“The Fed is following the markets, not the other way round.”
Christopher Wood
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. It also assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10-years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at USD 64? Do you realize how ridiculous those basic assumptions are? ….. What were you thinking?”
Scott McNealy of Sun Microsystems, leading tech company of the 1980s
Equity markets recovered further during the third quarter to leave their performance for the year to date at 4.1% in the case of the S&P and 0.3% for the MSCI World, while Europe’s index lagged behind being down 14.3%.
The investment environment remains highly unusual. While the global economy has suffered its largest contraction since the 1930’s, financial markets have rebounded strongly from the March lows courtesy of the extraordinary measures by Governments and Central Banks around the world. This stimulus is the sole reason that they have recovered. To put the scale of the stimulus in perspective the western Central Banks have purchased USD 6 trillion of public and private debt in the last six months, which is four times the amount of all the programmes in the five years following the 2008 crisis. Similarly they have announced USD 13 trillion (and rising) of fiscal stimulus, which is 15% of global GDP, which compares to 2% in the post 2008 period. As a result, we have seen a stark divergence of economies and market performance. However the market has discriminated between sectors according to how the pandemic has affected different companies. Broadly speaking the old economy industrial and retail sectors are pricing in the damage caused by the Covid virus, while the new economy technology sectors are pricing in the benefits of zero interest rates and the shift to digital services that the virus has accelerated. Meanwhile the gigantic liquidity that has been pumped into the system has started to cause some disturbing moves.
Effectively most bond markets have been put into a coma. Citi Private Bank estimates that the global bond market now yields just 1%, even including high-yield and emerging markets. Over USD 15 trillion of global bonds carry a negative yield, meaning that investors pay for the privilege of owning them. The real yield (i.e. inflation adjusted) of the US 30-year bond is -0.5% showing that investors are prepared to lend a dollar today and receive back 86 cents of purchasing power in 2050. In the UK to generate an income of GBP 50,000 from the UK 10-year bond requires an investment of GBP 25 million. For investors who need income life has become extremely difficult. These paltry rates may have a far greater effect on the world’s wealth in the long run than the Covid virus. More immediately with bond yields so low there is no protection against any return of inflation, so a crucial question is what are the chances of such a return? Even before the pandemic, there were concerns about inflation. De-globalisation, disrupted supply chains, stronger bargaining power for labour via the rise of populist politicians, and the oligopolisation of the large technology companies leading to greater pricing power were all threats to the long period of disinflation that the world has enjoyed since the early 1980’s. The huge monetary and fiscal stimulus this year adds more force to upward pressures on prices. The similar policies taken in 2009 never triggered inflation, but the scale of the current efforts are much larger, and most of the monetary stimulus after 2008 was absorbed by broken banking systems needing to rebuild their balance sheets. This time it is targeted at the general economy, with governments getting more directly involved in the process. The money is being put into the hands of people who need to spend it on wages and supplies, and is being promoted by politicians who have an eye on re-election. This is a much more inflationary cocktail than a decade ago. Still for inflation to rise requires this money to roll around the economy, and that would occur if unemployment starts to decline, and the output gap shrinks.
This abundant liquidity has already leaked into stock markets, with some technology related shares showing signs of bubble-like excess.
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