Liquidity is good for gold and mega-cap stocks
Yvan Berthoux - 30 July 2020
In the past few weeks, sell side institutions have shown interesting charts looking at the performance of the top 10 mega-cap US stocks and the ‘bottom 490’. While these titans are currently trading at comfortably higher values than their respective February peaks, the stock prices of the remaining 98 per cent of the S&P 500 have gone nowhere since April and are still currently trading at a 15 per cent discount relative to their February highs, on average. More importantly, the percentage of stocks whose prices have halved, or worse, in the past year has increased from less than 1 per cent in 2019 to nearly 6 per cent today, implying that a rising proportion of stocks are clearly in a bear market. For how long can the divergence between the mega-cap stocks and the ‘bottom 490’ persist?
As a response to the Covid-19 crisis, central banks have flooded the financial markets with liquidity in a bid to avert a deflationary depression. Figure 1 shows that the annual change in the G5 central banks’ assets reversed from a decline of USD 1.5tr in March 2019 to an increase of nearly USD 5tr in June 2020. The massive liquidity injections, combined with the rising economic and political uncertainty, created strong support for the gold price, which has shown a strong correlation with the change in G5 global assets in recent times.
The paradox is that US mega-cap stocks have attracted investor flows despite the risks posed to their valuations from the abandonment of monetary and fiscal disciplines. Equity markets have typically de-rated violently during deep recessions and whenever inflation risk is elevated, as now. Yet US ‘growth’ stocks have been co-beneficiaries of central bank liquidity injections, year to date, dragging the overall US equity index back to dry ground.
While many economists have argued that the level of equity valuations seems extremely stretched, given the current state of the economy and with a significant portion of jobs at risk for the coming 12 to 18 months, many others contend that ‘this time is different’. They have sought to redefine the likes of Amazon as defensive investments – even utilities – as consumers have migrated to online services out of necessity during the pandemic.
The test of this hypothesis is coming soon, as the gushing flow of emergency cash payments to individuals is destined to slow to a trickle. Can the tech giants continue to deliver growth – in earnings as well as sales – while the global economy languishes under the strain of adjustment post-Covid-19? It is difficult to turn completely bearish on equities while central bank liquidity is lubricating the financial system: betting against the US stock market could be a painful trade. However, the proposition that the mega-cap stocks are impervious to macro forces is soon to be stress-tested.
Data source: Eikon Reuters, EP calculations
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