Executive summary
There is Covid, but the markets do not seem to see it: they are looking ahead, amidst soaring economic data and economists’ forecasts that are perhaps too pessimistic. The balance is precarious, and volatility remains too high. As always, the signals are contradictory. Stock markets are experiencing a “V-shaped” recovery that remains highly uncertain: equity investments should be viewed with greater caution, even in a context where equities and liquidity remain the reference assets. There is a growing feeling that Europe, with better control of the pandemic and fewer political risks (US presidential elections looming), could finally do better than Wall Street.

Broadway or Wall Street?
It is a new spectacle, which surprises us every day, despite the fact that the score is always the same: we are only going up, supported by the Central Banks (and, on this occasion, by government activism at planetary level), in good times (expanding economies) and bad (recession watered down by policy makers).

It is estimated that over the next two years, even in the least pessimistic scenario, more than five years of real growth in per capita income would be lost in many advanced economies: this would be the fourth most severe recession in the last 150 years, after 1914, 1930-32 and 1945-46 (dates associated with two world wars and the rise of totalitarian regimes). The hypothesis seems irrelevant to the masters of the markets, who look ahead and see different scenarios. Assuming and not conceding that financial asset prices still have a predictive meaning. There is no shortage of contradictions, and explanations and justifications that bring everything back to rationality[1] abound.

Interest rates, still at their lowest in years, mostly negative even in nominal terms, would signal continued deflationary pressures. Or would it? Central banks now even manipulate ETFs that replicate the junk bond market; in Japan, the BoJ has been buying equity ETFs for years.

Conversely, the “equity risk premium” implicit in the Standard & Poors 500 index, which has returned to levels not far from 4%, would “in normal times” reflect expectations of sustained and stable economic growth, perhaps even inflation, not an economy hit by a tsunami. But these are not normal times and, above all, the “new normal post-Covid“, apart from the most obvious trends (and therefore taken for granted by the markets), is still to be imagined.


The fact remains that we are here to record a quarter with Wall Street posting +18.5% (but the DAX did even better, see table below), the best performance since Q4 1998, better even than Q2 2009.

The comparison between the three periods is not accidental, there is a thread linking them linked to the transformation of the Central Banks: from lenders of last resort to illiquid but solvent counterparties, they have turned into puppeteers of the markets (the “godfathers”), endowed with unlimited capital, conscious agents of the mutation of a financial ecosystem now dominated by the great managers of global capital (the “masters”).

The 1998 episode followed the rescue of the famous hedge fund Long Term Capital Management, the ‘Nobel Prize fund’, the first to use leveraged arbitrage on a large scale, with tens of thousands of open positions financed by repo agreements. [2]The 1998 episode followed the rescue of the famous hedge fund Long Term Capital Management, the first to use leveraged arbitrage on a large scale, with tens of thousands of open positions financed by repo agreements. Its impending insolvency threatened to paralyse the money markets on Wall Street. A foretaste of what would happen ten years later. The bailout, hastily organised by the New York Federal Reserve, with the participation of all the major US[3] investment banks, was followed by an overwhelming injection of liquidity[4] that took the stock markets back to their highest levels (the S&P 500 rose by 21.5% in the last quarter of the year), starting the run-up to the great ‘TMT’ bubble that[5] exploded in the spring of 2000.

The second quarter of 2009 saw [6]the start of what was to become the longest-lasting bull market in history, which lasted until February of this year. In September 2008, the failure to rescue Lehman Brothers accelerated the crisis in the global financial system, which had been corrupted by the excesses of structured finance and speculative overexposure to real estate. The Federal Reserve and the US Treasury managed to save the system even then, weaving a rescue net based on moral hazard. After Lehman was allowed to fail, all other financial institutions were bailed out and the first quantitative easing operation was launched. This was followed in the next decade by many other operations by the central banks of the main advanced countries. It is no coincidence that the term ‘QE infinity[7] has been used.

The second quarter of 2020 was no different (see graph). But each time the stakes, and the risks, get higher[8]. With the arrival of the Coronavirus meteorite, which caused the fastest and deepest recession in living memory, the Monetary Authorities were very quick, in the two central weeks of March, to orchestrate an intervention of exceptional intensity and effectiveness, aimed at nipping market tensions in the bud (skyrocketing volatility and soaring spreads); at the same time, governments also intervened, for once in direct (and we shall see how temporary) support for household income and corporate liquidity. The market immediately took note of this and reacted accordingly.

