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Market Commentary

4th quarter 2020

Reading time 15 minutes
  • Thanks to vaccination, only a temporary slowdown in economic growth is expected for the second Corona wave. In addition, central banks and governments are paving the way for the post-pandemic period with further stimulus measures.
  • After rising in September and October, market risk indicators fell sharply in the last two months of the year.
  • The prospects of a consolidated economic recovery led to a broader upswing unlike Q2 and Q3. At that time, predominantly technology-heavy stocks set the tone.
  • Rising government spending (and debt) in Europe helped the EUR regain investor confidence, while in the U.S. the depreciation of the USD continued to accentuate.
  • Unlike in the U.S., European interest rates declined somewhat - due to lower inflation expectations.
  • Brexit: The deal is finally in the bag. This is certainly a positive sign for both sides, even if many details have (still) not been clarified.

Decoupling of real economy and financial markets continues

The second Corona wave and the associated return of (full or partial) lockdowns caused the markets only minor concerns. Financial markets have overcome the uncertainty surrounding the U.S. presidential election already a week before the polls closed. In fact, the VIX index (a measure of expected market risk) already started its decline at the end of October, after having clearly risen for the previous two months. After a brief breather in September and October, the stock markets continued their almost monotonous upswing until the end of the year - despite the exploding infection figures and the renewed and in many places indefinite restriction of economic activities. The decoupling of financial market development from the real economy was the dominant theme in 2020, and there are currently no signs in sight that this trend is likely to reverse in the near future.

Vaccination and government support measures as a remedy for corona

Financial markets generally weight the future much more heavily than the present. Future dynamics count more than the current situation - even if the latter, with all its economic and social restrictions, places a heavy burden on the majority of the population. But with the launch of the largest vaccination campaign in human history, there is finally a light at the end of the tunnel. And, as we struggle toward the end of the tunnel, the economy is being kept alive by a new round of government support. A newly elected Democratic-led US government, not shy about budget deficits, and an equally generous EU will further cushion the bumpy road through the pandemic. The US approved in December a USD 900 billion aid package among others to help hard-hit families and businesses.

EU sends out a strong signal

The EU has also done its homework: EUR 750 billion for a Covid aid package and EUR 1.1 trillion to promote digitalization and a "green economy". This puts a definitive end to 10 years of austerity. Even the Brexit deal sounds like good news - at least better than nothing. "The Economist" writes: The end is where we start from. The Brexit deal regulates the movement of goods, but not services, including the financial sector, which is so important for the UK. The largest neighbor is and remains continental Europe. Continuous negotiations with the EU are inevitable - as Swiss, we know that all too well.

Not all government spending is the same

In the US, rising government spending, budget deficits and debt, combined with a negative trade balance, led to a depreciation of the USD. This is good news for emerging markets, which borrow predominantly in USD. It is not surprising, then, that there was record high new borrowing last year. Many emerging markets were less affected by the second Covid wave. Accordingly, the economic and market recovery was also faster. Especially in China and South Korea: both CSI 300 and Kospi equity indices reached new all-time highs at the end of the year.

Unlike in the US, the prospects of rising government debt in Europe had a positive impact on the EUR. It gained slightly against the CHF and even strongly against the USD. Do different rules apply to the EUR than to the USD? No, the difference lies in the EU lower debt and trade surplus. In addition, the planned spending and the end of austerity was seen as a strong political signal in favor of the EUR and against populist movements within the monetary union.

Developments on the interest rate front also differed on this and the other side of the Atlantic. Higher government debt and a weak USD pushed up inflation expectations and with them interest rates on US government bonds. For the less dynamic economies on the old continent, however, additional debt is not (yet) seen as an inflation driver. The appreciation of the EUR against the USD could even have a negative impact on the economy. Against this backdrop, the interest rate level for EUR, GBP and CHF investments declined slightly in Q4.

A broad market recovery in anticipation of a sustainable and long-term economic upswing

Economic activity and unemployment are still far from pre-crisis levels. It will probably take a while longer to reach the previous level. The way to do this is through government spending, liquidity injections or even "helicopter money." But the scenario of an economic upswing and a return to “normality” is now clearly evident and it has influenced market dynamics in Q4. Until September, mainly technology-heavy companies drove the market. When the market anticipates the start of a new economic cycle, "traditional" companies from sectors such as energy, financials or industrials tend to benefit as well - this was exactly the picture presented in Q4. Geographically, the upswing in Q4 was also more homogeneous than in the two previous quarters - i.e. Europe was again able to keep pace with the US markets. Incidentally, the same pattern was seen after the dotcom crisis in 2003 and the financial crisis in 2009. In Q4, risk indicators weakened and are now well below the long-term average - not only for equities, but also for bonds and currencies. Under these circumstances, our risk-based strategies - as in 2003 and 2009 - were only able to participate in part of the upswing and accordingly lagged significantly behind the respective (capital-weighted) benchmark indices.

Inflation - currently shines with absence, but is still the main character

Fear of the pandemic, economic and social restrictions on the one hand, new record highs and low risk indicators on the financial markets on the other - circumstances that do not seem compatible. Or do they? One economic variable has been holding back for years and helps explain the conundrum: inflation. The absence of inflation is the foundation that supports the unprecedented government spending and the generous supply of liquidity by the central banks in the first place. As already mentioned, these measures enable us to make it to the end of the tunnel reasonably unscathed. The theoretical basis for unlimited money printing and spending to smooth out cyclical distortions is now the talk of the town: Modern Monetary Theory (MMT). The former chief economist of Morgan Stanley, Stephen Roach, speaks plainly: MMT is neither modern nor a theory. It works as long as inflation is absent or supposedly dead. In fact, we see little inflation risk on the horizon right now. But as we all know, we didn't see Corona coming either - just as every past crisis was usually a nasty surprise. We don't want to be a killjoy, and we are aware that the conditions for a healthy social and economic recovery are in place. However, we also recognize a certain fragility in the system. The unorthodox monetary and fiscal policies of the past 10 years have systematically suppressed market risk, distorted financial market mechanisms, and made the whole system dependent on public intervention. All of this poses a latent risk to financial markets. When it comes to long-term investing, we remain true to our old-fashioned virtue of putting risk at the center of our considerations. If we follow this simple principle in a disciplined manner, we unfortunately have to accept that there will also be phases of subdued performance - just as we experienced in the last quarter and over the last two years.

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