Konrad Kopacz No Comments

It’s the end of summer and the long sunny days are quickly dwindling away. As we enter September, children are getting ready to go back to school and many adults are getting ready to go back to work. Life has changed in the last 6 months and now we await to see if the original projections of a second wave are going to come to fruition.

Source: Quotestream

 

Before getting into the details let’s take a look at the COVID-19 updates. While many thought by the end of summer we would have seen a drop in cases, that has not been entirely true on a global stage. Global cases stopped accelerating at the end of July at around 250,000 – 270,000 new cases a day. Still, in September we are still around those numbers, so from a positive outlook, at least we have flatlined. This has been mostly attributed to the increase in cases from the countries that were later to the game. India, for example, is still accelerating, they have recently contributed 91,000 cases a day alone which is about a third of the global cases. Let’s hope they can get their situation under control soon. Below, is a graph showing some selected countries with their peak cases and their current 7-day average.

The numbers have come down in the countries that first experienced the outbreak and now these countries have begun to reopen. However, there will most likely be an increase in cases in the coming months, but the big question will be how fast will cases accelerate? Only time will tell but for the purposes of this article, the bigger question will be whether or not businesses close further hurt an already fragile economy.

Moving to the economy, we currently are still stuck in the “first wave” hangover and we are not 20 years old anymore. Unemployment in the US and Canada remain high at 8.4% and 10.2% respectively, but the improvement from the peak is dramatic. Both are about double what they were in February at this point but as long as they continue to drop that will be taken as a positive by the market. With so many unemployed, all eyes have turned to the real estate market and the question of how these unemployed individuals are going to be able to pay their rent and mortgage payments. In the last 6 months, they have been protected by government paycheques and tenant protection by the governments, but that will not last forever and we will need to see employment come back around the time the free money runs out. In Canada, that date is October 3rd, 2020, and in the US that is currently unknown as the Democrats and Republicans refuse to budge with the upcoming election. So, once again we are stuck in a wait and see but, with all this uncertainty how is the market continuing to push to all-time highs?

To start, the market is being pushed to all-time highs mainly because of one thing: Government Stimulus. This has been discussed numerous times this year and continues to press on. These stimulus packages that the governments have passed are like nothing ever seen before. This is not just the cheques individuals receive in the mail but also the government loans for business, bond purchases, bad debt guarantees, almost zero interest rates, etc. This has been an unprecedented amount of money the governments have come through with. In the US, the packages so far have been estimated as high as 29% of their 2019 GDP. This is a massive number, considering that looking at 2020 as a whole, the US is expected to be down about 6% in GDP. We are not mathematicians but those numbers don’t really add up. One of those largest factors would be the drop in interest rates and the notion that they will keep them low for a very long time. Not only does this make lending almost free this has an amplified effect on the stock market, this drastically moves up the price you would pay to earn a dollar. If $100 in a savings account earns $0.25 a year, then what you would pay to earn $0.50 goes up and what you need to pay for $1 goes up even further. This has led to massive valuation upgrades to the entire market and why companies like Apple are worth over $2 trillion dollars when they earn about $56 billion in profit a year. Or in simple math terms, paying $2,000 to earn $56.

While we are feeling the pain in the real world the market is not really reflecting that pain and even though there should be volatility going forward the market may still APPEAR strong as long as the governments maintain these policies. We have highlighted “appear” for a reason because there is a downside to all this government stimulus and low-interest rates, they will eventually have to pay it back. This payback has caused a devaluation in global currencies, but since everyone is stimulating we are not really seeing the effects of this. In order, to view it properly we need to compare money against tangible objects that store value. The best ones right now are precious metals and cryptocurrency. Below is a chart showing their values this year.

While there are many factors the 3 listed above have all seen a dramatic increase in value as price in US dollars. Part of this can be attributed to the massive amount of extra money in the world and what people are willing to pay for a base storage of value.

Now if we were to take the same storage of value table and compare it to the SP500 we can compare the indexes in terms of a neutral unit of value.

 

 

If we were to put the S&P 500 index in terms of a storage of value, the returns show a dramatically different picture than what we are seeing in US dollar terms. The market is showing a drop of about 17% relative to gold (storage of value), which would be a better indication of the actual performance of our economy. Shielded by the appearance of a devalued currency and expanded multiples the market looks great but factoring the new pricing it paints a slightly different picture.

Looking forward the market is showing signs of cracks as the fundamentals are not improving as quickly as investors would like and COVID-19 does not appear to be going away, coupled with a US election patience appearing to be wearing thin. There will be some very important events coming up that will determine which direction the market will take.

Second Wave Progress
This most likely will happen but to which degree and will the governments shut down businesses again. Most governments around the world are strongly against shutting down their economies unless there is a large scale break out. So barring an accelerated spread, it looks more likely that we will be operating similarly to our current state.

Vaccine and Treatment Progression
Some companies believe they will have enough data by October to determine how successful their vaccine trials have been. This means shortly after that they can begin mass distributing the vaccines and governments around the world are lining up to put in their billion-dollar orders for these drugs. While some will be better than others, there will most likely be some sort of vaccine before the end of the year. How successful or how harmful is still unknown but there will definitely be something and this might calm investors’ nerves around COVID-19 a bit.

US Elections
Biden started off with a staggering lead for the 2020 presidency, but Trump is slowly catching up. Right now polls give Biden the edge in 11 out of 14 “battleground” states, and of these states, Trump won 10 of the 14 in 2016. Trump will need to do some serious campaigning to win these states if he would like a shot at a second term. Some of the biggest issues have been Trump’s handling of COVID-19 and social issues, which have led to reduced support in the Republican voters. A Democratic victory would most likely be good for the market as they are trying to pass another $3 trillion stimulus package, which may help in the short term but the long term effects are yet to be determined. Next month we will take a more in-depth dive into the upcoming US Election.

Market Overvaluation
The first few days of September have already hit the stocks with the highest valuations and as investors have rotated into the beaten-down companies. This has occurred a couple of times already in this most recent rally, but until there are clear signs of economic progress while quick and violent this most likely will be short-lived.

Looking forward, the trends of the year remain intact and a stock market decline is not going to change that, the work from home trend remains intact until 2021, especially with the colder weather coming. The government stimulus and low-interest rates will remain accommodating for the foreseeable future which should keep valuations high and assets prices elevated. Real Estate is the biggest concern, but this has been a concern for 10 years and real estate prices in Canada are up 14% year-over-year already. Even with a 10% real estate correction, we would still be up 4% since last year, so we are not making any predictions of a housing crash with mortgage rates below 2%. There will be volatility going forward in the stock indices but this does present new opportunities, and we need to embrace it. We will continue to position portfolios in line with these changes.

Sincerely,

Konrad, Justin, and Merriel

More articles and information is available at www.lkwealth.ca

Source: BCA Research, Bloomberg, Reuters, Yahoo Finance, Trading Economics
Disclaimer: This newsletter is solely the work of Konrad Kopacz and Justin Lim for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.

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