Who will pay the bill, and how?

In the mid-2020s, a year that will go down in history, the impact of ongoing economic policy interventions in the major economies is far greater than in the 2008 – 2009 period. Fiscal initiatives alone imply an average worsening of budget deficits by around 8% in 2020, with estimates still very divergent (see charts).

Monetary policy interventions were the most rapid – more and more often now Central Banks are filling gaps in the responsibility and proactivity of governments – and the most significant in terms of size. The result of the coordinated activism of the major Central Banks (G3 countries) has made available to the market an increase in their balance sheet assets of some $4.4 trillion, or 10.7% of their countries’ total GDP. The net result is an increase in G3 central bank assets of 23% over the course of 2020 and corresponds to more than 3.5 times the global liquidity expansion experienced at the time of the Great Financial Crisis. In addition, the Monetary Authorities are ensuring that interest rates will remain at zero for what market participants see as an infinite amount of time. [9]What alternative do institutional investors and their private clients (who belong to the highest fifth percentile of the wealth distribution) have but to pour a flood of money into ETFs [10]representing the major stock indices that then trickles down to the riskiest and least liquid assets?  

The combined effect of the growth in central banks’ balance sheet assets and the surge in the private prudential savings rate is causing the greatest expansion of liquidity in recent history (see graph). This liquidity, in one way or another, continues to flow to the financial markets and stagnates there, encountering countless obstacles that prevent it from flowing to the real economy. [11]

The objective of reflating the economy, so dear to the Central Banks as to be unrealistic, is moving further and further away, and is only having an effect on financial asset values. Real inflation, assuming and not conceding that it is a desirable objective (once the genie is out of the bottle it becomes uncontrollable), will start with the direct monetary financing of public deficits: we will get there, sooner rather than later, when savers understand that investing in government bonds, with increasingly negative real yields, has become the classic trap for frogs immersed in the pot of cold water on the cooker.

Here and now: the immediate market outlook

The perennial battle between the bulls and the bears became fiercer in June, with volatility remaining fairly high (VIX stable above 35). As always in recent years, the cyclical “value” sectors’ attempt to recover seems to be already losing steam.

On the other hand, the improvement in the performance of European markets seems to be more solid than that of the US, despite the stainless momentum of the technology sector. Uncertainty also conditioned the movements of other reference assets: the dollar, after a brief period of weakening, stabilised at 1.12 against the euro; gold continued its moderate positive trend; oil stabilised, pending positive news on the demand front, while currencies and bonds of emerging countries remained chronically weak.

The trend in the main risk-off indicators, US treasuries, continued to signal the expectation of an uncertain economic recovery (30-year yields fell further from 1.6% to 1.4% over the month, while 10-years returned to the 0.6% zone, with implied real interest rates expected to be between -0.8% and -1%). The reliability of these indicators is extremely doubtful, for reasons already mentioned: prices are literally made by the Federal Reserve, which continually intervenes with words (“forward guidance“) and deeds (purchases on the market, including the junk segment).

Wall Street’s temporary stall reflects the dichotomy between nowcast indicators signalling a strong recovery in consumption, activity and mobility post lockdown and the still worsening medium-term outlook.

The gradual reopening of activity fuelled a sharp rebound in the coincident PMI indicators of economic activity in both manufacturing and services. The latest IHS manufacturing data from early July, very close to the 50 mark, which separates growth from contraction, even saw China and France surpass that mark.

In advanced countries, household sentiment indicators are soaring, not least because many jobs are only temporarily lost: immediate government support has had a positive impact on household incomes. However, uncertainty reigns supreme: as time has gone by, tempers have cooled as there is growing evidence that the pandemic is not yet under control, as outbreaks have rekindled everywhere, and as infections have surged in US Sun Belt states (see chart) and South America. About 40% of US households see the reopening process either suspended or reversed.

 The medium-term economic outlook remains hazy, but clearly worsening, and is subject to extraordinary variability compared to ‘central’ expectations.

