Don’t fight the Fed but don’t depend on it either

Investors will be smarting if withdrawal of stimulus knocks all assets at the same time

Karen Ward

Crisis or no crisis, the rules of the game have changed for investors.

Before quantitative easing, investors could rely on government bonds and stocks to work together, through the cycle, to reduce portfolio volatility. A central bank would cut interest rates when economic times were tough, the outlook for corporate earnings dismal and stock prices under pressure. As interest rates fell, rising government bond prices would typically bolster a portfolio damaged by falling stocks.

The relationship also worked in reverse. As the benefits of lower interest rates stabilised the economy and the outlook for corporate earnings improved, central banks could then normalise their policy rates. For equities, the prospect of stronger corporate earnings overwhelmed the fact that you were discounting them at a higher rate of interest.

In short, the inverse correlation between stocks and government bonds created a perfect symbiotic relationship, helping those investors with a balanced portfolio to sleep easy through good times and bad.

But with the advent of QE, the narrative has shifted. And the scale of that shift has become increasingly apparent during the pandemic, as illustrated by the Federal Reserve’s commitments in March and April to buy assets as far down the risk spectrum as high-yield credit.

The game has changed because the Fed is not operating under the same incentives as private investors. The darker the economic outlook, the more it is willing to buy. Its resources are, in principle, limitless.

An investor cannot “fight the Fed”.If few fund managers are complaining, that is because everything has gone up — stocks, credit and core bond prices.

Since the Fed’s major intervention in March, the 10-year US Treasury benchmark has provided a positive return of 1.7 per cent, while the US investment-grade index has risen 16 per cent and US high-yield by 21 per cent.

The S&P 500 stock index, meanwhile, has recouped almost all its losses in the year to date.

Investors may be less happy when central banks try to turn off their monetary taps. If the data keep coming in better than expected, as happened last week with the June US jobs report, then central banks should be in retreat.

I am not talking about raising rates or even selling assets back; I am talking about shifting from “emergency” policy to “accommodative” policy — from fully opened taps to a more moderate flow. What happens when policymakers signal that new asset purchases will be scaled back?

We have already had a glimpse of what is in store. At its last policy meeting, the Bank of England announced it would slow the pace of its purchases. The news did not go down well.

Gilt prices fell on the day, as did UK stocks.

For global markets it is the Fed that matters. The minutes from its last meeting, released last week, suggest the central bank realises it needs to shift away from its current guidance, which can be paraphrased as “whatever it takes for as long as it takes”.

That message is too ambiguous. Investors are left combing through the weekly purchase report to gauge the Fed’s appetite and intent for different segments of the market. At a minimum, the central bank will have to be clear whether its credit purchase programme will end on September 30, as indicated by the current schedule.

There is some speculation that the Fed will lock the taps on, committing explicitly to capping borrowing costs through a policy known as yield curve control. But what if it does not?

Given the new rules of the game, investors should start to consider the implications of a change in the monetary tide. I would suggest two key points of focus.

First, do not assume you will be able to offload assets at the central bank indefinitely. Be comfortable with what you hold.

Own the credit and stock of quality companies with manageable levels of debt, good prospects for earnings and those that screen well on sustainability criteria.

A purely passive approach to investing may have served its purpose so far. What happens when the tide recedes remains to be seen.

Second, seek shelter in assets that have been less influenced by central bank liquidity. Even the most diligent investor will be hurt if a shift in monetary policy weighs on the price of government bonds, credit and stocks at the same time.

In my view, investors should consider looking beyond public markets to areas that, given their illiquid nature, have been relatively insulated from central bank distortions.

Asset classes such as infrastructure and real estate should serve as ballast to a portfolio.

Grudgingly or not, investors must accept these new rules.

There is no point fighting the Fed. But you cannot rely on it either.

The writer is chief market strategist for Emea at JPMorgan Asset Management

Keep the Geeks in Charge of the Internet

By enabling people and businesses to remain connected while under lockdown, the Internet has helped to prevent the global economy from collapsing entirely. And yet the engineer-led nonprofit organizations that oversee the stable functioning of the global Internet are again under attack.

