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Dirk Steinhoff
July 6, 2020

U.S. Stocks Just Had Their Best Quarter in Over 20 Years

Only just three months ago, we were all lamenting the end of the bull market in stocks, when stock markets around the globe lost 30% of their value, and more, in a stark correction. The rebound since then has been nothing short of astonishing. Clearly, central banks still have some mojo left…

A massive monetary stimulus by the U.S. Fed, as well as literally all other central banks around the world, combined with all versions of fiscal stimulus and support packages, have propelled this impressive stock market recovery. For how long will this be sustainable? Well, that clearly is the trillion-dollar question.

An incredibly strong rebound amidst great uncertainty

Source:, FactSet

Without a doubt, the level of debt will eventually have to be reckoned with. At this point, however, it appears that at least the US, the European Union and China will be able to sustain the credit bubble for some time. In essence, we are witnessing a period of strong deflationary forces (e.g. weak demographics, cheap production in Asia and China, low productivity and money velocity, and high unemployment) met with unprecedented inflationary fiscal and monetary policies.

Ultimately, the question is: for how long will central banks be able to keep interest rates this low?

The arsenal of tricks that governments and central banks have at their disposal is still very wide and deep. Therefore, for now, the current low-interest environment may continue for many more years. Of course, at some point, the bill will arrive and have to be paid. But even before that, these financial repression policies will lead to all sorts of distortions that impact prosperity for the majority of the people. And, this may (if it has not already begun to) eventually backfire in the form of social unrest and revolt against the ruling elite.

Ultimately, the big question is, how long will central banks be able to keep interest rates this low? As developed and some emerging countries are challenged by the aforementioned forces (demographics, excessive debt, etc.), central banks will continue to work towards keeping rates low, hoping that economic growth will pick up. However, achieving GDP growth will be difficult for some time.

Meanwhile, governments around the world are running huge deficits, piling up more and more debt. In Europe, literally all members have exceeded the Maastricht Treaty thresholds, breaking deficit records across the board.

European government deficits for 2020, as a percentage of $GDP

Source: ECR Research, Refinitiv Datastream

The tools to keep rates suppressed are focused on setting low official rates and supplying excess liquidity. Central banks can do this in various ways. They have always set short-term interest rates. However, they were generally following market forces. We now may witness a period during which they operate “against” market forces, which will become increasingly difficult.

It is worth remembering that the global fixed income market amounts to almost US$300 TRILLION. It is much larger than only that of the government bonds market. As of now, central banks can manage the government paper yields if needed. Therefore, a critical point will be reached once central banks need to “manipulate” the corporate market beyond Treasuries.

At that point, we expect bond yields to rise, particularly amongst weaker borrowers as the market demands higher premiums. Or, yields may rise in a weakening economy, when investor fears rise or their trust in governments subsides. As Felix Zulauf pointed out recently, “as central banks - in a world of ever rising issued debt paper - buy ever more paper outstanding, the currencies of the weakest economies decline and inflation rises. In such a scenario, the world would see one currency after the next decline.”

In the end, this will have to lead to a monetary crisis and the collapse of the financial system, as trust in governments, central banks and the legal state evaporates, accompanied by growing and ever more creative financial repression measures. This is the scenario that is driving a growing number of investors to gold.

However, that scenario still appears far away. There is a perceived disconnect between what the market has done and the economic recovery. The reality is, therefore, that the second half of the year may see a lot of choppiness. In the meantime, however, central bank liquidity is flowing into stocks (asset inflation galore!), driving them higher. Still, financially sound companies in the right sectors are worth investing in.

And so the formidable “stock party” goes on…against all odds. Of course, we will be very cautious in managing our downside exposure. But we will also be sure to reap the benefits from the current state of affairs, as counterintuitive as it may seem, even against the odds of an underlying economic structure that equally doesn’t look “formidable” at all.

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