Omar´s Outlook - Feb 2020

Flying High

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Given the state of modern education, I presume that only the older readers would have heard the classic tale of Icarus, the ancient Greek hero who, having successfully made wings for himself from feathers and wax, in his hubris flew too close to the sun, which melted the wax and caused him to fall into the sea. The poor guy apparently could not swim, so he drowned.

I am being reminded of that story in the context of the current market situation. Seemingly, the sky is blue, without a single cloud there.

Complacency among market participants is off the charts and there seems to be a competition on just who can fly the closest to the sun – that is, to take on yet more risk and/or leverage.

New records are being set on an almost daily basis, and pretty much across the board, regardless of how fundamentally opposite the characteristics of these assets are.

Here is gold denominated in Australian dollars, now at all time record pricing (click to enlarge).

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Here is the domestic All Ordinaries index; at close to record high, despite a small stumble in the past few days, despite droughts and bush fires, and despite an economy so weak that while the RBA has set interest rates at an all-time low, yet it intends to cut again soon.

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Here is the proxy for possibly the most conservative asset class, the Australian government inflation-linked bonds (via the similarly named iShares exchange traded fund). The yield (interest) paid on these things is now only around 2% p.a. and yet the sector as a whole has appreciated by some 13.5% over the past 2 years, having recently set a record high.

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Over in the USA, the “mother of all unicorn stocks”, Tesla Inc, has doubled in value over the past 3 or so months. Its market capitalisation is now in excess of $100 billion (USD) and higher than that of Volkswagen, the world’s No 1 automaker.

This is despite the fact that Volkswagen delivered some 10.8 million vehicles in 2019, as opposed to Tesla’s 367,000, and despite the ongoing lack of consistent profitability.

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So given the economic backdrop, what is the reason behind all this madness?

The following two charts provide some explanation. They are US-centric, but can be applied pretty much anywhere in the developed world.

The first one shows the relationship between asset prices and major central banks’ initiatives (Quantitative Easing and similar programs), as compared to corporate profitability. It is easy to see that it is liquidity – that is, money printing – rather than economic growth, driving the bull market.

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The second one illustrates the disconnect between the US GDP growth and the net worth of US households. This is the “missing inflation” that the central bankers apparently cannot find.

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The problem here is that inflationary gains are not real. As the chart shows, they have a habit of reverting to the mean.

When will this occur? – Nobody can tell. But nothing lasts forever and we are now flying very, very close to the sun.