Fadi Chehade

chehade2_Getty Images_digitalinternetglobesecurity

LOS ANGELES – The coronavirus pandemic has rapidly transformed the Internet into the most critical infrastructure on Earth. By enabling people and businesses to remain connected while under lockdown, the Internet has helped to prevent the global economy from collapsing entirely.

Indeed, with fear and social distancing continuing to separate many of us, it has become the connective tissue for much human interaction and economic activity around the world.

The worse economic fundamentals and forecasts become, the more mysterious stock-market outcomes in the US appear. At a time when genuine news suggests that equity prices should be tanking, not hitting record highs, explanations based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics can shed some light.

But few appreciate how this critical global resource has remained stable and resilient since its inception, even as its scope and scale have undergone uninterrupted explosive growth. In an age of widening political, economic, and social divisions, how has the “one Internet” connecting the entire world been sustained? And how can we best continue to protect it?

The answers to both questions start with understanding what makes the Internet – which consists of tens of thousands of disparate networks – look like and function as one network for all. These components, or unique Internet identifiers, include Internet Protocol (IP) addresses, which are associated with every device connected to the Internet, and Internet domain names (like,, or, which we use to search for and connect to computers easily.

These unique identifiers ensure that, no matter where you are or which network you are connected to, you will always get in touch with the right computer with the desired domain name, or reach the right target device with an embedded IP number (such as a smart thermostat, for example).

This simple, elegant architecture reflects the genius of a handful of brilliant engineers who created the Internet a half-century ago. Since then, it has never failed to help us locate the billions of devices that have been added to the thousands of networks that make up today’s cyber economy. Should the identifiers fail, we would experience immediate digital chaos.

Given the identifiers’ critical role, it is imperative that they not be compromised or controlled by any authority that is not committed to maintaining the Internet as an open, global, common good. In the wrong hands, they could be used to fragment the Internet and enable top-down control of usage and users by governments with malign intentions. And such fears are real, given authoritarian governments’ online meddling in elections, national security networks, and digital commercial transactions in the last few years.

So, the key question is who should be entrusted today to maintain the security and reliability of Internet identifiers. The answer is simple: geeks, not governments.

The same engineers who built the Internet established nonprofit institutions, such as the Internet Corporation for Assigned Names and Numbers (ICANN) and the Internet Engineering Task Force (IETF), to take responsibility for the unique identifiers and maintain the Internet’s original ethos of openness. These and other institutions coordinate global efforts to manage the protocols necessary for the Internet’s stable and reliable operation, and the engineers who run them today do so with remarkable independence, precision, dedication, and humility.

The last major assault on these institutions’ independence came in December 2012, when a group of governments at the United Nations’ World Conference on International Telecommunications (WCIT) attempted to take control of the unique identifiers. This effort was thwarted thanks to the vigilance of democratic governments that valued the power of a single global Internet to foster innovation, commerce, and international cooperation.

But today, in the midst of the chaos caused by the COVID-19 pandemic, authoritarian governments are once again using the UN to try to seize control of critical Internet resources from engineers. During a recent International Telecommunication Union meeting, a proposal for a new standard for core network technology was submitted.

Regrettably, and more worryingly, extreme activist groups and democratic governments also are carelessly intruding on the work of these independent institutions, for example to police free expression on social media. For example, after Twitter attached a fact-check warning to two of US President Donald Trump’s recent tweets, he threatened that his administration would “strongly regulate” or close down social media platforms that he believes “silence conservative voices.”

Organizations such as ICANN and IETF have spent decades developing and refining consensus-based decision-making processes, involving inclusive and transparent “bottom-up” participation by engineers, businesses, civil-society organizations, and governments. The danger is that by subverting these institutions’ established procedures, official interference and lobbying will make them easy prey for authoritarian regimes.

Attempting to reshape from outside the decisions of bodies like ICANN, or to fuel the efforts of authoritarian regimes to shift control of the Internet to governments within the UN framework, contradicts the Internet’s original ethos and could be devastating for us all.

We must commit to safeguarding the resilient system that enables the Internet to function free of political interference or control. At a time when our physical and economic health are faltering in the face of a potent virus, protecting the independent, democratic, and transparent institutions that have dependably governed the Internet infrastructure since its inception has never been more important.

Fadi Chehadé, a former president and CEO of ICANN (2012-2016), is a member of the UN Secretary-General’s High-Level Panel on Digital Cooperation and an advisory board member of the World Economic Forum’s Center for the Fourth Industrial Revolution.

