By Dr. Jens Ehrhardt, Founder and CEO of DJE Kapital AG
Bonds and gold as stabilizing elements, equities as profit drivers
The year 2020 was primarily influenced by the Corona pandemic. The first quarter suffered the fastest and sharpest stock market slump worldwide in economic history. The Corona shock hit the world in a very vulnerable situation,in which the economy was already slowing down significantly internationally so that the pandemic massively reinforced the existing downward trend.
Investment activity as an economic indicator
The US Federal Reserve had made the mistake of reducing total assets for far too long (until September 2019), slowing down the economy for a long time. With reference to the very low unemployment rate the Federal Reserve had for a long time failed to see that massive monetary stimulus was necessary to offset the downward trend of the US economy that already existed before Corona. However, as we have repeatedly stressed the US labor market is not a leading indicator and is in no way suitable as a barometer of future economic development. We pointed out that the propensity of companies to invest is the outstanding economic indicator.
Due to weak economic growth and already very low capacity utilization of US companies there was a de facto investment freeze in the second half of 2019. But when stock markets slumped more sharply and faster than in 1929 or 1987 the US Federal Reserve switched to massive expansions faster than in previous recessions trying to compensate the previous massive management error. The Trump administration also switched to massive stimulus faster and more massively than the Obama administration in the 2008 financial crisis. The US national deficit which had already been high before the pandemic - in order to absorb the weak economy - was multiplied once again: with rates of increase last seen in 1943 in the Second World War.
Stock markets on a recovery course
The massive monetary and fiscal policy stimulus enabled Wall Street and world stock markets to recover unusually quick and strong. We predicted a V-like recovery at the stock market's low point, whereas otherwise comparisons were made with the beginning of the Great Depression in 1929/1932 and most observers did not expect a V-like but rather a W-like recovery with new lows. The Ifo Institute spoke of a GDP slump of up to 20 per cent in Germany, while towards the end of the year a contraction of only about 5 per cent is now probably becoming apparent. Most observers underestimated the speed and scale of the stock market recovery.
Throughout most of the year it was reported that the stock market had completely detached itself from economic realities with its rise and that a new bear market was therefore to be expected. What most people don't realize is that the monetary stimulation of economic history always has a time lead of about one year ahead of the real economy - as first worked out in the scientific works of Dr. Ehrhardt in the early 1970s. Monetary know-how with regard to stock market developments had already enabled us to achieve relatively good market performance during the Internet crisis in 2000/2003 and during the financial crisis in 2008/2009.
Monetary and fiscal policy stimulus determine the stock market year 2021
Economic and stock market developments in 2021 should be dominated by continued monetary stimulus. As the Federal Reserve and the European Central Bank massively increased their quantitative easing efforts in the second half of 2020 correspondingly positive stock market and economic developments can be expected in 2021. With regard to monetary lag effects we should therefore be able to observe a favorable stock market trend in the first half of 2021. The stock market trend in the second half of the year will depend to a large extent on whether the US Federal Reserve sticks to its stimulus policy or whether a surprisingly good US economic trend and rising US inflation will cause the Federal Reserve to pull back. The time lag effect of monetary measures on the stock market is about six months making it difficult to forecast stock markets beyond that.
Much will probably also depend on the extent to which the fiscal stimulus promised by the US government can actually be implemented. The composition of the US Senate is important in this respect. Since it will not be decided until January 2021 who controls the majority it is not yet possible to make accurate forecasts on fiscal policy either. A Republican-controlled Senate is likely to cut the trillion-dollar fiscal stimulus package to a large extent. A Democratic Senate would probably spend between 2 and 5 trillion US dollar. It should not be underestimated that with such drastic stimulus measures the risks of inflation could also grow again. Actually, periods of recession or periods of weak economic growth as in the past ten years are characterized by low inflation rates. Over-stimulation, even with helicopter money, could, however, increase demand on the goods markets to such an extent that the rate of inflation would rise surprisingly. In such a case, the currently positive stock market forecasts would have to be reconsidered in the course of 2021.
