Catapult Insights – Global Macro Perspectives – September 2020

Download this Catapult Insights edition in PDF

Where to from here?

With all the major US stock market indices, bar the Russel 2000, now at all time high, COVID numbers globally still not decreasing, the prospect of vaccine breakthrough before year end still uncertain (at best) and the economic recovery post lock-downs in developed economies across the globe “stalling”, the question has to be: Where to from here?

Bi-furcation seems to be the word that keeps popping up, whether it is to describe financial markets, labor markets, the real economy, wealth distribution and/or stock picks… most elegantly captured in the newly minted “K-shaped” recovery.

To me it is merely proof of the mainstream realization that COVID will have a lasting negative impact on significant parts of life as we know it (the lower leg of the K) and the only reason we are still talking K and not L is because of a very narrow group of “COVID-winners” comprising large tech and those that are able to take advantage of current liquidity support in financial markets. The true impact on the real economy however (not quite showing through the thin stock market and largecap veneer) is pretty dismal and growing more troublesome by the month.

So let’s take a quick look round the globe to put things in to perspective…

• Chinese industrial production has picked up but it is still below pre-COVID levels. Containerized freight indices showing no signs of “catch-up” demand or positive bull-whip effect.
• Mainland Europe is coping with renewed outbreaks of the virus after easing travel restrictions for the summer and travel bans for certain areas are back in place.
  • Activity (retail, mobility etc.) levels jumped in July back to around 15-20% below pre-COVID levels but most indicators now suggest this recovery has stagnated in August and/or is receding.
  • EU will likely be forced to come up with a “bigger” bailout as the risk of a “double dip” recession increases post Summer.
• Emerging markets around the world are still struggling with COVID. India is now the worst hit in terms of numbers (75k new daily cases and over 1.000 deaths per day). India’s GDP declined 23,9% (YoY) with consumer spending down 33,8% since the beginning of the year.
• Notwithstanding recent USD weakness against the Euro and the AUD the most vulnerable emerging market currencies (Mexican Peso, Brazilian Real, South African Rand and Turkish Lira) are all struggling to regain COVID induced losses. With large USD denominated debt obligations they will be the first dominoes to fall if the global economy does not recover or the USD is not devalued further.
• In the US the rate of increase of new case numbers has finally turned negative but we have yet to hit peak infection with new cases still averaging around 45k per day and deaths are still stubbornly stuck around the 1.000 per day mark.
• The website “tracktherecovery.org” does a wonderful job of tracking the recovery progress and highlighting the so called “bifurcation”.

• It is clear that fiscal programs will need to be extended to prevent further decline. These programs however will do little to reverse the damage done to SME’s and the real economy and to the extent they are not aimed directly at ordinary citizens they are increasingly impeding necessary restructuring and increasing distortionary effects on markets and wealth distribution.
• In Europe, after last months disappointing quarter on quarter Q2 GDP declines, PMI’S (purchasing manager indices) are above 50 signaling month over month expansion, but unemployment- and high-frequency data give an opposing view.
• Employers across Europe have been slower to react due to better labor market protections and unprecedented governmental support but early signs are beginning to show that the impact will be hard felt in Q3/Q4…and that’s before the latest surge in infections or a second wave, possibly offset somewhat by positive news on the vaccine front.
• My conviction is that the midsummer (historic) mandate to issue a (limited) amount of Eurobonds will quickly prove too small a “band-aid” for the gaping wound that is Southern Europe’s budget deficits in combination with their already elevated debt to GDP Ratio’s. I for one cannot rhyme that fact with the current bout of Euro strength relative to the US Dollar.

…So what do we make of recent FED announcements?

• The FED has indicated (during the recent Jackson Hole retreat) to be OK with letting the economy “run hot” and letting the yield especially on the long end of the treasury curve (10 & 30 year bonds) increase somewhat on the back of rising inflation expectations.
• At some point however this increased yield will start to undermine the justification for astronomical tech valuations and the current dollar weakness that many are currently so content with…The question is when and indeed if these yield pick-ups and inflation will manifest themselves, as to date yields have failed to push decidedly higher.
• Declining treasury yields and US Dollar weakness are expansionary / inflationary for global liquidity conditions whilst rising treasury yields and a stronger Dollar are contractionary/deflationary. I for one am therefore very skeptical of the FED’s ability or indeed intent on letting yields or the Dollar rise much and thus by default I am not a buyer of any near-term inflation danger. Longer term I see stagflation as more likely than reflation.
• Any reversal of current short sentiment (against) the Dollar resulting in a rising/stronger dollar will be detrimental to global recovery/reflation hopes and is therefore likely to affect equity markets negatively.
• From now till the end of the year there will be an undercurrent of second order effects of COVID, the global shutdown and the response thereto grinding away towards the “new normal”. All of which is still overshadowed by the possibility of a second wave which may or may not be alleviated by success on the vaccine/drug front (which I choose to ignore for now).
• The FED’s ability to “prop-up” markets with monetary intervention is coming to an end. Having driven markets to new highs and sucked in retail investors in the process we are now poised for a period heightened market volatility/vulnerability in which the ultimate outcome will be determined more by fiscal than monetary policy. In the US this is being handicapped by upcoming elections and I believe this will test Europe’s new found solidarity before year end.

Other points of interest, risks and asset allocation perspectives

• Equity markets remain difficult for me with volatility (VIX) still double normal levels (ticking up recently), elevated valuations and the risk reward skewed to the downside. Banks are still difficult to fathom but high quality/ unlevered utilities, infrastructure, commodities and staples are areas that I think could perform if stagflation is the longer term outlook.
• My preferred current asset allocation is still 25% USD cash/treasury, 25% EUR cash, 30% precious metals (mostly physical and some ETF), 20% high quality commodity, staples and infra-linked equities plus a bitcoin for every family member, just in case.
• I am slowly plowing EUR cash position into commodities, utilities and staples on market weakness. I am however actively setting tight stop-losses for all asset positions to protect against possible market correction and will use cash to rebuild portfolio and add EM & US tech equities position if/when a correction comes and valuations become reasonable.

Files

Catapult Insights – Global Macro Perspectives – 2020.09