House view: June 2020

June 2, 2020

Global equity markets in the past weeks have continued to retrace the heavy losses incurred in late February and March. While the global pandemic situation remains grave, there are many countries experiencing a distinct reduction in the number of infections (at a much higher testing rate than only four weeks ago). Therefore, the lifting of lockdowns still in place will continue going forward.

Whether we will see a second wave of covid-19 cases, in our view is close to certain. As the virulence and infectiousness of SARS-CoV-2 are very high, this offers the prospect of another wave of lockdowns in many countries, something that would weigh further on the respective economies. Frankly, however, this appears not to be the basic scenario of global investors that have bid equity prices further up in recent weeks, though not anymore at the pace of the early days of the recovery.

S&P 500 vs. unemployment rate


Optimistic 2021 estimates

Obviously, the short-term earnings development of listed companies should not be one’s primary focus, as stock prices represent the (discounted) cash-flows of the successive years as well – cash-flows that most likely will rebound strongly in the years 2021 and later. However, taking a look at 2021 earnings estimates, these appear still to be rosy, considering the many uncertainties many industries are facing. Compared to trailing-four-quarter earnings in early 2020, the 2021 earnings estimates project a 6% growth rate vs. 2019 earnings per share (EPS), something we consider lofty at the current time. But even based on these EPS estimates, today’s P/E is at the highest since early 2002 (see chart).

S&P 500 estimated P/E FY 2021


This to us tips the risk/reward balance currently, especially considering the enormous amount of uncertainty given the lack of precedent in modern history, towards a very cautious positioning in risk assets.

The major argument of more bullish views on the equity market is univocally the government support that is being dished out at unseen levels, both on a fiscal and monetary front. The US are among the most supportive governments, as the Fed’s balance sheet has swollen by some 3tn within a mere good two months and may be expected to further rise significantly. Fiscal stimulus in the order of 4tn has also been promised by Congress. With the Treasury expenditures only starting to be handed out, this will result in a wave of Treasury issuance (again) unseen. Thanks to the Fed explicitly using unlimited amounts (“The Federal Reserve will continue to purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions.” FOMC Statement, March 23, 2020), interest rates appear well-anchored to current historically low levels for quite some time.

Ongoing debt monetization

We fear that the outright debt monetization that is taking place in many regions (US, EMU, Japan) will at one not too distant point lead to a reset in inflation expectations. This brings up the question of how to position long-term for such a scenario. One obvious portfolio candidate is gold. Having long traded at fixed exchange rates to currencies during the Gold Standard and then again during the Bretton Woods era that ended in the early 1970s, the price then was let to float, leading to the first strong gold bull market in the 1970s, an era when inflation last was in double-digit areas for years in many countries. That inflationary era had many influencing factors, however the use of the money printing press by the United States during the costly Vietnam war had an important role in fueling inflation.

Nowadays, inflation seems gone for good after a period of four decades of generally falling inflation rates to levels not far from the 0% line. With the current stand-still in many industries, short-term price pressures appear rather unlikely. Medium-term however, the shock to supply, coupled with again growing demand poses a severe threat. Should we see a continuation of the current “yield curve control” measures (a euphemism of buying domestic government bonds) by central banks, which is very likely, a rise in inflation would mean that real interest rates to plunge further as nominal rates remain anchored at very low levels. Low (and especially negative) real interest rates have historically been very bullish for gold as one may consider these the opportunity costs of holding physical gold which does not deliver any dividend or coupon (see chart).

Gold vs. real USD interest rates

A scarcity argument for gold

From a theoretical standpoint, the price of a given good should rise if its relative scarcity to the good exchanged for increases. Applying this mechanism to gold vs. major global central banks’ balance sheets (which grew about tenfold in the past 20 years, see chart), the outlook for gold remains highly attractive, especially considering the prospect of further large injections of central bank money into the system.

Gold vs global central bank balance sheets


Whether now is the exact right timing to add to gold positions, remains another question, though. We feel that a lot of positive sentiment currently makes gold a crowded position in the short term, making it poised for setbacks. We would advise to add into this potential near-term weakness that could take the gold price to levels below 1600 or even 1500, implying some 10-15% downside. Long-term, however, for the reasons laid out above, we feel very bullish for the yellow metal.

The same, if not even stronger argument, we can see for silver, the “poor man’s gold”. Currently trading at about a ratio of around 100x to gold, this relation seems poised to revert to long-term averages, considering the stretched valuation of gold vs. silver (see chart).

Gold vs. silver ratio

Oil market distortions


One effect of the lower level of oil prices directly impacts US shale oil producers which on average need higher prices to be profitable. Should we not see an eventual recovery into at least the mid-40s per barrel, a significant portion of the production gains of the past years (see chart – US DOE domestic oil production) could disappear, leading to better balance between supply and demand. However, as OPEC+ countries would need significantly higher oil prices to only balance their bloated government budgets, there are also incentives to curb production from the “more traditional” oil producers in the Middle East.

US total crude oil production


The future development of the pandemic – primordially, in our view, the question of whether and how a second wave will strike societies again – will be the decisive factor when it comes to macro-economic or oil price forecasts. We feel that a longer period of low prices will be needed to take out the weaker parts of the US shale production and hence there is a distinct possibility of another rise in tensions between the gulf monarchies and Russia, should prices rise further from the current crude oil price levels in the lower 30s.

Weak market internals

Coming back to the topic of whether to take on equity risk at this position, there are a number of market internals that do not augur well, we believe. For instance the fact that only few companies are lifting the major indices, which can be easily seen by the outperformance of the capital-weighted to the equally weighted S&P 500 index which has even accelerated of late (see chart). This “advancement by the generals, but not the troops” rarely used to be a harbinger for a positive market environment.

S&P 500 vs. S&P 500 equal-weighted


Finally, there is a geo-strategical dimension to keep in mind as well. The confrontational stance by the White House and parts of Congress towards China as well as latest legislative action by the Chinese parliament infringing on Hong Kong’s autonomy rights under the name of national security concerns have worrisome implications. As there are no signs of any side backing down from the belligerent rhetoric, oddly reminiscent topics such as “the US-China trade war” with all its negative repercussions will start to take over the headlines from covid-19-related ones, we fear. To put it simple: this is not a time where valuation expansions take place.


  • The rapid recovery continued based on a focus on positive news (a potential covid-19 vaccine and treatment) appears to have run its course.
  • Pandemic-related lockdown measures are being lifted in many countries, however the global daily number of new SARS-CoV-2 infections continues to be high. Any return to normalcy will be painfully slow, while a second wave of infections is looming, weighing on economic growth for many quarters.
  • National governments’ policy responses have cushioned the effects of the economic standstill in many places. Going forward, the sheer amounts of government bonds being issued will keep central banks on the hook. Such an outlook should prove enormously positive for gold and other real stores of value.
  • The crude oil market is undergoing a structural change with many oil producers producing losses. This will in the longer term have an impact on supply, but short-term, the price of oil is dependent on single countries’ decisions on production levels due to filled-up inventories and still only slowly returning demand.


DISCLAIMER: This document is intended for marketing purposes.

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