Covid-19 is still making its relentless way around the planet, and even where it was supposed to be done with it is showing a nasty tendency to return whenever restrictions are eased. Financial markets are now paying more attention to its progress than to monetary policies, and equities appear to be caught between a relatively successful normalisation process in Europe and obvious failures to contain the disease in the USA. Donald Trump’s relaxed handling of the crisis has damaged his chances of re-election; the virus seems set to dominate the election campaign and Joe Biden is not considered to be a particular friend of equity markets.
The crisis has certainly emphasised the digital economy’s domination and even acceleration. The IT sector accounts for 27.7% of US market capitalisation, and if we add communications services (where Google and Facebook are classified) we can raise that to 38.4%. IT accounts for only 2.6 million American jobs in a 152 million strong labour force, but has suffered little on that front. The US leisure and hospitality sector has dropped 7 million of its 19 million pre-Covid jobs, and its share of market capitalisation has dropped from 1.9% to 1.5%. Surging bankruptcies in retailing are causing difficulties for shopping malls and the real estate firms that operate them. Smaller oil companies are falling like dominoes, leaving heavy debts behind them. While the more fragile hotel chains have benefited from payment moratoriums, they cannot hold out forever and business failures will mean even more non-performing loans. The financial sector’s share of capitalisation has sagged from 22.6% in 2006 to just 10.2%, but Federal Reserve liquidity injections and a 0 billion asset purchase programme that extends even to junk have saved their day. Credit spreads have reverted to normal for prime names but are still high otherwise. In terms of share prices, IT and healthcare have not suffered from the crisis and are trading at their highs. More than 100% gains have been recorded from biotech firms working on vaccines and for DocuSign, an electronic signatures specialist. Tesla is up 129%, reflecting its status as a four-wheeled computer. E-commerce is headed firmly upwards. Thanks to its digital bias, the US market is only 10% off its peak, with a massive performance gap between the real and virtual economies.
After liquidity injections worth as much in a few weeks as in the six years following the 2008 crisis, the Fed will press on with this policy. Nobody has objected to it so far, as it is all about confidence. Stagnant demand has prevented any rise in inflation, and additional liquidity has simply boosted savings. The current risk environment and absence of viable projects are limiting investment opportunities. Yields on government bonds are zero or negative, and triple-A corporates offer little more. The equity market may be deep but it looks increasingly expensive. It is worth remembering at this time that while central banks can continue to drown us in paper money, they cannot print gold! This asset has outperformed all other asset classes over the past 20 years; although it did miserably between 2011 and 2018, it has again outpaced the S&P 500 since the 2018 crisis. It is still some way off its highs associated with the 2008 crisis. We may be getting on this particular train a little late, but we are now recommending exposure to gold, whether in physical or paper form – or in mining, especially given where interest rates are.
World GDP is expected to decline 3.9% this year. Eurozone GDP is set to drop 7.6%, with the worst numbers coming from Southern Europe including France. The USA is at -5%. Asia is still in positive territory, again outperforming the OECD. Earnings estimates are stable; our model is factoring in -26% this year and a 14% rebound in 2021 for the S&P 500. The market is valued at 18.6x 2021. Our S&P 500 valuation is a largely unchanged 2,935 points, compared with a close at 3,009 points, with a CAGR of -0.1%. We are maintaining our equities overweight recommendation and would be looking to increase our allocation in the event that the index corrects below 2,900 points. This is via short call position that could earn us 70 points.