US inflation as a key factor in central bank policy
In general the development of US inflation is extremely important for future FED policy. It is true that the prospect of holding on to record low interest rates over the next three years has already been mentioned. However the Federal Reserve is likely to correct this if surprisingly massive inflation rates were to prevail. For the time being, however, the central bank is likely to be relatively generous and not yet tighten the reins even if inflation rates rise well above 2 per cent. This is known as symmetric inflation control. In other words, for the longer period with inflation rates below 2 per cent longer periods of over 2 per cent are to be permitted. However this is unlikely to apply if the rate of inflation more than doubles.
Without significantly higher US wages, a significant reduction of the savings rate, a strong expansion of consumer credit and an acceleration of the velocity of money circulation, a strong expansion of US inflation is rather unrealistic. Because of its importance for central bank policy US inflation needs to be monitored closely - especially in the real estate sector, which is very heavily weighted towards rents and owner-occupation. However it is quite possible that fears about inflation and the associated rise in US interest rates in 2021 are just as misguided as they have been for the past ten years - when central banks regularly expected a significant increase in these key parameters of any economic development.
Geopolitical tensions remain a risk factor
In addition to the pandemic the beginning of a new Cold War between West and East also played a role in 2020 and in previous years. There were not only restrictions on world trade towards China but also towards Europe. Hopefully the USA will withdraw its geopolitical aggression in 2021. B However, this is not certain, as demonstrated by the disputes regarding subsidies for aircraft manufacturers or the sanctions against Germany for Nord Stream 2. So geopolitics are a risk for 2021 including future developments in Belarus - the last buffer state between NATO and Russia after the fall of Ukraine to the West. China's territorial claims in the South China Sea could also cause temporary unrest. Such political influences, however, usually only mask the underlying positive overall monetary trend in the stock market in the short term.
US dollar as geopolitical weapon against China
Currency developments are also likely to play an important role in the stock market outlook for 2021. In the past a weak dollar has been positive for world stock markets as it has been accompanied by a relaxation of liquidity. Historically the dollar regularly fell after a recession was over - and the money previously poured into the safe haven of the dollar flowed back home. China in particular suffered more than others in a recession because of its high dollar loans. So a strong dollar would also be a geopolitical weapon against China. Just like the US bans on exports of advanced semiconductors to China. This is a factor that could put an extremely severe brake on China's economic development.
Nevertheless, the Chinese will strive to become the world leader in all key industries by 2025 at the latest. Social unrest such as we have seen in the USA is not to be expected in China. The people are behind the government and national interests are high on the agenda. The country is proud of its superior management of the pandemic crisis compared to the West. Not only in China but also throughout Asia the pandemic or the limitation of the number of victims has been managed incomparably more successfully than in Europe or North and South America. The development has been the worst in Great Britain, the USA and France.
Europe suspended in the debt union
In the past two decades, Europe has already been characterized - probably primarily due to the Euro - by a particularly weak economic development compared to Asia and the USA. In the wake of the pandemic Europe has developed surprisingly clearly in the direction of a debt community. Under pressure primarily from France an aid fund of 750 billion Euros was set up - especially to support the Mediterranean countries suffering Corona damages. This together with the new 5-year budget meant that for the first time European Community debts of over €1.8 trillion were decided. Up to now the EU has not been able to take on its own debts under the Maastricht Treaty. The EU budget was financed by contributions from the member states. After the departure of Great Britain, the second most important contributor after Germany was eliminated. The higher contributions of the individual countries that were necessarily due as a result would probably have been difficult to collect from the EU and now the new debt union is preferred.
This was also the first de facto implementation of the concept of so-called Euro-Bonds which the German government had repeatedly and clearly rejected. The debt union has the advantage for the Mediterranean countries including France that they can largely benefit from the German low interest rates. This means that the alignment of interest rates in Europe is probably only a matter of a short time. The extremely low or negative interest rates and the LTRO corporate loans below ECB interest rates which are subject to additional premiums should stimulate the European economy in 2021 just as much as the extremely high budget deficits for Europe. In most European countries these are likely to be around 20 percent for 2020.
In 2021 such extreme new indebtedness is again expected. As a result the European economy will no longer be slowed down by the principle of gradual budget balancing as has been the case since 2009. Instead similar to the US and Asia strong fiscal policy action will be taken after ten years of weakening the European economy with the pursuit of budget surpluses à la Germany.
