ivana-cajina-HDd-NQ_AMNQ-unsplash_edited

We cherish independent and rational analysis. 

BFI Perspectives 

  • Dirk Steinhoff

The "Unloved But Welcome" Rally Won't Last

Stock markets have continued to rally despite the growing tensions with China, outbreaks of riots across the United States, and the aftermath of the (almost-over) coronavirus lockdowns. The S&P 500 has risen by 40% since the March lows. This comes as a surprise to some investors, us included. Others appear to believe in a continued and strong recovery. It’s quite puzzling.


At BFI, we continue to expect a second and possibly even more dramatic correction in financial markets. Goldman Sachs seems to concur, predicting that this “unloved but welcome” stock market rally is unlikely to persist.


And yet, the prevailing optimism – not to call it irrational exuberance – inspired by the reopening of the economy and the end of the lockdown has apparently not been dampened one bit by the riots in America. But fears of the virus have made way for anger and hatred in the streets. Businesses are staying shut, supply chains continue to suffer, and unemployment rates continue to rise. And some “health experts” (we use that term reluctantly these days) are still warning of a “second wave” of the coronavirus.

However, it does appear that investors still have strong faith in the actions of central banks and governments as they ramp up their stimulus again and again. So, the stock markets march right on. This leads to a situation where the stock market no longer reflects the real economy. BFI strategy advisor, Mr. Felix Zulauf, in his May Investment Commentary, describes this disconnect between markets and fundamentals as follows:


“We often refer to the economy and the stock market as the master and his dog. The master walks slowly but steadily in one direction whereas the dog runs ahead, falls back but eventually moves in the same direction. At times, the two seem connected, and at times they appear disconnected. But they do belong together, and it is only a question of time, when the two are again moving in the same direction. At present, the market and the economy are disconnected, worldwide.”


We would like to share a word of caution here: Don’t run with the lemmings! There are too many fundamental factors that should be considered. If you are not actively managing your portfolio and prudently protecting yourself to the downside, the probability of falling victim to another downturn is considerable.


Trillions will be lost in output. The U.S. Congressional Budget Office estimates that the COVID-19 recession will cost the U.S. economy $15.7 trillion in real economic output by 2030, adjusted for inflation. That number does not consider the global economic impact.


We are moving deeper and deeper into the land of global bankruptcy. Governments everywhere are racking up debt to “rescue us all from disaster”. So far, the majority seems to want precisely that medicine. However, trust will recede at some point, as more and more countries will find it increasingly difficult to service their debt. Particularly US dollar debt of developing countries, and then perhaps countries like Italy, will falter rapidly as soon as even a glimpse of rising interest rates manifests itself.


A long and painful road to jobs recovery. It is questionable as to how quickly jobs will recover to pre-crisis levels. In our view, it will be a very slow and difficult process. Small and even medium-sized businesses are failing en masse. Everywhere in Europe and America, failures are on the rise. In the U.S., commercial bankruptcy filings in May soared by 48% year over year, a preview of the carnage yet to come. According to Moody’s Analytics of June 2nd, 2020, “of the 8 million business establishments operating prior to the crisis in the U.S., it would not be surprising if close to a million do not make it. New businesses will eventually form, and the economy will recover, but that process will take years, not months.”


The gains since March have been driven by a small number of stocks, and by the bears. You should not be fooled: the rally appears to be driven to a substantial degree by bears, rather than bulls. Several analysts, including those at Citi, point out that one of the odd parts of this rally is that while money has been continuously flowing out of this market, prices have still risen. The reason why may be that the gains have been driven by short sellers buying back short positions they opened at the start of COVID. In a recommendation that speaks volumes about the bank’s concerns, Citi published a warning to its clients this week that the markets will tumble.


>> Read more on the long path to recovery.