blocks cause at most short-term imbalance, some unrest. One catches oneself again. If the hiker is tired, or converted to the stock markets: if the driving forces of the stock market prices are not solid enough, a fall can result. The driving forces of this stock market boom are mostly to be found in the loose monetary policy. Not necessarily in great growth of the economy, sales or profit margins. Of course, there is also the structural change, which brings an upswing to certain branches of the economy, such as in technology stocks. But even there, prices have been driven by low interest rates. The cheap money brought blossoms to light such as dividend payments financed by bonds (Apple) or share buybacks instead of investments (various companies). Or simply the flight of capital, in search of yield, into risky assets such as shares.
In addition to stumbling blocks, there is a fork in the road here and there. Whether we are close to such a fork will become apparent in the coming months. In addition to the fundamental question of whether interest rates are bottoming out or whether we will continue to see falling interest rates, there are concrete events coming up: A victory for the US Democrats in the Senate (by-elections in Georgia) would give the Democrats the power to tend towards a new edition of globalization. Where Trump has resisted this and wanted to put China in its place, which has been able to emancipate itself during Obama’s term in office, the profiteers of the old, familiar order should be able to gain a foothold again. On the other hand, due to the 2020 elections, the political landscape in the U.S.A. could change sustainably. With Biden/Harris in particular, but also elsewhere, higher government spending would be more likely. And the central banks will continue to buy up bonds vigorously. As a result, they are putting pressure on private buyers, which could put pressure on yields. However, should interest rates rise (emerging inflation, increase in risk premiums), this would be an advantage for the “value” stocks that have been lagging behind the growth stocks in recent years. A steeper yield curve at least should give the financial stocks additional air. Finally, however, not to be forgotten, there is still the run-down economy, where with each week it becomes more difficult to get going again. Many no longer go to work, but are currently still receiving money from the government. Which stumbling block will bring a fall is difficult to foresee. Since the financial crisis, the markets have been able to recover again and again thanks to the supports. Keeping this in mind and still being part of the positive price development is the challenge.
“Be fearful when others are greedy, and be greedy when others are fearful.” Warren Buffett
EDURAN AG
Thomas Dubach