Governments are going all out – the latest EU agreement on a common recovery package being a highly significant example.
Central banks are providing extraordinary backstops.
At the same time, the pandemic-induced shock wave has created tremendous economic uncertainty.
So how exactly can equity investors make head or tail of all this? What asset allocation will best serve their interests now that stock markets are recovering, but in a climate of overall uncertainty?
A convenient, and frankly lazy way out is to use never-ending “central-bank intervention” as an excuse for whatever your approach may be.
The unknown unknowns
The fact of the matter is that no one – including central bankers – really knows all the consequences of endlessly expanding the money supply to pay for oversized fiscal deficits, not to mention how it will play out in the long term.
It’s worth recalling that when central banks made their first foray into large-scale financial asset purchases in 2009, the vast majority of economists warned that such unconventional monetary policies would drive inflation through the roof.
They did no such thing. On the contrary, interest rates began a decade of dizzying decline. So even back then, nobody had a serious grip (to put mildly) on the economic processes and market shifts set in motion by those policies.
A convenient, and frankly lazy way out is to use never-ending “central-bank intervention” as an excuse for whatever your approach may be.Now fast forward to ten years later and add the threat of a mysterious worldwide virus into the equation. Plainly what’s called for is humility in the face of the unknown and a willingness to refrain from sweeping forecasts – almost invariable built on sand.
Fortunately, there is an iron law that should enable investors to deal with such extreme uncertainty: not all financial assets are fragile.
In fact, some of them can not only withstand uncertainty (or even chaos) but may even thrive on it.
Essayist Nassim Taleb has referred to them as “antifragile” assets. That’s the place to be, instead of trying to predict the unpredictable. The challenge is determining which assets fit the bill.
Monetary policy impact
In current circumstances, tech companies and gold can be considered antifragile, which explains their high share prices today.
To understand why, we need to go back ten years.
What the record shows since 2009 is that financial asset prices are the only area in which monetary expansion has produced inflation.
And it isn’t hard to see why. All the vast resources created by monetary policy, which were supposed to inflate consumer prices, didn’t carry much weight in the end against the powerful deflationary forces at work.
Excessive debt loads have stifled demand; globalisation has fueled price competition; population ageing has led to higher savings rates; and new technology has paid off in the form of rising productivity.
In other words, the “inflationary power” of expanding the money supply got channelled by default into equity and bond prices.
The use of monetary policy to deal with economic crisis has therefore proved most beneficial to investors – particularly those with holdings in the sectors most directly related to the irresistible deflationary trends under way.
Noteworthy examples obviously include tech companies with no debt or even abundant cash flow, as well as healthcare providers that are making money on an ageing population and large, globally integrated firms that have powered the trend towards international supply chains.
Meanwhile, the shares of manufacturing companies and banks, which need a booming economy to be able to generate operating profits and invest for the long term, have been withering on the vine.
The upshot of this polarisation in equity-market behaviour is that so-called cyclical companies, whose fortunes vary with economic growth, have very little weight today in the major market indices.
What the record shows since 2009 is that financial asset prices are the only area in which monetary expansion has produced inflation.In contrast, tech and healthcare names, whose share prices don’t reflect the strength of the economy, but rather its deflationary torpor, are now over-represented.
New normal?
So, what does today’s high-flying stock market tell us? Simply that investors who are positioned to take advantage of a sorry state of macroeconomic affairs are doing well.
Yet another piece has been added to the puzzle in 2020: Covid-19.
Though how the pandemic will evolve is anyone’s guess. Not only is it already accelerating existing deflationary trends, but it is also reshaping consumer behaviour, perhaps lastingly so.
How have markets adjusted to this extra dose of uncertainty?
First, as could be expected, investors have stepped up their positions in sectors that “like” the deflationary pressures created by economic uncertainty.
Second, they have focused, within those antifragile sectors, on companies whose profit margins are clearly being boosted by changes in consumer behaviour such as greater home working opportunities, video gaming, the cloud, e-commerce and a concern for the environment.
Third and last, responding to the unprecedented degree of uncertainty today (regarding the business cycle, inflation, politics and geopolitics, and exchange rates), they have shifted the rest of their holdings into another antifragile asset called gold – the traditional multi-risk insurance policy.
Since the start of the year, the two most lucrative bets, though they aren’t really bets at all, have been the Nasdaq Composite, which is weighted towards IT companies and has gained 25 per cent, and the Gold Miners Index, which is up 35 per cent.
Investors, then, have themselves defined what an optimum asset allocation is in times of extreme uncertainty – when only fools would rely on economic forecasts.
Didier Saint-Georges is managing director and strategic investment committee member at Carmignac
