Investment Idea

What will be the new normal in the global economy?

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Mikael Syding
17/04/2020 | 7 min read

The financial markets and the global economy have long lived on borrowed time and borrowed money. One month ago, valuation measures that adjust for cyclical effects on company profits were three times as high as the historical average of the S&P 500. This means that the market could fall by 67% without being more than normal.

The financial markets and the global economy have long lived on borrowed time and borrowed money. One month ago, valuation measures that adjust for cyclical effects on company profits were three times as high as the historical average of the S&P 500. This means that the market could fall by 67% without being more than normal. This was before discounting the special effects of quarantine measures due to the Covid-19 epidemic. There is now a risk of both falling sales and unusually low valuations. If that were to be the case then 67% of the stock market decline from the top is not enough to find the bottom.

Record valuations require a much larger decline to normalize


Note: Past performance is not a reliable indicator of future results.

The central banks are doing what they can to curb the fall, but unless the money lifts the companies' sales or profits, only the valuations continue to be too high, which means low returns for a very long time to come until fundamentals have grown in price. It is better if the stock market quickly finds its own bottom and I believe that fortunately it will be so.

The Corona Quarantines are likely to reach their peak in Europe around the end of April and in the United States by the end of May. The negative news about corporate profits, GDP, credit losses, revealed pyramid schemes, hedge funds closing down, problems for banks and insurance companies, unemployment and consumption becomes more evident in June and July. During Q3 and Q4, you may be able to make a good forecast of how long-term problems will be when you throw a wrench into a debt-ridden world and how the situation should be handled and how quickly confidence in financial markets returns.

The crash could be one of the fastest ever and rebounds among the most intense ever

SP500 5yr

Note: Past performance is not a reliable indicator of future results.

Everything else with the corona crisis has been bigger and faster than previous crashes. I expect it to continue. Thus, volatility is here to stop. Perhaps the stock markets are already bottoming in July, although the recession, which may last 1-2 years, has barely been confirmed then. But in order for me to believe in a bottom, much lower rates than today, at least 33% down from now, are required. The combination of a deep recession, massive incentives and (perhaps) cheap shares, but a very uncertain information situation, paves the way for huge blows in the stock markets - maybe we will see single days with movements of 20% up and down. How to shop in that environment? What to buy and when?

Silver can provide a fantastic buying opportunity under $10/ounce

Silver 5y

Note: Past performance is not a reliable indicator of future results.

To avoid a total debt deflation, large monetary incentives are required. It raises the price of real assets after the initial crash phase when everything falls due to forced sales. Right now, gold usually coincides with shares, even though the price can already be considered very attractive. Gold will probably be what comes first. Silver is more cyclically sensitive and is not directly driven by rising money supply, but a few quarters into the probable recession, it may become a historic buying situation in silver. The question is whether shares can be bottled already in connection with the disaster reports after Q2 in July and August. It would be amazingly fast and unusual and it is more likely that bankruptcies, unemployment and weak consumption will also affect Q3 and Q4 so much that the reports will reduce shares to lower levels around the turn of the year.

The world's most important commodity – oil – is an important real asset

Oil 5 yr from 5yearcharts com

( Note: Past performance is not a reliable indicator of future results.

In the real asset pursuit, the oil sector is actually quite good. Right now, oil prices are being squeezed by price wars between Saudi Arabia and Russia and concerns about recession, but oil and energy are the most important real asset available, so you can definitely find bargains among crashing oil stocks - but keep in mind to avoid indebted companies.

Further on, it is still true that banks are too large to be allowed to go under. The big banks will retain their share of the economy as the dust settles. However, the road to it can be extremely volatile and the course bottoms far down from today.

Gold is the winner of monetary stimulus

Gold 5y

Note: Past performance is not a reliable indicator of future results.

Many who learned to invest in the long bull market are losing enthusiasm for the stock exchange. At the same time, the population hump from the 1940s is retiring and selling shares. The new normal will be big fluctuations and relatively low values for several years. Continued incentives and various measures to deal with debt mountains and inflationary trends are lifting crypto currencies, gold and silver more and more rapidly, but also there during major fluctuations. The new normal becomes trendless and quite chaotic and demands on its own analysis, patience and larger buffers or protection in the form of eg. Options. It is also likely to be more difficult to raise money for cash burners such as Uber and Netflix, and extremely high P/E numbers are far more uncommon.

The tug-of-war between quantitative easing (QE) and everything else creates tremendous opportunities to trade assets relative to one another.