The Monetary Fund has revised down its 2020 global growth forecast from -3% to -4.9% compared to April, with a recovery in 2021 of 4.8% (see graph). The World Bank “sees black”, with -5.2% followed by +4.2%. The OECD is even more pessimistic: in the base scenario it estimates a 6% squeeze this year, followed by a 5.1% recovery; in the most negative scenario,

which foresees a second pandemic episode at the end of 2020, global economic activity would contract by 7.6% this year and remain well below pre-crisis levels at the end of 2021.

It remains to be seen how reliable the estimation models used (essentially the same for everyone) are in the face of an exogenous shock of this magnitude and the truly impressive reactions of policy makers. The impression is that the peak of pessimism has been reached, and that the ex post outcomes will be less catastrophic than is currently expected.

The markets, given the apparent valuation levels[12] (opinions differ as always), seem to be discounting a rather rapid recovery. This scenario would see economic activity recovering to the pre-covid level expected by the end of the year and profits more or less fully recovered by the second half of 2021. The alternative scenario, the one espoused so far by most international institutions, sees these targets pushed forward by 12 or even 18 months.

All in all, the guidelines proposed in recent months remain sustainable.

The preference for equity exposure, sustained mainly by the stimulus provided by policy makers (which will regain vigour and brutal incisiveness if a possible resurgence of the pandemic were to occur) remains valid, especially in the absence of credible investment alternatives, but greater caution should be exercised in view of the greater risks that characterise the US market, which remains the main global benchmark.

Washington and Wall Street: dangerous relations.

First of all, the medium-term economic outlook could worsen further due to the pandemic, which is out of control in the southern states: according to the OECD, US GDP will fall by 7.3% (8.5% in the worst scenario) in 2020, with a recovery of 4.3% (1.9%) in 2021. These expectations are much worse than in April.

Then there is the issue of the glaring asymmetry that now characterises the main Wall Street indices, dominated by the capitalisation of a very few digital multinationals (see graph). How long this situation, in some ways aberrant, will last remains a mystery. The absolute prevalence of the sectors that represent the present and future engine in terms of technological innovation and the ‘green’ revolution is justified, but the measure has been exceeded.

In proposito citiamo testualmente un noto analista di borsa statunitense che, di recente, ha ben rappresentato i possibili (dicotomici) sviluppi: “Last Wednesday, the Nasdaq composite exceeded by 2% its pre-Covid-19 high of 9817, set on February 19, but then fell back sharply. If the Nasdaq now rebounds above last week’s 10,000 level, history suggests that the bull market will resume, and many more intrinsically worthless companies will soar to unimaginable heights. If, on the other hand, the outbreak of madness on Nasdaq turns out to mark a double top, the post-Covid equity bubble could deflate very quickly and the next big event for investors could be a test of the March lows. Which will it be? I have no idea, but I am pretty sure that market psychology, rather than monetary policy or economic data, will decide the answer”.

However, the speed of recovery and technical market issues are likely to take second place to political events: the presidential elections are fast approaching, with Trump about 14 percentage points behind Biden in the polls. In the coming months we can therefore expect all kinds of things from the outgoing president, on his favourite battlegrounds: the leading rhetoric at home, focused on the mantra “low & order” and that of continuous international provocation, with the focus of the crosshairs this time on Europe, without neglecting China and the border countries. The first steps have already been seen: the Administration has suspended negotiations with the EU on the Digital Tax Plan and blocked any attempt at tax reform that might affect digital multinationals, threatening retaliation if the EU goes ahead. Meanwhile, Washington is considering new tariffs worth around $3.1 billion on a wide range of products exported by France, Germany, Spain and the UK, in retaliation to EU subsidies to Airbus. With China, it is thought that Potus may throw out last year’s agreement and raise tariffs again.

Apparently the Wall Street bosses, who love continuity, especially when it is pro-big business, are hoping for a second term (however dangerous it may turn out to be). The Biden alternative, assuming he keeps his promises (which is always doubtful) and has a majority in the Senate, could be “punitive“. It is hard to imagine that a democratic president would not intervene to try to contain if not reduce the great advantages accumulated by one per cent of the population over the last thirty years and the oligopolistic power of global corporations. Significant fiscal interventions will be necessary both for corporations and for the wealthiest, also to contain the budget deficit that is estimated to be between 13 and 16% of GDP in 2020.