Here's What's Driving Gold Higher—and What's Next for the Gold Bull Market

by Marin Katusa

For the first time since 2011, gold traded hands above $1,800 per ounce.

Naturally, this has every goldbug and self-proclaimed expert on YouTube shouting from the rooftops.

Before we jump into what is going on in the gold markets, let’s first take a look at past bull markets.

Below is a chart that shows the previous major bull markets in gold. You will see that all but one of the major gold bull markets resulted in gold appreciating at least 400%. Using January 2016 as the low point for the current gold bull market, gold is up 69% from its lows.

History may not repeat itself, but it’s critical to understand what is driving the price of gold right now.

What is Driving the Gold Market Higher?

Right now, there are several major economic factors driving gold higher.

1) Large Government Stimulus Packages Around the World

This leads to currency devaluation. The global fiscal-policy response to the coronavirus is $9 trillion to date and likely to climb further. This is supportive of assets like gold, which are a store of value.

Below is a chart that shows the fiscal-policy response of major economies around the world.

The fiscal-policy response is illustrated as a percentage of the country’s GDP.

2) NIRP – Negative Interest Rate Policy

Around the world, central banks are cutting interest rates. Starved investors are clamoring for any bond trading with a reasonable yield. This drives bond prices higher and bond yields lower.

Low interest rates discourage investors from investing in government bonds and forces them to look elsewhere for safe-haven investments—such as gold.

Below is a chart that shows government bond yields around the world.

You’ll notice that Europe is nearly all red.

The combination of investors starving for yields and central banks’ NIRPs has driven most government-bond yields into negative territory.

The rest of the developed world is not far behind.

These low rates have driven the total amount of negative-yielding debts to levels we’ve never seen before.

In the past 5 years, global negative yield debt has soared from zero to over $12 trillion.

3) The Deflation and Stagflation Trade

I have written extensively about the weak productivity and GDP, high unemployment, and high costs of primary goods (food, water, shelter).

This type of economic environment incentivizes investors around the world to buy safe-haven assets, which are stores of value.

The International Monetary Fund (IMF) is projecting a deep recession and slow recovery.

In its most recent remarks on June 30th, the IMF revised its forecast for global GDP to -4.9%.

What is more worrisome is that the IMF forecast for developed nations is comprised of nations like the United States, Germany, and China.

The IMF forecasts they will contract by 8%. Also, the IMF projects that total business losses will be over $12 trillion.

Below are the 2020 projections for the gross domestic product of major economies.

Let’s not forget that Mexico is a very important trading partner for the U.S. There are many troubling signs in the market.

4) ETF Inflows Continue to Hit New Highs

Gold-backed ETFs have seen record inflows for weeks on end, as investors clamor for exposure to the metal.

As ETFs create new units, each of which is backed by gold, this requires the ETF to purchase more gold.

What’s Next for Gold?

I don’t see the Federal Reserve bank, or any other major central bank around the world, slowing the money printing presses.

Nor do I see any central banks of developed nations having the ability to raise interest rates.

This type of currency devaluation provides a solid, long-term thesis for gold.

I do think gold needs more time to consolidate in this upper range before making a sustainable move higher.

Could Silver Play Catch Up?

Using January 2016 as the start of this bull market, it is clear that silver has drastically underperformed gold.

The chart below shows silver is only up 30% from January 2016, compared to gold, which is up 67%.

This has led to a record diversion between the valuation of gold and silver.

And this is demonstrated by the gold-to-silver ratio.

Much to the chagrin of silver bugs, the ratio has continuously made new highs, meaning that gold is taking off—leaving silver behind.

In fact, I don’t think the gold-to-silver ratio is particularly helpful as an investment tool.

The gold-to-silver ratio reminds me of the oil-to-natural gas ratio of the mid-2000s…

For decades, the oil to natural gas ratio was fixed at 6 to 1 because the pricing was fixed on an energy equivalent basis.

The shale revolution changed that when in 2007, the shale produced so much gas that the ratio became irrelevant.

Silver is an industrial metal with some precious metal attributes.

Don’t forget there is very little primary silver production.

That means a lot more silver is produced as a by-product of existing mines.

Also, a slower global economy does not bode well for industrial metals.

