Saxo: We Are Suspending Market-Based Economies… At Worst We Are Replacing Them With State Capitalism
Sat, 07/04/2020 – 14:07
Saxo Bank, the online trading and investment specialist, has published its Q3 2020 Quarterly Outlook for global markets, including trading ideas covering equities, FX, currencies, commodities, and bonds, as well as a range of central macro themes impacting client portfolios.
“Over the past three decades, after the end of the Cold War and especially with China’s momentous admission into the WTO in 2001, the world has become ever more connected and integrated through technology and globalisation. However, starting with the Trump presidency – and with a breathtaking acceleration over the space of just a few months thanks to the Covid-19 pandemic – the world is being driven by self-interest, distrust and a game of us versus them in political circles as well as companies’ supply chains” says Steen Jakobsen, Chief Economist and CIO at Saxo Bank.
“This great turning away from world-spanning supply chains, plus an impulse shading towards autarky, will bring widespread reshoring and incentive programmes to produce domestically. The first areas in focus will be medical supplies, after the embarrassingly dire lack of preparedness nearly everywhere for what was arguably an inevitable pandemic. But the new need to measure political accountability in terms of national self-sufficiency in pivotal industries will mean that energy, food supplies and technology will all be declared “mission critical”. Potential higher marginal costs for producing locally will prove less important than the political imperative to prove robust self-sufficiency. In short, prices will rise for nearly everything – and in real terms, not just through price inflation.
“This will be extremely expensive: for the consumer, for governments and for jobs. But what could prove far worse than the implications of deglobalisation is the unfortunate reality that Covid-19 has accelerated the death of free markets as the driver of economies. The move to bail out everything is understandable but deepens the risk that real GDP growth will continue to trend downwards on the zombification of the economy.
“The Covid-19 crisis was immediately devastating because our debt-saturated economies are so very highly tuned and fragile. With ZIRP, NIRP and bailouts for everyone all the time, this has been forever abolished. No more “forest fires” to leave fertile new ground for new actors to jump-start the economy and hence a future of ever-lower productivity and real GDP growth inside a massive debt burden.
“The impact on markets and employment will be extremely negative when the stimulus runs out. Through direct and indirect lending, bailouts and grants, government spending in many countries will be more than 50% of GDP. Government interests will have a strong voice in boardrooms, and new government regulations are on the way to “save the economy and jobs” with taxpayer money.
“The great irony is that although Covid-19 brings massive human and economic impacts, the even bigger risk is our response to the crisis. At best we are suspending market-based economies, at worst we are replacing them with state capitalism. That model can never ever win, as open markets are required to best drive price discovery, allocation of goods, innovation and even democracy.
“The combination of localisation, ‘my-nation-first’ and state capitalism brings massive headwinds for growth, employment, the social fabric and the markets. These approaches to tackling the Covid-19 crisis are a one-way street into a narrowminded, provincial, nostalgic narrative that states can go it alone. But fighting both the pandemic and future similar risks needs a more global approach, not a local one.”
More pain ahead for equities as the world resets
Supportive monetary policies in response to the crisis have brought fiscal and monetary institutions closer and all-out stimulus to fight the biggest economic contraction since the 1930s has fostered speculation on a scale we have not seen since 2000. However, as this is written, the S&P 500 has just had its worst session since March and the VIX has exploded higher, so the impact from Covid-19 is far from over.
Peter Garnry, Head of Equity Strategy, said: “As we enter Q3, markets remain fragile. The VIX is indicating a very volatile summer, where Q2 earnings releases will finally reveal the real damage to the corporate sector and potentially give us a rough sketch of what’s ahead.
“Valuations have bounced back to levels where the risk-reward ratio is not attractive in a historical context. History suggests that there is a 33% probability, at current valuation levels, that the international equity investor will experience negative real rate return over the next ten years.
“The past year has pushed the outperformance of US equities over European equities to an extreme spread in a historical context. European equities have lost out to US equities to the tune of five standard deviations on a relative basis since 2007. The drivers have been a strong USD, higher valuations on US equities relative to European equities, higher US earnings growth combined with large buyback programmes and a tectonic shift in market capitalisation towards technology companies – where Europe has lagged. Measured on 12-month trailing EV/EBITDA, US equities are valued 65% higher than European equities. This massive valuation spread requires a flawless US earnings path from here.
“US equities generally have lower financial leverage than European companies, which is a positive in an uncertain macro environment. However, valuation is the key factor in explaining future returns, so with the historic outperformance of US equities combined with rich valuations we believe investors should begin to be overweight European equities – despite the political risks in the EU.
“Looking ahead, Localisation is an important emerging theme that we believe will play out in the next decade economically and in equity markets. One theme that makes sense in this transition is investing in small caps with a domestic revenue profile in non-cyclical parts of the economy (healthcare, consumer staples and utilities). The transition to a more localised global economy will create an uncertain path for many companies and therefore the good old strategy of investing in in high-quality companies with low financial leverage is also attractive in our view.
“We believe that certain sectors of the economy, such as the green transformation, will also continue to do well because the current economic model is a net drag on the environment. Other industries such as healthcare, robotics and 3D printing will also get a boost from policies of self-reliance and domestic-oriented production in the developed world. Companies with a strong digital presence and business model will also naturally do very well. However, with extreme valuations among some online companies’ investors should be cautious of “bubble stocks”.