PRESIDENT Donald Trump has been in office during an incredible equity bull market, and he claims this is the result of the greatest economy in history.
Is it?
No.
Not even close.
The national deficit is too high, and a near-zero interest rate environment is a sign of low demand for goods and services. It is not a sign of a growing, dynamic economy.
Additionally, the strong equity market and the US’ GDP are only distantly related.
They are not the same.
For example, during the “Great Financial Crisis” of 2008, stock markets around the world plummeted approximately 40% to 60%, but of course, the real economy did not shrink by that much. The following bull market saw the S&P 500 nearly triple in just six years, which is also not reflective of real GDP growth. While there is correlation between GDP and equities, neither is a serious indicator of the other.
The American bond markets are US$10 trillion bigger than the equity markets.
Bonds and treasuries are also a far better indicator of economic health than stock indexes.
I speak with fund managers and analysts frequently, and most are having difficulty valuing the equities they hold. This is because the Federal Reserve has been buying the debt of corporate America in order to support stability and maintain growth in the markets.
It is a bit like American corporations are driving a car at top speed, comforted by the knowledge that Lewis Hamilton is controlling the brakes.
How has this affected equity prices?
To quote a Friday note from equity strategists Sophie Huynh and Charles De Boissezon of Société Générale, “without QE (quantitative easing), the Nasdaq 100 would be closer to 5,000 than 11,000, while the S&P 500 would be closer to 1,800 rather than 3,300” through the end of October.
Think about it. Fed asset purchases have inflated the capital value of US corporations upward of 100% beyond fair value, and will continue to do so until further notice.
This is nothing less than a decoupling from reality.
When Hamilton is no longer controlling the brakes, the price to be paid will be a massive correction seeking fair value.
The Fed will look to cushion the blow to the economy by slowly tapering asset purchases rather than stopping completely, but the correction will resonate.
So, how does the investor navigate this minefield?
Firstly, the markets will take advantage of lame duck Trump and rally till Christmas.
Nothing will have changed, and it will be seen as an opportunity.
I mention Christmas, because of the Senate run-off in Georgia. Should one or both Democrats lose on January 5, then Joe Biden will be a lame duck president needing executive orders to get legislation passed. However, this actually suits the equity markets, because the less regulation or legislation, the better it is for Wall Street.
If the Dems win in Georgia, and vice-president-elect Kamala Harris has the casting vote, then expect a short-term correction. The Biden administration will have the power to implement corporate and income tax increases. It will be a short-term reset.
The Covid-19 pandemic looms large over everything in our lives. Rather than war, diseases and viruses may be the dominant game changers of the first half of this century.
Next year, however, will see a reopening of the world’s economies due to vaccines and a determined effort to live with the pandemic. The markets will react strongly and positively.
When investing in the US, it is always good to look at the Fed’s most recent comments and policies. In a historic shift in late August, chairman Jerome Powell announced that policymakers will allow inflation to run modestly higher for periods of time, rather than employ the past practice of using pre-emptive rate hikes to control price pressures. The new practice is known as “average inflation targeting”.
What this actually means is that to help corporations with short-term debt issues, the Fed will no longer pre-empt inflationary pressures with interest rate hikes, but allow inflation to rise to at least 2%, before even considering intervention.
Additionally, the massive asset purchase programme of US$120 billion per month will continue to support American corporations.
So what to do?
Time is your friend.
Be patient.
Take a minimum five-year view.
Hold at least 25% cash.
Rather than unit trusts, consider and carefully select low-cost exchange traded funds that are designed to closely track indexes and particular sectors.
And, try not to look.
Corrections are normal, as are recessions.
Hold, and you will be fine. – The Vibes, November 13, 2020
Gareth Milliams is a co-founder of Hermes Family Capital. He is a multi-award-winning investment adviser. In 1994, he co-founded the first offshore financial services business in Japan. This ultimately led to consultancy work with ABN AMRO, where he led a team developing and marketing bespoke funds to banks throughout Asia. Presently, he is advising a family office in the Philippines