In conclusion, despite the Federal Reserve‘s relentless activism, US markets may be less attractive to international investors than in the recent past.

Brussels, safer port?

Against this backdrop, a rebalancing towards European assets (in addition to Japan and the Asian tigers) is appropriate and is already under way, supported by recent economic trends and the recovery of credibility of European institutions. While it is true that medium-term expectations are still negative[13], the balance of power must also be

tipped towards the much improved economic data and the management of the pandemic, which is much more efficient and less erratic than in the US. But the decisive factor is the signals coming from Brussels and Berlin. The European institutions have finally shown a surprising capacity to react, thanks to Chancellor Merkel‘s turnaround, by defining how the ESM is to be used and, above all, by approving the “Next Generation EU“, a maxi plan for recovery worth 750 billion euros, 500 billion of which in the form of contributions and 250 billion in loans. The Fund is linked to the new EU budget 2021-2027 (the “multiannual financial framework”), which has a total scope of 1,850 billion.

However, the European Commission’s proposal was not unanimously approved by the 27 member states at the EU Council meeting on 18-19 June due to opposition from the ‘frugal countries’. It was decided to postpone everything until mid-July. In spite of the difficulties, the impression is that, with the agreement of France and Germany, the Recovery Fund could get under way and that it could represent an epoch-making turning point, the birth of true European budgetary sovereignty.

We will see, in mid-July, how it will end.

Milan, 2 July 2020

Enrico Ascari                                        

Quantyx Advisors S.r.l. Via Valera 18/C 20020 Arese (MI)

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[1] As has always been the case in the past before the subsequent bitter acknowledgements.

[2] LTCM’s principals included Robert Merton and Myron Scholes, who were awarded the Nobel Prize for economics in 1997, as well as a number of leading figures from the Salomon Brothers bond house.

[3] Except Lehman Brother, who refused to participate and perhaps paid the price ten years later.

[4] It then became fashionable to use the periphrasis ‘Greenspan put’ to indicate the then Fed Governor’s propensity to intervene to ‘save’ the markets (the ‘put’ was first activated with the 1987 crash).

[5] The acronym TMT stood for technology, media, telecommunication.

[6] The Anglo-Saxon specialist press shamelessly spoke of the ‘end of the market’ and the ‘death of capitalism’.

[7] If the Central Banks’ purchases of securities at maturity are renewed and subscribed to an increasing extent, with a continuous growth of the balance sheet assets, they are in fact “printing money” in a covert way (subscribing to increasing shares of securities issued by the Treasury).

[8] This is also because for years now, the players have been eating their leaves and the golden rule for winning on the stock exchange has become that of buying on every downturn (even if the timing remains difficult to interpret).

[9] “We’re not thinking about raising rates. We’re not even thinking about raising rates,” Fed Governor Powell recently said, certifying that at least until the end of 2022 interest rates will remain on ice.

[10] It should be noted that these instruments are increasingly issued and managed by global asset managers (Blackrock, Vanguard, Fidelity, etc.), who have by now consolidated an oligopoly that also indirectly exerts an enormous power of conditioning on the US Administration.

[11] It has to be said that expanding economic sectors require high knowledge rates but low capital intensity. The picture may change in the future if the expected large-scale infrastructural interventions and the green conversion of fossil fuels take place.

[12] The graph on the left shows a scenario of the expected earnings performance of the S&P 500 in a historical comparison; the graph on the right (source: Goldman Sachs) shows a historical comparison of various valuation metrics to demonstrate that the US market is overvalued, but not to an alarming degree.

[13] For the ECB, the Eurozone’s GDP is seen as falling by 8.7% in 2020 followed by a recovery of 5.2%, for the IMF it is -8%; the OECD, in the base scenario, assumes a fall of -9.1% in 2020 followed by a recovery of +6.5% in 2021; in the worst scenario it is -11.5 and +3.5%. Goldman Sachs is not far behind, hypothesising -11% for the EU, France, Spain, Italy between -13 and -14%, and Germany at -9%.

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