Home Business NewsBusinessBanking News Markets rebound strongly as the real economy worsens

After the market carnage that took place last month, April has been much more upbeat and optimistic, certainly according to financial markets.

The “kitchen sink” approach taken by central banks where they have embarked on unlimited QE and will purchase every financial asset they can get their hands on, has led to a continuation of the risk asset rally that began at the end of March.

This 10-15% rally across most equity markets has caught many cautious investors off guard and left them questioning whether the worst is really over and if the global economy can get back on track as lockdowns begin to be relaxed.  Has the FED truly managed to save the world again?  Or have they just broken the markets beyond repair?

Those with one eye on the commodity space, particularly oil, might be inclined to say the latter.  On April 20th, we witnessed something that most market participants didn’t know was even possible, Oil prices went negative reaching MINUS $37 per barrel.

That’s correct, you could buy barrels of physical oil and get paid for it!  This was the first time in history that has ever happened and was due to a major imbalance in the WTI Crude oil futures market and a shortage of storage capacity in the US (Cushing Oklahoma to be precise).

The technical breakdown of this market was a symptom of the extreme oversupply in the oil industry as demand for any products derived from crude oil has evaporated due to the pandemic causing a complete shut down of global economic activity.

As a result, crude oil inventories have been increasing at staggering rates leaving producers, who are already operating at reduced capacity, with nowhere to store the excess barrels.  With oil prices being as low as they are now, most US shale producers are at risk of bankruptcy which would lead to even more job losses.  So far since the crisis began, approximately 25 million people have been made unemployed in the US alone and that number is likely to get worse.

We are currently experiencing the deepest and quickest economic downturn in history (including the 1930s).  A great deal of damage has been done across all sectors of the global economy, some of it irreparable, and the lifting of lockdowns is unlikely to trigger a speedy recovery despite what some overly optimistic analysts are saying.

The bullish sentiment that has buoyed markets has come from the fact that coronavirus new case counts seem to be slowing down in most major economies which was a necessary condition to even think about removing lockdowns.  Also, healthcare systems have not been overwhelmed as some had feared and there are some positive test results regarding potential treatments for the worst affected patients.

Additionally, most discretionary money managers had de-risked their portfolios in March making the so called “pain trade” a violent move higher.  Retail investors have been quick to buy the dip in their most loved tech stocks which seem to have been somewhat “recession proof” based on their recent earnings results, leaving the Nasdaq index a mere 8% from its all time highs.

Finally adding fuel to the fire has been the CTA community with its systematic and rules based approach to trading and trend following which is forced to buy the market as it goes higher, chasing positive stock price momentum.  Overall it is clear that the stock market is not reflecting the harsh economic reality of this downturn and the main reason for this is the joint monetary and fiscal policy response that has pumped around $10 trillion back into the market to “plug the hole.”

Personally, I think this is setting a terrible precedent and exacerbating the moral hazard issues that the easy money policies of the last decade have created.  Does it make sense that corporations who over-leveraged themselves due to artificially low interest rates and used the money to buy back stock, making shareholders and directors fortunes, should be able to get bailouts funded by the taxpayer and future generations?

All of this while small businesses, who employ the majority of the workforce, struggle to get support to survive due to the red tape and bureaucracy of the system.  It concerns me deeply that when this is all said and done we will find ourselves with even greater wealth inequality along with massive infringements on our personal freedoms through open technological surveillance which again will benefit large corporations who can use or access the data for profit. The 1% that own assets will have their wealth preserved whilst the rest are left with fewer jobs, higher costs of living and a mountain of debt for them and their children to pay back as future taxpayers.

On a more positive note, the blatant debasement of fiat currency, zero to negative yields and the ominous economic outlook all provide the perfect environment for Gold and a huge opportunity.  This age old form of money and store of value should over the coming months and years move towards its fair value which I believe is ever increasing and multiples of its current price.

The main reason why it has not had explosive upside moves until now is that the USD has been holding a bid due to its reserve currency status and a massive global dollar shortage, particularly in emerging markets.  Once confidence in the USD eventually breaks, which at this point seems inevitable, the yellow metal will most likely see some quite incredible returns, similar to the 1970s.

What is so surprising is how under-owned this asset class is by institutional investors given the inflationary policies of world central banks.  Now that bonds are unlikely to provide the diversification that they have in the past and volatility is no longer “cheap”, this undervalued asset could provide the hedge that most portfolios so desperately need for an uncertain future.

Many veteran macro watchers have been calling for this bear market rally in stocks to end soon and are drawing parallels to previous sharp sell offs and rebounds, indicating that we have reached key technical retracement levels and so are ripe for a rollover in markets.

There is also speculation that the catalyst for the sell off to resume will be once lockdowns are actually released, as people will then realise that the restart to the economy will be much more laboured than is likely priced into markets.  Also the risk of second waves of the virus causing more havoc may need to be factored into future corporate earnings guidance.

The impact of massive unemployment and long lasting behavioural shifts will leave consumer spending weaker for many months, if not years. For me, it is no longer clear if stocks will retest or even break the lows to reconcile what is happening (and still likely to happen) in the real world against asset prices.

But if stocks don’t do the accounting then I think Gold ultimately will, when people lose faith in the value of printed currency in favour of sound money.  The history of money tells us that this path we are treading will almost certainly end with some kind of hyperinflation and that ironically will be much worse than the deflation we are so desperate to avoid.

Written by, Imran Lakha, Senior Advisor, Vector Capital Group AG & CEO and Founder of Options Insight, Financial Markets Training.

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