Optimists vs. pessimists

Chart of the week

The chart shows the cumulative money flows into the individual asset classes equities (dark blue), corporate bonds (light blue), government bonds (orange) and money market (blue) since 1918.  

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Why this is important

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Much of the money that was withdrawn during the Covid crisis and held in the money market or as cash is still parked there. Investors are still sitting on large amounts of money that can flow back into stocks or other investments, which would then lead to sharply rising prices.

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Optimists vs. pessimists

Rarely in the past have there been such two completely different camps when it comes to the future course of the economy and the stock market. As reported in one of the last blogs, on the one hand there is the camp of Michael Burry, who foresaw the financial crisis and the real estate crash in 2007 (played by Christian Bale in the film The Big Short) and on the other hand there is Warren Buffett, one of the most successful investors of all time. Michael Burry has sold all his investments and expects a strong collapse of all markets, Warren Buffett has bought massively in the last weeks.

We believe that the optimists are right, with a probability of 70%. The greatest uncertainty at present is the development of the war in Ukraine. Putin may offer a ceasefire at the next G20 summit, or there may be an energy crisis in Europe with a shutdown of entire sectors next winter. As we are in the optimists' camp, we are also fully invested, but are still cautious and prefer conservative stocks. We are therefore heavily overweight in value stocks. Make up your own mind about the situation.

Here are the arguments of the optimists and the pessimists.

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Arguments of the optimists

As the chart above (Chart of the Week) shows, investors are still sitting on large amounts of money that can flow back into equities or other investments, which would then lead to sharply rising prices.

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The chart shows the sharp rise in inflation in America since 2021 (black line). The dotted line shows the market expectations of most market participants, here using the example of the major US bank JP Morgan. Expectations are based on the assumption that commodity prices will remain at current levels and not increase further. However, many commodity prices (except oil and gas) have lost much of their value in recent weeks. Inflation could therefore decline even faster than many expect.

There is a lot of talk about higher prices due to supply chain problems. Such problems are difficult to measure, but one indicator is the transport costs for containers. These transport costs are reflected in the Baltic Dry Index. Transportation costs are practically back to pre-Covid levels. This is a clear indication that the supply chain problems are weakening massively.

The graph shows the number of economic indicators with positive changes (green) and negative changes (red). The market, as well as economic development, does not go up or down in a straight line. There are always fluctuations. Only in the 3 extreme cases (bursting of the dotcom bubble, financial market crisis and COVID crisis) we had bigger negative values than today. Many have been carried away by the current negative wave of economic news. However, a rebound is more likely than a further decline.

We already showed this chart at the beginning of August and the values have not changed much as of today. The chart shows the positioning of institutional with futures. The last time so few large investors bet on rising stock markets was at the peak of the Covid panic. Fears are greatly exaggerated, and the chart shows that many large investors are underinvested. By definition, a market crash can only occur when investors are overinvested and too carefree.

Arguments of the pessimists

The most reliable indicator that a recession is looming is a negative yield curve. Only twice in the last 50 years has the yield curve been as negative as it is today. In 1988 after the biggest stock market crash in history in 1987 and in 2000 after the dotcom crisis burst.  According to the definition of recession, two quarters of negative growth, we are officially in a recession in the U.S., but currently in a very weak one. The chart suggests a crisis like 1988 or 2000.

The most reliable indicator that a recession is looming is a negative yield curve. Only twice in the last 50 years has the yield curve been as negative as it is today. In 1988 after the biggest stock market crash in history in 1987 and in 2000 after the dotcom crisis burst.  According to the definition of recession, two quarters of negative growth, we are officially in a recession in the U.S., but currently in a very weak one. The chart suggests a crisis like 1988 or 2000.

Since interest rates began to rise in the U.S., growth companies have been suffering. Many companies that multiplied in value during the Covid crisis have crashed abruptly. Growth companies that have not yet generated profits and have to finance their entire business operations with loans have been hit particularly hard. The emblem of an investment strategy that invests in such values is the ARK Innovation Fund of investor Kathy Wood. It was the big stock market star in 2020 and 2021, but has now been almost completely disenchanted. The price development of the ARK Innovation Fund is strikingly similar to the price development of the NASDQ technology exchange during the dotcom bubble and crisis from 1998 to 2004. If this analysis is to be believed, the stock markets will not start to rise again until mid-2024.

Since 1980, interest rates have only ever trended downward. Since 1988, they have been below the average price over 120 months. The last time interest rates were above this average, there was a veritable interest rate explosion. Will that happen again this time?

The chart shows an overview of inflation figures in Europe. Such high figures have not been seen for decades. Inflation is not only a consequence of the Covid crisis and the war in Ukraine, but are based on a 15-year cycle in commodity prices, whose rise has only just begun. Hence the pessimists' slogan: inflation has come to stay.Is the glass now half full or half empty? Let us know what you think.

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