9 Jul 2020
In isolation, Q2 was quite good for stock markets. But in the context of what happened in Q1, we are still in the mire with our Wellington boot just out of reach of our hovering, stockinged foot. The FTSE 100 rose by 9% but is still down 17% year on year. The FTSE 250 recovered by 14% in Q2 (having been down 31% in Q1) but is -12% year-on-year. As usual, the All-Share was between the two.
It seems fair to say that we are no wiser about the probable economic outcome of the pandemic though we can see that there is a consensus that central banks can print any amount of money on the single condition that they don’t admit that that is what they are doing. In the US it is more explicit because it is more acceptable to say that anything large is too big to fail when it would involve the loss of large numbers of jobs. Even if you are not seeking re-election as President, it is hard to argue against that.
The response to Covid-19 is becoming highly political in the UK, despite there being no general election scheduled until 2024. Mass unemployment cannot be deferred indefinitely, even by money printing. Everyone must know this but no one wants to say it – governing politicians are terrified of hard truths unless they can be floated under a halo of brave sacrifice and oppositions bide their time until they can feign shocked surprise at how badly things turned out.
So we are left with a pretend future funded with pretend money.
Pretend money is far from being just a UK phenomenon.
The euro was infamously pretend money before the financial crash. Greece, Italy etc thought that they could borrow extravagantly but cheaply because their euro liabilities were implicitly guaranteed by the ECB. Kyle Bass, who, in around 2008, took long positions in German Bunds matched against shorts of Greek government bonds, called it the greatest asymmetric trade of all time.
Eight years ago this week, Bunds yielded 1.5% and their Greek equivalents 26%. The spread between the two was 24.5% having been around 0.5% when Bass took his position. The euro itself was regarded as under threat and Greece was being urged (sensibly, in my view) to default on its euro debts and to reissue the drachma.
Today, the pressure to rescue the euro area as a whole appears to be overcoming the resistance of even Germany. The premium of Greek yields over Bund yields had fallen to 9% by 2016 and today is back to 1.5%. (Bunds have a negative yield of -0.4% and Greek debt a positive yield of just 1.1%). We are almost back to the pre-crisis days where one man’s euro debt is as good as another’s.With one important qualification: in 2007, Greek’s debt to GDP was seen as unsustainably high at 103% whereas today it is over 180%. But luckily, it’s only pretend money.
Stock markets look like dark and confusing places. Most companies have been trying to maximise their chances of survival over a period of wrecked revenues of unknown duration. That’s good as far as it goes but it’s hardly an inducement to invest other at some of the stupid prices that were offered in March.
But there are a few reasons to be invested in shares – a) cash and bond alternatives offer terrible value barring an extended period of deflation; b) at some point inflation could return (as it traditionally would in a world of pretend money) and shares prices are susceptible to inflation too: c) all the gains of the last ten years that have been made in reducing income inequality will be lost to a serious recession. But the growing inequality of wealth fuelled by QE over that period is likely to continue and even accelerate. Owning assets, including and perhaps especially shares is likely to be crucial to financial well-being.