Risk appetite is consolidating with the rising COVID-19 case count still prevalent across many nations but the medium term liquidity driven narrative remains intact. Although the persistence of the virus reminds us that COVID-19 is very much “here to stay” until a vaccine is found, without fresh lockdowns the bullish momentum across the risk asset spectrum is set to continue, with setbacks part of a broader rising trend. As has been the case for many weeks, the narrative on the ground is not truly driving risk assets, although there are moments when reality collides with stimulus driven sentiment.
As we have discussed prior, the hope trade that has been unleashed as central bankers bid to backstop almost every asset class, providing abundant liquidity to financial markets with the promise of more as when is necessary, provides a powerful force to be reckoned with. G5 Central Bank balance sheets have expanded at a rapid pace, well beyond measures taken in prior downturns, which has to date proved successful in detaching risk asset pricing from fundamentals. In short, there is too much liquidity chasing too few assets. Moreover, although Central Banks are not mandating ever inflating financial assets, the Fed have implied they remain accommodative at all costs, incipient bubble or not. A recovery that lags expectations, a 2nd wave of COVID-19 with lockdowns re-imposed once colder weather returns, fiscal cliffs, persistently high unemployment, geopolitics – any number of downside risks will be met with action from Central Bankers and the Fed have exhibited their pain threshold is relatively low.
Regular readers are well versed in that the mechanics outlined above, manifest in a powerful force that continues to drive risky assets higher – the lack of alternative (TINA). That is the alternatives to equities look very unappealing (unless its gold!), this coupled with the expectation that rates will remain low for an extended period and the question of YCC for the Fed turning to when, not if, drives investors up the risk spectrum into equities. Essentially giving a green light to the “hunt for yield”, along with a dose of moral hazard. As we have said before, the existence of this dynamic perversely dictates one need not be positive on the expectations of a swift economic recovery, to be long stocks (and by default short efficient markets/price discovery).
Another driver remains, when rates are lower or capped at lower levels in the case of YCC, the market values future cash flows more richly and the effect on valuation is explicitly positive. For technology stocks with less debt, higher free cash flow yields, and earnings duration profiles with high forecast future cash flows the expectation of YCC and rates remaining low gives another green light to continue to buy this sector. The Nasdaq 100 hitting fresh record highs overnight is a direct product of these mechanics.
Gold knows there is no V-shaped recovery
Just as tech stocks are responding to lower yields, fiat debasement and debt monetisation, as is gold – with the added kicker of virus uncertainties providing an additional boost. Approaching 8-year highs as real rates are on the decline, the big picture for gold continues to be bullish. Regular readers will know we have long been bullish on gold and favour continued portfolio diversification into gold.
- France: 51.3 versus 32.1 in May
- UK: 47.6 versus 30.0 in May
- Eurozone: 47.5 versus 31.9 in May
- Germany: 45.8 versus 32.3 in May
With the focus on flash PMIs yesterday, although for risk assets liquidity continues to trump fundamentals, the data continues to confirm anything but a V-shape recovery. Whilst there is still a lot of uncertainty in the outlook and the virus unknowns “rule the roost”, rendering forecasts vague at best, it is clear the road to recovery is long and winding.
The data is consistent with lockdowns being lifted and a stabilisation in activity but does not indicate a return to anywhere near the prior level of output. PMIs are diffusion indices and aggregate via survey responses whether output, employment and orders are higher or lower than the prior month. They are not a measure of total activity. A reading below 50 indicates a continued contraction, albeit at a lesser pace relative to the prior month in this case which is not surprising as economies reopen. Digging deeper, employment sub-indices remain below 50 and highlights that there will be no V-shaped recovery in in employment and many sectors will in fact face permanent job losses. Persistently high unemployment will weigh on the economic recovery and highlights the need for continued fiscal stimulus measures as activity plateaus following the initial bounce on lifted lockdowns.