Although the main stock indices are on the rise, signaling the consolidation of the strong bullish trend that has been building up, this rise does not represent the performance of stock markets as a whole.
As of February 10th, while the S&P 500 is up +3.75%, the equally weighted S&P 500 was only up +1.17%. The top 5 stocks by market capitalization account for 60% of this index’s increase (Microsoft, Apple, Amazon, Google and Facebook). If we increase the scope to the 3,000 highest market cap American companies, the largest 1,000 companies rise +3.86% (Russell 1000), whereas the following 2,000 companies by market cap (Russell 2000) post a negative return of -0.05%.
The “new normal” is neither normal nor sustainable over time. The “new normal” means central banks buy and will continue to buy bonds, to the extent that may be necessary, regardless of prices, and even if it results in unbalanced markets. Investors have effectually been ousted from the race: unless you are able to print your own money on your home printer, the risk-return ratio offered by bonds is unassumable. Since the asset which traditionally has been the main recipient of global savings (bonds) is no longer an option and cash balances are penalized with negative rates, equity is the only possible investment left. Furthermore, as all investors need protection against contingencies defensive shares have now become safe haven assets. This paradigm shift will last as long as the central banks wish it to. Portfolios will be stocked full with equity, and the only protection available to investors will be a constant flow of positive results from issuing companies. If this flow fails, the whole castle in the air will also come tumbling down.
Based on this assessment, in our direct exposure to stock markets we continue to favor growth shares which we believe can rise to the challenge posed by their current stringent valuations. In defensive portfolios, that have a high level of hedging, we have adapted our index weightings to this new paradigm and are hedging our American stocks with the Russell 2000 instead of the S&P500. Coronavirus has paralyzed industrial processes, slowing down commercial exchanges and reducing consumption, and sooner or later its effects will be felt by the macro indicators followed by the investment community. Yea to Stock markets, but keep an eye on future developments.
Our bet on USD is starting to bear fruit; it has a positive “carry”, backed by the higher demand of American products and services vs. European ones. Moreover, the ECB feels no compunction about plummeting rates and its possible consequences on the financial sector, in order to devaluate the currency in an attempt to stimulate exports. A medicine with strong secondary effects which old Europe is finding hard to digest.