Q3 2020 Review
In my Q4 2019 review I drew attention to the downtrend to new post 2008 lows in global growth, in terms of both trade volume growth and industrial production. This was the platform for the global economy, BEFORE anyone had to factor in the impact of the virus. Economic recovery depends on this preexisting downturn recovering, as well as the covid virus effects. I also highlighted 3 levels of crisis, all of which have accelerated in 2020.
In my Q2 2020 Review I pointed out the emerging two year trend in favor of gold relative to the S&P 500 index. While the gold-to S&P 500 Ratio was broadly stable in Q3, the scope for gold to outperform US equities remains considerable and this key relationship will likely remain a focus going forward. The chart below shows just one indicator suggesting this new trend has further to go.
The twin deficits, the sum of the US budget deficit plus the Trade Deficit, have exploded in 2020 to a new extreme far above the 2008 peak. There should be no surprise that there is strong evidence of a correlation between the twin deficits and gold relative to US stocks.
The video in the link above has around 30 additional extraordinary charts reinforcing the case for gold and precious metals. It is worth reviewing to get some perspective on the unprecedented environment that confronts investors today.
Think this is just a temporary situation that will soon blow over in a year or so?
John Mauldin tries to make some sense of the budget deficit implications. The CBO produces its own assessment but is forbidden from making adjustments that most analysts would regard as more realistic. The red line makes allowance for this and suggests that the budget deficit is likely to rise above $50 Trillion in the next decade. Doubling each decade is not far off what it has already been doing. That’s called exponential growth in a population that is not growing nearly that fast.
The trade deficit has widened to a new record low. Disturbingly this shows that most of the temporary supports have been spent rather than saved boosting imports, while exports have declined due to weak overseas demand.
Investors need to fully realize that these are extraordinary and unstable conditions. The magnitude and speed of these changes is far beyond our usual experience. Furthermore, the markets are reacting differently than ever before with new highs in the S&P 500 coinciding with a US recession for the first time ever. Corporate bond yields have never been lower while their debt levels have never been higher.
The Federal Reserve’s intervention in the bond market has created arguably the worst return for risk in history in corporate bonds, in order to support yet another wave of record corporate bond issuance as shown in previous notes.
The Federal Reserve’s interventions have already boosted their own balance sheets, along with other central banks, to new all time records, which has boosted the S&P 500 index to new all time highs.
The chart below shows the remarkable correlation between central bank activity and the S&P 500.
Policy makers have provided record stimulus to save the day in the short term, but we are still counting the cost and the long term damage. We also have to wonder what further damage these measures will have on the long term outlook. Lower interest rates combined with ever increasing debt and central bank balance sheet growth have consistently failed to generate long term growth improvements ever since 2008, as shown in previous notes. Doubling and tripling down may be all the policy makers can do, but dependence on consistently failing policy seems unlikely the resolve the issue.
Getting through unprecedented conditions requires some careful thought to keep perspectives straight and reach important judgements about whether these developments may be permanent or transient, mean reverting or increasingly unstable.
When the uncertainty is so unusual and extreme investors need to ensure their decision making process is as optimal as possible. The best practices of the “best investors”, with multi decade track records of success have rarely been more important than now.
My new book “Invest Like The Best. The Low Risk Road To High Returns” will be available shortly, and it makes several points about how to execute optimally for long term high returns. These operating procedures become vital in current unprecedented conditions.
Short term returns tell you very little and can be completely misleading. The great 3 year returns of once the world’s biggest hedge fund, LTCM, were wiped out in just a few months.
Investors are far better served by focusing on the key “best investor” metrics, which are risk measures and measures of return/risk, or alpha. The investment process is what counts over time.
Capital preservation together with returns that compound, are by far the most important long term performance characteristics. This can be measured in real time, so investors can know in time whether or not they are on the right track.
This is the key distinction between LTCM and the Medallion Fund, for example, which only had one minor loss in just one of 30 years and consistently compounded at a high rate of return.
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