Favorable economic outlook worldwide - especially in Europe
The economic outlook should therefore be very favorable not only for the US and Asia but also, or even more so, for Europe in 2021 - always provided that the pandemic problems are reduced either by a reduction in the viral load or by vaccination successes. As the economy improves corporate profits in Europe should also be able to catch up with the fiscal policy-related shortfalls of the past ten years compared to the US and Asia. The only country that had avoided a Maastricht-based fiscal brake in recent years was France.
The country with the highest total debt in the world is Japan, followed by France if you add state, private households and above all companies - there France has the highest debt in the world. In absolute figures, too, French public debt is higher in Europe than in Germany or Italy. With a common currency it makes sense in the national interest to take on maximum debt to stimulate the economy. Possible negative consequences would have to be borne by the community - and not by the debtor alone. France could therefore do particularly well in 2021 in terms of the economy and the stock market in view of its sustained maximum debt and the reforms in Europe pushed through by Emmanuel Macron à la Gerhard Schröder.
Asian stock markets with low valuations and high growth
Globally, it is realistic to expect Asian stock markets, including Japan, to perform well again. Valuations there are low by international standards and growth is high. The new economic pact of the Asian countries including Australia is also positive - with China as the leading power. Although overvaluation and unhealthy concentration of investor money in internet companies can be observed in the USA, there is much to suggest that the Americans can even extend their internet lead internationally. However US anti-monopoly interests could be opposed to this as the Internet giants could be split up to promote competition. The Democrats are even more reluctant to accept the Internet giants than the Republicans who had already started initiatives in this direction in the Trump era.
Overvalued: US growth stocks
Basically it would only be healthy if stock markets could rise internationally on a broader front. In the absence of global growth, investor money from institutional and private investors has so far been invested almost exclusively in US growth stocks. For example, five internet giants in the USA are valued three times as high as all shares in Germany and Great Britain combined. A current comparison shows how unhealthy the situation has been in some cases recently with regard to valuations: the largest stock corporation for the brokerage of digital conferences was worth about two thirds as much as all European telecommunications companies taken together. Such comparisons are already a reminder of the overvaluations of the year 2000.
Value stocks with considerable catch-up potential
Although the comparison with 2000 cannot be made accurately for a number of reasons, if equity investments are to be successful a precise differentiation must also be made in the growth stocks sector. So-called value stocks which should benefit from a general economic improvement should have considerable catch-up potential. Although stock indices reflect significant gains over the last three years they are not necessarily the most attractive. However, unweighted, the vast majority of share prices today are still below the highs of January 2018. Compared to international benchmarks such as the S&P 500 the German share index today is still well below its historic high from 2000. This shows that shares are by no means overvalued today - especially not against the background of record low interest rates which central banks will have to keep low for longer for economic reasons. Otherwise the still burdening international debt levels are likely to become a problem.
In focus: Gold and bonds during recession - equities during economic recovery
Gold was for a long time the favorite investment of 2020 alongside long-dated government bonds. Only when interest rates, especially for long-dated bonds, rose towards the end of the year and the real interest rate increased again gold investments came under pressure. Added to this was the fact that from a market technical point of view American hedge funds in particular were very one-sidedly over-invested in gold investments while traditional buyers from China and India failed to appear in 2020. Gold and government bonds are an optimum in a severe recession. If the economy improves - which can be assumed for 2021 - the stock market should perform positively on a broad front, at least in the first half of the year.
Note: All information published is for your information only and does not constitute investment advice or other recommendation. Long-term experience and awards do not guarantee investment success. Securities are subject to market-related price fluctuations which may not be compensated for by the active management of the asset manager or investment advisor. This information cannot replace a consultation. All information has been provided with care and to the best of our knowledge at the time of preparation. Despite all due care, the data may have changed in the meantime. Further information on opportunities and risks can be found on the website www.dje.en. The sales prospectus and further information are available free of charge in German from DJE Investment S.A. or at www.dje.en The fund management company is DJE Investment S.A. DJE Kapital AG is the distribution agent.