Jamais vu

Neither fiscal nor monetary policy can solve the problem of new growth in the current phase. What may help to maintain stability in the short term may endanger prosperity in the long term. We can only hope that the virus weakens or that an effective vaccine becomes available soon.

Getting as close as possible to full employment

Ultimately, the aim of every government is to enable as many people as possible to find a job. To accomplish this, John Maynard Keynes used government spending policies to manage economic cycles. When this stopped being effective in the 1970s – both inflation and unemployment were high – the US Federal Reserve under Paul Volcker began to focus on low, stable inflation instead. This was meant to form the basis for a more efficient economy. Efficiency rather than income equality became the new goal. As a result, short-term interest rates instead of fiscal policy became the focus for managing economic growth. However, this approach has not been working effectively either since the 2008 banking crisis, and now the corona-virus has complicated things even more.

Are we facing the imminent merger of fiscal and monetary policy?

«Jamais vu» refers to the phenomenon of experiencing a situation that you recognise on some level but that nonetheless seems novel and unfamiliar. It remains impossible to decisively categorise the situation since we are in the middle of a period of reflection with an ongoing battle of opinions. Some players want to keep to the same course, with central banks continuing to print money and hold securities on their own balance sheets (QE). Others are calling for an expansionary fiscal policy in the form of increased spending or tax cuts. Such measures are to be funded by debt, which central banks would facilitate with zero interest rates. And progressives are demanding the abolition of physical money. They want a digital currency so that interest rates can be pushed further into negative territory.

Money not ideal for storing value

We currently find ourselves following the second recommendation, and preparations are underway to embrace the third, e.g. in China, but such ideas are prominent in Europe as well. In view of this development, it is no wonder that precious metals are shining with even more lustre. Money admittedly works well as a means of payment and as a measure of value, but its function as a store of value is sacrificed in favour of system and structure preservation.

Can we draw any analogies with the past?

n 1918, workers in the Ruhr area in Germany were paid for their resistance against the French with newly printed money. “Money for nothing” was followed by hyperinflation. At that time, however, production output was pushed to the maximum, whereas today there are practically no shortages anywhere. During the Great Depression from 1929 onwards, highly expansionary monetary and fiscal policies were also pursued. Inflationary pressure appeared only years later, which was countered with price controls. This accommodative monetary policy led to stagflation in the 1970s. Such a scenario seems possible once again, particularly if the world divides itself into blocs and fiscal and monetary policy are merged.

An analogy to 2000 is most likely to be found in the sharp growth among tech stocks. During the dot-com bubble, tech stocks were trading at absurdly high prices. Back then, however, there were also several investment alternatives, such as real estate and bonds with 5% interest. It is the widespread belief that digitalisation changes everything that is reminiscent of the tech bubble.

The year 2008 is not a fitting analogy. When the over-extended financial world collapsed, affecting the real economy, the authorities all over the world came together to solve the resulting problems.

We have the exact opposite occurring in 2020. The highly efficient global economy was broadsided by the measures to stop the spread of a virus – with knock-on effects for the financial world. And global cooperation is no longer trending.

Is a crash coming?

Granted, stock exchanges have recovered surprisingly quickly in the wake of the sharp slump in the spring. Nevertheless, stock markets make a strong distinction between growth stocks, stable companies and cyclical industrial companies. One lesson from the tech euphoria of the 1990s is this: if the digital sector does not do as well as expected, its shares will correct themselves – and non-technology shares will also suffer. Not all stocks are expensive.

Based on our discussions with company directors, we have noted that companies in the non-digital sector are the ones most cautious about the future. They are reducing rather than expanding their output, and projects are being postponed. Once the pandemic is over, this will be the basis for positive future development.

Resilience and ability to act

n uncertain times such as these, conventional risk measures such as volatility are of little use. Resilience is what is in demand now. It should be possible to withstand difficult market conditions without sustained adverse effects. For their part, companies are complementing efficient “just in time” capacities. For investors, resilience means maintaining their ability to act at all times, with the focus on liabilities. We recommend having as little outside capital as possible and reserving two years of cash to cover your living expenses. Now that stock markets are trading at the same levels as at the beginning of the year despite the weak real economy, even three to four years of cash reserves would be appropriate.

Resilience for investors could also mean making investments that are not connected to the stock markets. Unfortunately, bonds are no longer an option, but precious metals or more illiquid niche products still are. Carrying out a resilience test makes sense to us. How would your portfolio do in a bear market similar to that of 2000–2003 and would you still have the ability to act?

Inflation and gold as key indicators

We are sticking to our original advice: overweight equities, supplemented with precious metals and niche products. Bonds remain less appealing. We keep an eye on the two key indicators of gold and inflation because they act as a seismograph, recording the state of the financial system. The price of gold has already risen sharply due to the high levels of uncertainty, but market expectations for future inflation are still very low. Financial markets are expecting only 1.5 % inflation per year for the next 30 years in the USA. However, should inflation forecasts rise alongside precious metal prices, we would expect a strong reaction on equity markets – with a move away from highly valued growth stocks and towards neglected value stocks. Of course, long-term bonds would then become «expropriated assets».