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Many investors have also been on the lookout for a ‘much-awaited’ shift out of these core, expensive growth stocks to the more ‘value-oriented’ sectors of the market such as financials, industrials, retail and travel. While we have seen at least a few ‘false starts’ in that group, including a sharp rise in early June, the impetus to a major shift into ‘value’ has to be a clear signal that the re-opening of the economy is taking place at a faster pace and economic growth is starting to recover. Those hopes were once again dampened in July as the pandemic gained new momentum in the U.S. south and west as well as Brazil, India, Spain, Australia and parts of Asia. Travel and leisure stocks quickly reversed their earlier gains, financial stocks slumped again and money moved back into those technology and growth sectors. While we will continue to see bounces on optimism about a vaccine or a ‘flattening’ of the pandemic curve, we continue to be skeptical about the pace of recovery as consumers will take a very long time to return to their old shopping and travel habits, if ever. Meanwhile, the massive government debts incurred just to keep the economy afloat during this pandemic will have to be dealt with at some point in time and will only retard the pace of any recovery once it does begin to occur. That was the story following the financial crisis where we saw a decade of ‘below trend’ growth and we expect to see even a more muted recovery in this round. Stocks rallied after the financial crisis on the tailwinds of massive interest rate cuts. With interest rates already close to zero, we don’t see anywhere near the same time of lift to stocks and their valuations.
Looking further into the explosion in government debt and central bank balance sheets, we have for many months now believed that the ultimate victim of this largesse has to be paper currencies around the world, particularly in the U.S. where the debt increases have been most dramatic. This, we argued, would lead to a depreciation in the value of fiat (paper) money and a rise in gold and other precious metals. Our view has lots of company now! Gold stocks have been leading the way in 2020, after an initial sharp sell-off at the beginning of the pandemic. The biggest tailwind for gold is the record low level of interest rates, which negates the argument against gold that it pays no income. Stocks have only begun to reflect this resurgence in gold. While gold has already had a significant move to multi-year highs and financial players have become larger players in the group in the short term, suggesting risk of a short-term pullback, we are still buyers on any further weakness. These moves tend to be longer in nature than expected, especially since the gold market is not large compared to other financial sectors and it doesn’t take much of a shift in assets to create a ‘buying boom.’ Gold stocks remain below the levels seen in 2011 when gold last touched current levels and the miners have also instituted much stricter financial practices in the past few years and refrained from the ‘mega-mergers’ that lead to the collapse in prices at the end of the last cycle.
Another major factor supporting gold and other commodities is the depreciation of the U.S. dollar, which has come under pressure recently as the virus spread continues in the U.S. and investors worry America will lag the global economy. The dollar is paying the price for the growing U.S. deficits, which will have to paid for with record growth in Treasury debt. The world’s reserve currency initially benefited from a flight-to-safety, which drove it to a three-and-a-half year high in March. Now, as the world’s focus has shifted back to fundamentals, the dollar has rapidly slumped to a two-year low as the U.S. lags most of the world in halting the spread of the coronavirus. The U.S. was also already on a dangerous debt path even before the pandemic began. Traditional economic theory calls for governments to spend freely and cut taxes during downturns to offset waning demand and save jobs, and then rein in spending and raise taxes during expansions. During the global financial crisis, the U.S. ran four consecutive years of $1 trillion-plus deficits, but as the economy began recovery, deficits shrank back below $500 billion. Bu this time around, deficits were rising even during an economic expansion as big 2017 tax cuts and a 2018 spending increase pushed the country further into ‘red ink.’ The deficit was projected to top $1 trillion again this year even before the pandemic. Countries that make their own currency can’t go broke because they can simply issue more debt. While most governments around the world have ramped up their debt during the pandemic, the U.S. stands out as the worst offender, with debt approaching US$25 trillion and growing! Beneficiaries from a weaker US$ would be the Emerging Market economies that have borrowed in US$ as well as commodities and multinational U.S. corporations.
While the bubble in stocks continues to inflate, we are constantly looking at amazement at some of the stats around how extended parts of the stock market have become. The rise of the very largest stocks has been astounding, with each of Microsoft, Amazon and Apple having market values of over US$1.5 trillion. To put that in some perspective, that makes each of them larger than the entire value of the South Korean stock market, the 12th largest economy in the world! If we include Facebook, Netflix and Google, the technology sector now weights a record of 37% of the S&P500, but aggregate sales of this group make up only 10% of the index, precisely the same percentage of sales it was at the peak of the technology bubble in March, 2000. As Mark Twain supposedly said, “history doesn’t necessarily repeat itself, but it rhymes.”
Everyone knew it was coming, but the anticipation made it no less ugly: The U.S. economy shrank an annualized 32.9% in the second quarter, the worst quarter on record, easily surpassing the worst times of the depression in the 1930s as the coronavirus pandemic forced businesses to close their doors and kept millions of Americans shut in their homes for weeks. The collapse was unprecedented in its speed and breathtaking in its severity and the outlook will not get better in a hurry as crucial lifelines, like the extra US$600 in weekly unemployment benefits, are expiring, and lawmakers have yet to agree on another stimulus package. Congressional and Central Bank support have buoyed the economy in recent months and, in the absence of a vaccine, further action is critical to maintain economic momentum.
The third-quarter GDP print is bound to look deceptively strong as it is coming off such a low base and could be as high as 25%. But to get a consistent recovery, employers will need to see this as sustainable before bringing back more of the seventeen million workers that are currently claiming UE benefits. Rather than looking at aggregate growth numbers, we think there is more information in the flow of incremental demand, and that picture is much less favorable. New York Fed’s Weekly Economic Index, a basket weekly gauges ranging from initial jobless claims and federal taxes withheld to fuel sales and railroad traffic—that is scaled to align with real GDP growth. The latest reading of about negative 7% shows that the economy is springing up from April lows but still far from pre-pandemic level of 2% in the beginning of February. In the U.S, continuing claims for unemployment have remained in the 17 million range for the last three months. That compares to a level below 300,000 prior to the pandemic. Clearly there are millions still out of work, primarily in the service sector and in the lower wage area such as restaurants, hotels and retail. Many of those jobs will not be coming back for a long time, if ever. An improvement in small-business revenue has also started to fade and is now down 17% from January as the number of small businesses that are open are falling, a signal of business failures as the crisis continues. Lagging performance of bank stocks is probably another signal that small business losses and defaults are a growing risk that is still not fully accounted for, despite record loan loss provisions taken last quarter by all the major Canadian and U.S. banks.