When in mid-February last year investors started to realise that a novel respiratory illness in far away China was going to engulf the whole world, they triggered the biggest stock market sell-off since the Great Depression of 1929. Never did stocks fall that far with more speed. The US stock market, as measured by the S&P 500 Index and the Dow Jones Industrial Average, dropped more than 30 per cent within a few weeks. All over the world a similar drama played out. Bonds started to sell off even earlier, pushing up the yield of US 10-Year Treasury Notes into alarm territory: for a short moment the US Treasury market seemed to seize up completely.
What then followed was for some investment observers not only puzzling but outright incomprehensible. With infection rates and fatalities soaring and the whole world going into lockdown, the economic fallout was expected to reach World War II dimensions. The world’s biggest businesses ‒ manufacturers, airlines, hotels and the commodity industry ‒ ground to a complete standstill. Loans were not serviced, rents remained unpaid and revenues dropped to zero. People were out of their jobs and businesses pulled down the shutters. Yet stock markets went through the roof.
Writing about this in spring last year I expected a recovery to previous levels would take at least five years. Bereft of revenue, businesses started to hoard cash and to take on new debt at a staggering scale. How could they possibly return to health?
What was called for was not a return to profitability, but financial survival. I saw banks wobbling, real estate falling into an abyss and the stock markets dropping for longer periods than we have ever witnessed in our lifetime. What then followed was the biggest rescue programme by governments and central banks in peacetime.
As a result of their combined efforts, stocks started to bottom out only four weeks later and started to rise and reach in aggregate new heights only eight months later. Of course, some lost big time, like the travel industry and heavily battered basic materials. Yet only few went under, and the big technology companies, all of them profiting from stay-at-home orders, soared and pulled the whole market with them. Remember that this was a time when we still doubted that effective vaccines would be developed any time soon. We consumed much less, bought only necessities (remember the scramble for loo rolls?) and put our money into savings instead.
Working from home, or not working at all, created new winners. Video conferencing Zoom, home delivery and cloud service provider Amazon, computer and smart phone manufacturers like Apple, streaming services, gaming, and obviously, producers of PPE, like mask and glove makers and sellers of disinfectant.
Fear is our best friend, as the fear of an imminent meltdown makes it less likely to happen
With the surprise entry of efficacious vaccines, produced by pharmaceutical companies like Pfizer/BioNTech, AstraZeneca and Moderna (yes, its shares won big time too) optimism spread from the tech winners to old-fashioned companies formerly known as dividend payers – equipment makers, miners, and even Old Oil, boosted by a sizable demand for crude and metals from China, which was quick to shift into growth mode and to order at a frantic pace. Along the way, in all this unbridled investor optimism, companies like Tesla were carried to lofty, sentimental valuations, causing pessimists to regret their more sober place on the fence. Start-ups promising a rosy, faraway future, and SPECS ‒ empty shell companies sitting on a pile of unused cash promising a future not even drafted yet ‒ were the flavour of the day, supported increasingly by stay-at-home, retail investors using trading apps like video games, unnerving professionals who still tried to work out valuations.
Now the world’s economy is shifting into working mode again. Freight rates are multiplying. Shipping containers are in short supply. Managers look at their empty parts storage and start to replenish apace. Delivery of many components they have stopped ordering, like microchips for the car industry, cannot match this sudden, unexpected demand. Prices for managers and consumers pick up ‒ as suddenly as the stock market after the crash. And we all start to fear again. Inflation looks much more plausible now than any time since the Great Recession of 2008. Bond prices drop as investors expect interest rates to pick up too in tandem with inflation.
The bond sell-off last month saw US Treasury yields rising to more than 1.6 per cent. This is historically still a very low level, but to see yields triple within half a year still looks alarming, and even more so when central banks seem to take it in their stride and refuse to intervene. After all, it was them helping us into ever lower interest rates, desperately trying to induce investment and consumption by gobbling up a decade-long savings overhang. This is very bad news not only for bonds with ultra-long maturities, but for shares too, as their rich valuations are carried by the assumption that low interest rates are here to stay and can thus justify ever more meagre returns. This is particularly damaging for “growth stocks”, such as companies like Tesla, which promise meaningful earnings only in the faraway future.
The investment community is as yet undecided if rising interest rates signal a return to health and could therefore support still undervalued industrial laggards as well as banks, which are considered to profit from a tick-up in rates; or if such rate jumps indicate the beginning of the end. Many analysts, fearful of what is essentially yet again a new situation, draft alarming pictures of our immediate future: runaway inflation, stock market bubbles bursting, tech in a downward spiral, bonds in bear territory for a generation, gold losing value, the US dollar rapidly devaluing. As plausible as all of these scenarios may be they cannot happen simultaneously.
Most of them actually cancel each other out. Moderate rate rises will admittedly diminish the attractiveness of gold as we already experience, as the metal does not pay interest. But runaway inflation should traditionally be supportive of gold prices, as is a weakening US dollar. I will give you another example: as we have witnessed lately, rising bond yields have increased the attractiveness of US Treasuries when compared to euro bonds, thus supporting the US dollar.
As bad as a rising dollar may be for developing market debt, it will slow US inflation, making further rate rises less likely. This is not to say that we do not live in a fragile investment world (which I will illustrate further in my next column). We may well have to face a future with sadly diminished returns, dotted with cataclysmic events. But at the moment we are not yet out of the tunnel. It seems too early to fear a crash at the exit. But this fear is our best friend, as the fear of an imminent meltdown makes it less likely to happen.
The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com
Andreas Weitzer, Independent journalist based in Malta