The Bear Market in Equities will be Short Lived

Logically, the American stock market should correct now as earnings begin to get reported and companies are forced to issue guidance in an American economy which has been locked down.

Still they will correct less than otherwise would be the case if it were not for the Fed’s extraordinary eagerness to buy other people’s debt.

This is because the Fed’s actions primarily influence credit spreads and it is the action in “credit” which drives “risk on” and “risk off” and the related action in the US dollar.

If the market believes the Fed will ultimately backstop everyone, and that is the message the Fed has sent by establishing the precedent of starting to buy high yield debt, that is a reason to be turning more offensive on a correction.

Still no one should doubt that the Fed’s actions are interfering with the capital allocation process. Meanwhile it is interesting that Amazon is trading again at new highs (see following chart).

Amazon Share Price

Source: Bloomberg

The base case is that this is not going to be a prolonged bear market in equities because the health crisis should peak this quarter. In this respect the data in New York City remains encouraging, most particularly the decline in the number of people entering hospitals in the city with Covid-19.

This declined from 681 on 6 April to 176 on 22 April (see following chart).  And if this view is too sanguine on the health issue, it is very unlikely that Donald Trump is going to continue to lock down the American economy into a depression six months ahead of a presidential election.

New York City Daily Hospital Admissions for COVID-19

Source: NYC Department of Health & Mental Hygiene

The Real Bear Market is in Government Bonds

Rather the real bear market which is just beginning is in government bonds in the Western world, and in particular Treasury bonds, a point which will be made crystal clear if the Fed tries in coming months to lock in nominal yields via some adoption of the Bank of Japan’s yield curve control, as is quite likely.

Fixed income investors who do not want to be locked into ultra-low nominal yields by central bank fiat, otherwise known as price fixing, should use the current recession concerns to exit all holdings of G7 government bonds and buy sovereign bonds in Asia and the rest of the emerging world in those countries where they view the fiscal policies as comparatively conservative.

Meanwhile it is clear that many institutional investors, such as commercial banks, pension funds or insurance companies, may be locked into their own government paper because of regulatory mandates to own a certain percentage of “risk free” assets.

Source: Bloomberg

A Broken Bond Market is Very Bullish for Gold

If the view is that the Coronavirus, and the subsequent monetary and fiscal policy response, will be viewed by historians as the catalyst that ended the 38-year bull market in Treasury bonds (see previous chart), that development also should be a massive positive for gold.

On this point, it is entirely logical that gold should have rallied by US$83/oz since the Fed made its unexpected announcement on 9 April to expand its asset purchases to certain high-yield corporate bonds and newly issued static CLOs (see following chart).

Gold Bullion Price

Source: Bloomberg

It is also worth noting that the gold miners have started to outperform gold bullion again since mid-March, having underperformed since the start of the year.

The NYSE Arca Gold BUGS Index has outperformed gold bullion by 50% since 13 March, after underperforming by 33% since the beginning of 2020 (see following chart). This outperformance is nearly always a sign that gold is heading higher. The next target is the all-time high of US$1,921/oz reached in September 2011.

NYSE Arca Gold Bugs Index Relative to Gold Bullion Price

Source: Bloomberg

Donald Trump vs. COVID-19

Meanwhile, to return to the near term, as the virus infection spread has peaked out this month first in Western Europe and later, hopefully, in America, the focus will grow on the political blame game, first, on the management of the crisis and, second, on who was to blame for it.

Since the American presidential election is only six months away, the politicization of Covid-19 will be most intense in America. As regards the issue of how the crisis has been managed, Donald Trump has got his mojo back after the initial “own goal” of downplaying the health threat.

In this respect, the 45th American president is truly a master of turning on a dime in terms of managing the political spin. He is also right in terms of his current focus on seeking to get activity going again sooner rather than later, and significant progress on this front should be expected by the end of the current quarter.

The reality is that support for lock-downs will fade the more the economic hardship bites, particularly if fear of the virus recedes at the same time. This means the Donald has enough months left to turn things around if he can get the economy moving again.

Still he wants to be careful with being aligned with specific monetary and fiscal policies that can be linked to bailing out fat cats, such as the private equity industry, since it was Main Street revulsion against the Wall Street bailouts of 2008 which was one of the drivers that got Trump elected in the first place.

But it was not the main driver. The most important message which got him elected, aside of course from “crooked Hillary”, was the campaign to return manufacturing jobs to America and the related attack on globalisation.

In this respect, it is unfortunately the case that Covid-19 has served to politicize the China issue again. This is not necessarily a partisan issue. There is an element in the Republican Party which views China as the enemy, just as there is on the Democrat side.

But with allegations still being made that the virus came from a Chinese government laboratory in Wuhan, as well as continuing focus on Beijing’s alleged covering up the virus for a critical period in January, there will be many voices arguing that China should be held to account in the forthcoming US presidential and congressional election campaigns.

This creates a bit of a dilemma for the Donald. Obviously, he can jump on the China bashing bandwagon and play that theme in a re-election campaign. The recent decision to stop US funding of the WHO was one easy win on this theme.

World Health Organization President Tedros Adhanom

Still it is also clear from the track record that Trump is not a national security zealot and that his instincts are for promoting business and trade once he has a trade deal with China he thinks he can sell.

In this respect, there is still an opportunity for him to build on his phase one trade deal by negotiating a phase two, declare victory and drop all existing tariffs. Certainly, if anyone can spin such an achievement it is Trump.

Meanwhile it is also the case that the supply-side disruption triggered by the virus has further highlighted problems with the “just in time” manufacturing model. This will further encourage diversification of manufacturing out of China, a trend already established by the tariffs. Another obvious medically related policy very likely to be adopted will be to end US dependence on pharmaceuticals manufactured in China.

So, it will be hugely important which way Trump decides to jump. Will it be to champion his trade deal as a “win”, or will it be to declare China an enemy and campaign on the China bashing theme? There is no need for him to make up his mind now give the number of variables. Still the base case for now of this writer, until proven wrong, is that the Donald still wants to promote his trade deal in the context of a recovering American economy.

The views expressed in Chris Wood’s column on Grizzle reflect Chris Wood’s personal opinion only, and they have not been reviewed or endorsed by Jefferies. The information in the column has not been reviewed or verified by Jefferies. None of Jefferies, its affiliates or employees, directors or officers shall have any liability whatsoever in connection with the content published on this website.

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