Investors, entrepreneurs and consumers are cautious about the money before an economic and financial upturn takes off. Consumption is low, borrowing is weak, valuations are low and capital is expensive and scarce. But as a few brave dare to invest their capital, start a business, or save less and consume more, a self-reinforcing spiral is taking over. Investors and lenders compete for the companies and offer ever-cheaper financing. Unemployment is falling and companies' sales and profits are growing faster than they usually are. At the end of the cycle, unemployment is low and optimism as high as debt and profits. Everyone spurs and takes extra risk, as leverage, to take care before the housing or share train leaves the station with them left. In this situation, the economy and the financial market dominoes are lined up and it is only necessary that the first little one rolls over and pushes the next piece to bring the others in the case - as with the subprime housing loans in 2007. But if the politicians are on top they can stop the chain reaction by catching the first tile in the air through various forms of stimulus measures. For many years this has worked, but at the price of all the cyclical variables listed above having been stretched to the breaking point.

States, students, companies, car buyers etc. are more indebted than ever. The valuations are about as high as 1929 and 2000 - yes, still after the fall in March. And the biggest net buyers of stocks down the last ten years are about to turn into sellers: the companies themselves who have a hard time rolling their bonds, passive funds, and baby boomers who retire and need their money. In addition, unemployment is record low (and can only reasonably go up, which reduces optimism and consumption capacity).

In 2000 and 2007, the situation was similar, but with the difference that everything is more screwed up this time: higher values, higher debt, more corporate bonds and repurchases, more dominance of passive investment strategies, more boomers in retirement age, higher globalization rate (which can decline) and China has much greater economic weight. To this powder canvas is now added, one of the worst shocks you can imagine: a pandemic that makes entire industries bankrupt for a few months, with spread effects to retail, real estate companies and banks. Once the dominoes have begun to fall, one does not turn a damned recession so easily, but it is clear that the authorities are doing everything they can to try.

This creates a very volatile tug of war, with almost 10 trillions (trillions) in stimulations at one end of the rope and, well, all of the above at the other end. The outcome will be large, fast and frequent throws up and down for currencies, shares, bonds, precious metals and commodities. Relative prices between different assets can change extremely much and quickly. And here are huge opportunities for you as an investor. If you monitor a number of quotas such as gold / silver, gold / OMX, gold / oil, oil / OMX, gold mines / gold, bitcoin / gold, USD / SEK, Spotify / Netflix to name a few, and identify levels where it seems reasonable or likely that the quota is unlikely to become much more extreme especially for a long time, so you can jump back and forth between the assets. It is like scissoring up the stairs to the Lustiga Huset on Gröna Lund (a fun park in Stockholm).

If you do it right, it goes up extremely fast. And maybe you can also have a strategic direction over time on the business, because it is almost certain that when the economy subsides, gold will be several times more expensive than the stock index than it is today. And if you get right into the gold / silver trick then the ratio could reach 50 sometime during the cycle, but at the same time there is a risk of a relationship of 150 and even as much as 200, if gold pulls away above 2 000 USD/oz first, while the recession is pushing down silver against 10 USD / oz.

When the smoke starts to settle and your relative trades have given you a good position to buy shares in the longer term, it is important to understand that everything does not quickly and easily return to how it was during the last up cycle. It won't be as easy to fund cash burners as Netflix, Tesla and WeWork, or to boost stock prices with buybacks financed by corporate bonds. Sooner or later the high-risk games will come back to fashion, but expect the economy to have a hard time tearing up. Instead, many short recessions are likely to succeed each other, much like in Japan since 1990. I will start with two interesting strategies. One is to buy companies with large cash and positive cash flow that are partly stable in themselves, and can make cheap acquisitions or otherwise increase their market shares. It could be companies like Apple, Berkshire and Walmart. Even pure necessities in the food sector and, for example, electricity companies as well as perceived necessities such as telecom services can, in turn, become cheap enough in the downturn.

The problem is that everyone else also sees this so there can be many false starts before the shares bottom out for real. Buy a little at a time when it is affordable enough, but dare to wait until it gets really cheap. It takes time for the economic cascade defects to culminate when the most vulnerable market in history encounters the worst trigger in memory and is answered with the most massive stimulus the world has ever seen. Even unexpected industries such as oil companies and luxury companies can offer great opportunities, but choose companies with care. You don't want to get caught up in an oil company with credit problems, or half-dozen luxury brands that suffer from middle-class poverty - no focus has to be on the ultra-rich who can always afford to jump in comfort.

Finally, it is always companies with an independent growth force that will be the big winners. The 2020s may be the decade of gold and technology companies. A number of key technologies have synergistic effects on each other, which over time will make Moore's team look tired. It will be as difficult as ever to pin down the winners, but perhaps it is still true that Alphabet, Microsoft and Amazon have attracted inextricable leadership that allows them to always acquire or compete out the startups. On the other hand, there may always come a new Mark Zuckerberg who refuses to be acquired and who has such a unique technology that even the giants shake.

@Mikael Syding

This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capital protected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.


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