Silver will do okay, but gold is where the action is and will continue to be.

How is Marin Katusa Investing in Gold?

I have spent two decades in the resource space as a professional fund manager and investor.

I make 99% of my income from investments within the resource space.

I’ll let you in on a simple formula for achieving big success in resource markets…

Here are two of my most important criteria:

• Management team quality and track record of success

• Assets located in +SWAP Line Nations.

A bad management team can screw up a good deposit.

On the other hand, a good management team possesses both intellectual and physical capital.

This allows it to create situations with exceptional upside and less risk.

My old rule was to avoid the AK-47 nations.

Those are nations where AK-47s are required to feel safe, both for traveling and as a local.

Having traveled to over 100 countries, I’ve strapped on the bulletproof vests and hired ex-military for security.

I avoid that now.

It might make for a good story, but in reality, it’s not worth it.

I’ve taken my thesis a step further during the COVID-19 pandemic, with my +SWAP and -SWAP Line Nations argument.

This suggests that nations with access to US-dollar SWAP lines will receive preferential treatment and trade agreements versus those without access to US-dollar SWAP lines.

I think this is a trend that will build over the next 3–5 years before coming to fruition.

Positioning yourself in the resource game requires more than throwing a dart at the board.

Buying an ETF like the Junior Gold Miner ETF will give you some exposure, but not a lot.

The sniper approach is simply the best.

The Real Test of Europe’s Banks Comes This Fall

Lenders face a rough second half as governments unwind the programs that cushioned the initial blow of the coronavirus crisis

By Rochelle Toplensky

Second-quarter results from Europe’s banks won’t be great, but it is in the second half that the sector faces its toughest test.

Lenders’ profits have already been crushed by the economic fallout of the global pandemic. Yet the true scale of the damage will only start to be revealed over the coming months, as European economies reopen and governments unwind some of their extraordinary support.

The U.K. announced a $38 billion stimulus plan this week to give businesses a boost as it rolls back its job-retention program between August and October.

European support programs, which contribute to the salaries of over 40 million furloughed workers in Britain, France, Germany, Italy and Spain, have so far prevented the kind of official unemployment spike seen in the U.S.

A pool of ready-to-go employees will help companies restart more quickly and has likely saved some viable jobs, but others will disappear. Insurer Allianz estimates that, of those 40 million, nine million are “zombie jobs” that will be gone by the end of next year.

That spells rough times ahead for Europe’s already struggling banks. Low interest rates and fee rebates have ravaged lenders’ second-quarter revenues, though some such as BNP Paribas and Barclaysare expected to report strong trading and capital-market earnings to compensate.

Allowances for credit losses will be up, but figures will be approximate at best. Wage-support packages and payment holidays are still cushioning the economic blow in many European countries.

Until they expire, banks can only guess the underlying level of personal and corporate distress.

In the second half, a deferred wave of defaults will likely take a sizable bite out of European banks’ meager profits.

Hardest hit will be banks with lots of unsecured consumer debt and those lending to troubled industries such as travel, discretionary consumer products and oil and gas. Barclays’ exposure to credit-card debt in the U.S. and U.K. could be a drag, for example.

European banks’ capital buffers—typically measured as the ratio of core Tier 1 capital to risk-weighted assets—will take a hit from both sides. Loan losses will reduce the core Tier 1 capital balance, while downgrades of borrowers’ credit ratings will raise the risk-weighting on loans.

Capital levels will fall and investors are likely to miss out on dividends for the rest of the year.

They might avoid additional capital calls, though: European regulators have been sympathetic and flexible in applying their rules in this crisis.

Returns on tangible equity are likely to be in the low single digits—far less than the sector’s 11% average cost of capital, as estimated by UBS —with few options to improve.

Interest rates will remain stubbornly low for years. There may be more costs to cut, even after years of restructuring. Digitizing additional services is a key lever, but requires investment and often takes time to deliver results.

Consolidation might help. Politics and a patchwork of regulation in Europe still make cross-border mergers very unlikely, but domestic deals could happen in fragmented markets like Germany and Italy. Even this may be difficult in the near term, though, as many banks don’t know what their loan books are worth, never mind the value of potential targets.

Bank investors might find little to cheer in the coming results season. Unfortunately, they’d best get used to it.