Massive liquidity injections due to central bank balance sheet expansion and increased savings rates have catapulted equity markets worldwide. Even so, we caution against underestimating the risks in the second half of the year!
Governments are trying to reopen after the lock-downs
With the exception of South America, worldwide efforts to reopen economies are gaining momentum.
Labor market data out of the US have been less catastrophic than feared
Alongside the resumption of economic activity there has been an improvement in labor markets worldwide, even in the particularly hard-hit US. While the consensus expectation had been for the US unemployment rate to rise from 14.7% to 19% in May, the reported figure showed a fall to 13.3%. Thus, non-farm payrolls did not decrease last month by 7.5 million as expected. Rather, 2.5 million new jobs were created. This employment report is probably the biggest positive economic surprise in years.
Despite an improving labor market further measures of stimulus are being planned
President Trump is already planning a further package of stimulus. Among other things this should include a cut in income taxes.
Europe starts to catch up the US in terms of stimulus
Europe is catching up with the US in terms of both the speed and extent of its measures of stimulus. The European Central Bank (ECB) will expand its Pandemic Emergency Purchase Program (PEPP) by an additional EUR 600 billion to EUR 1,350 billion. It will also extend the life of this program beyond the end of the year to at least mid-2021. There are country-specific stimulus measures in all EU countries. For example, Germany decided on yet another package worth 130 billion euros just last week.
Stock market boom and “melt up”
Since the corona virus-related lows of mid-March, almost all stock indices have gained massively, in some cases (most obviously the Nasdaq) even setting new highs. Given the appalling news flow on the real economy, these stock price gains can only be attributed to rapid, massive and simultaneous expansionary countermeasures in both fiscal and monetary policy. We caution that the pandemic is not over yet and that the World Bank, with its estimate of a 5.2% contraction in the world economy this year, predicts the worst global recession in 80 years. (Its 2020 GDP growth forecasts for the US and Europe are minus 7.4% and minus 10.1% respectively). Although coronavirus cases in former “hotspots”, such as the US (especially New York), Switzerland, Italy and Spain are declining sharply, the virus is spreading in other regions of the world, especially in South America and in the interior of the United States.
Excess liquidity is driving the equity markets
Central banks are aiming to achieve a positive wealth effect through the manipulation on a massive scale of the yields on low-risk investments.
One consequence is that the worth of the ECB’s balance sheet is now approaching 70% of Eurozone GDP. Large parts of the Eurozone (and of the rest of the world) are insolvent, being kept alive artificially through the ongoing monetary creation of the central banks. Further, higher savings also boost the monetary aggregates, thus generating liquidity which can also flow into stock markets. With Germany’s constitutional court probably powerless to resist Europe’s political response to the Covid-19 crisis, this Ponzi process could go on for a long time.
Transatlantic economic hostilities are breaking out on many fronts.
The Trump administration is trying to prevent the introduction of “digital taxes”. Austria, Brazil, the Czech Republic, the EU, India, Indonesia, Italy, Spain, Turkey and the UK all want to introduce such taxes. “Digital companies”, such as Apple, Google, and Amazon, can offer their products across borders and thus generate profits without having “traditional business operations” in countries where their goods and services are sold. Current tax law has difficulties in recording such undertakings in such a way that creates “tax fairness” relative to their competitors and to more traditional companies. Many online service providers, especially US companies with valuable intellectual property, are able to book revenues and earnings in “tax havens” and not in those countries where sales are generated. Many international, and often American, companies have managed to greatly reduce European tax bills through aggressive tax planning. Since taxation is the sovereign right of individual EU member states, forging a common EU policy vis-à-vis the US is going to be difficult. President Trump will do all he can to protect “his” US companies against the “digital taxes of the rest of the world”.
The US government’s protective response could include measures against European auto manufacturers, although these auto producers are really bystanders in this tax dispute. In the election campaign, the Trump administration is likely to present digital taxes as an “attack on America” and threats against non-American auto producers as a “just and appropriate response”.
Political and geopolitical troubles
Protests and looting in the US, racial unrest, the increasingly aggressive “takeover” of Hong Kong by China and Israel’s plans for annexation of parts of the West Bank all point to geopolitical risks being elevated. Any implementation of Israeli annexation plans seems certain to produce further unrest.
The Trump administration has announced further restrictions on Chinese students wishing to study in the United States.
Current US unrest creates division among Republicans as well
Colin Powell, US Secretary of State between 2001 and 2005, and an ex-general, has accused President Trump of “lies” and has strongly opposed to the use of the US military against its own population. On this, Secretary Powell joins an expanding group of senior, (ex) military men expressing opposition to Trump. Former defense ministers James Mattis, Leon Panetta, Chuck-Hagel and Aston Carter have already sharply criticized President Trump’s attempt to deploy the US military in response to the ongoing protests. As the Washington Post has commented: serving officers in the U.S. military are always ready to defend the nation. However, they should never be used to violate the rights of those they have sworn to protect. Such an engagement in the midst of the politically charged protests would undermine the apolitical nature of the US armed forces. This is essential for democracy and for the continued confidence of Americans in their military. A loss of such confidence would indeed threaten America’s security.
We note that Colin Powell, a Republican, has now recommended voters choose Joe Biden over Donald Trump this November. And yet again Fox News has come in for criticism, this time for showing a chart linking US stock market gains to the rate at which African-Americans have been murdered.
Since 1861/65 the USA has probably never been as close to a civil war as “now”.
Risks in the second half
The chance that the “melt-up” will continue in the second half due to ultra-expansionary monetary and fiscal policy needs to be assessed against the following risks: Donald Trump’s use of the “trade war with China” campaign tool, the danger of a second wave of the corona pandemic, further damage to the hitherto successful “globalization” model with extensive disruption in global supply chains. The US presidential election also poses a risk. Joe Biden wants to increase government taxes, which would lead to lower profits for US companies. According to a survey by the Wall Street Journal and NBC, President Trump is at 42%, significantly behind Biden at 49%, in terms of voter preferences. The main reason for Biden’s lead is probably that he is more trusted to unite the country and end current (racial) unrest. But in terms of the economy Trump still outscores Biden as the one more likely to get the economy moving again.
Contact: Thomas Härter, CIO, Investment Office
Telephone: +41 58 680 60 44
Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
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