The month of August continued the odd action in capital markets that has become the hallmark of 2020. While summer markets traditionally have been very thinly traded and volatile, this month continued the very narrow run in select technology stocks, leading most markets to all-time highs. With some concerns around earnings, the reopening of the economy and the failure to pass a fiscal stimulus bill in the US, not many would have expected a month in which the S&P500 only saw three negative days and a total monthly return of 7.2%.
The mania around certain stocks, such as Tesla, is bringing back many comparisons to 1999. That was another market that saw an increase in retail investors chasing new themes and technologies. No one knows how far this will run, but most of us remember how 1999 ended.
The price action of both Tesla and Apple in August following a 5:1 stock split (Tesla up 74.2% and Apple up 21.7%) is a rare occurrence. But when it’s happening with the largest company in the world and another of the top 10 on the S&P 500, it’s hard to ignore and needs to be watched very closely. Tesla is quickly becoming the company that best represents the current euphoria around stocks; it’s the canary in the coal mine.
With markets up so much in the last five months, many have taken profits and locked in gains. As such, they are surprised by the move in the last few weeks. It may be the case that everyone is overthinking everything and we should have just stuck with the understanding that there is no way equity markets won’t be at all-time highs on US election day.
Central banks have embarked on a course of money printing that the world has never witnessed before. As global debt levels have expanded at a rapid rate, it seems the approach the banks are now taking is to inflate asset values globally in an attempt to make debt levels look like less of a problem in relative terms.
The recent speech by Federal Reserve Chair Powell at the Jackson Hole meeting saw the admission of what many had expected for many months; the central bank is expecting to see inflation return to the market. The term they are using for this is “inflation averaging.”
In simple terms, this means the Fed is preparing to stay extremely dovish for a very long time, with no rate hikes expected over the next few years. In the past, the central bank would closely monitor inflation levels in the economy to gauge when they should reduce or end accommodative programs.
This new concept admits to everyone they are prepared to let inflation run above target levels in the short term, looking instead at the average of inflation over a number of years. This is a big change of course for markets and investors.
One of the winning trades for 2020 has been gold. The sector saw some profit taking in August after an amazing run to breach the US$2000/oz level in July. This should be looked at as a buying opportunity for the medium to long term.
In periods of inflation, one of the greatest protection strategies is real assets. This could be a perfect environment for gold, silver and real estate for a number of years. As more money is printed to inflate away the debt, you may want to focus on assets that will hold their value through this environment.
We continue to expect a volatile second half of 2020. One of the more interesting dynamics in the market at the end of August was the risk in the CBOE Volatility Index (VIX) in parallel with the stock market. The US presidential election now looks too close to call and, as we head towards November, we don’t expect the mood to become any more cordial. We still have to monitor the risk of a second wave of COVID-19 as schools reopen and government support programs are either removed or modified. Still, the narrative around the election will soon become all encompassing.
With markets hitting all-time highs in the last month, many were quick to proclaim the end of the “shortest bear market in history.” Only time will tell if this was the case or if we are only currently in a window of calm, supported by both governments and central banks.
Once the current debt deferral and relief programs end, the training wheels will be off the economy and we will finally be able to understand what has really occurred in the last year. So much has profoundly changed since March, it will be hard to see a full return to normal, especially in any timely fashion.
In a best-case scenario, we will see a return to health for many small businesses and employment quickly rebound to the levels of last year. This would allow for interest rates to begin to normalize, commodities to recover and currency volatility to pass. In this scenario, we would expect to see the equity market push to new highs with a more broad-based move and new leadership from cyclicals.
For the current leadership sector of technology, which so often has been the sole beneficiary of government regulation around the work-from-home rules, we are entering a period where good news is bad. A return to normal increases their competition and lessens their scarcity premium. As the saying goes, “when growth is scarce investors pay up for growth.” But if growth is seen everywhere, value may finally get its day to shine.
— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
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