Dear Investors and Friends,
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way – in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only”…
The famous line, opening one of Charles Dickens’ most comprehensive works and dating back 161 years, has never been reflecting current events more accurately than today. And while the author’s tale about two men in two cities that leads up to the French Revolution captures the spirit of 1789, the year 2020 may have just as much change in store for future generations to write their novels about. On New Year’s Eve, 2019, America faced one of its most prosperous times in history, with a stock market at an all-time high, record low unemployment for Americans from all walks of life, and GDP growth rates finally back on track at a pace unseen since 2008. The country had every reason to look optimistically to the future. And as the majority of the population went about their lives, the world as we knew it literally came to a standstill overnight. All of a sudden, Oscar Wild’s realization, “to expect the unexpected shows a thoroughly modern intellect”, could not have been more accurate.
With the arrival of the Coronavirus, governments around the world have been tailspinning into chaos and wreaking havoc on the global economy. Instead of taking responsibility, analyzing the problem, and addressing the issue in a scientific manner, based on research, numbers, and previous experience in dealing with Coronaviruses, political leaders acted like headless chickens and gave-in to an overall pandemic-panic. A panic that has been caused and fed by a media machinery that had decided to broadcast the global spread of the disease nonstop, turning it into twenty-four-seven “headline news”, and reaching out to every single household for every minute of every day. Not a new phenomenon, but certainly unmatched in its intensity due to today’s technology and social media, exposing humanity to a news cycle like we have never experienced before. And while there are legitimate risks caused by the spread of this latest Coronavirus, it had become quite clear quite early that the vast majority of the population had not much to fear, other than the same symptoms that relate to the flu or the seasonal cold and which typically resolve within two weeks. But instead of preparing a forceful and targeted response that would have focused on protecting those who were most at risk - mainly the elderly population and those with existing underlying conditions - governments around the world made a choice to go into complete lockdown, the most extreme measure possible and quite an unsophisticated “one-size-fits-all” approach. A measure that turned out to be as naïve as it was unpractical in a globalized world. And as we know today, the lockdown has caused unprecedented damage to the global economy. It is going to take a long time for most countries to recover from the political outfall of this crisis that has caused destruction across the board and deteriorated the livelihood for millions of people around the globe.
Looking at the economic and political landscape, even before the Coronavirus hit, it has become evident that we had been dealing with two extreme long-term scenarios; on the one hand, the awakening giant with China in the east, and on the other, a slowly declining superpower with the United States in the west. In-between, we find a whole patch-work of different western countries that all have developed some sort of a social welfare state, to different degrees and intensities, while many emerging markets in the Asia Pacific region have indeed emerged and become some of the world’s fastest growing economies, resembling a free market system that can hardly be found anywhere else anymore. Interestingly enough, many of those countries have left their communist or socialist past behind and base their economic success on a system that much more resembles the original format of capitalism than what we find in most of our developed economies, including the United Stated; the cradle of free trade in the capitalist world. Especially China, while still governed by totalitarian rule, lately has adopted many free market principles unheard of before. What we are looking at is a geopolitical change that will be developing a new world order at an even faster pace after Covid-19, as it seems that he pandemic has turned even formerly reliable western strongholds of entrepreneurship, backed by a reliable legal system, into economic wildcards. The shut-down of economic activity has destroyed thousands of businesses, lead to millions of people being unemployed and ruined whole industries in an unprecedented fashion. In many cases, the outcome reads like a final blow to many countries that already found themselves in economic disarray before the crisis. And while western governments had been interfering in their economies by means of monetary policy, to “afford” the privilege of a welfare state for decades, the scope of government intervention had never been at a price tag as expensive as the response to the Covid-shutdown has become. Even though the cause for government intervention is often rooted in good intentions to solve a current problem, it almost always creates new and unforeseen future issues. Such scenarios have been created throughout history and ultimately become known to the world as bubbles when they burst, leaving chaos and destruction behind. From the Dutch tulip bulb market bubble in the 1600s to the housing crisis in 2018, it has been happening over and over again.
Today, we are facing another such bubble which is the global monetary system and its decades-long creation of FIAT money by central banks, allowing governments to spend their way out of crises – or so they believed. In light of the most recent current events however, investors have come to the realization that the trillions in taxpayer money additionally spent in response to this latest crisis, combined with a lack of underlying tangible value, rapidly declining economic activity, and an evaporating trust in government are likely to trigger out of control inflation; a very real future scenario.
And while it is fair to say that most countries are guilty of having mismanaged their budgets for many years and fed into the monetary bubble through expansionary monetary policies, the buck stops with the United States, home of the world’s reserve currency. The latest downfall of the largest single economy is going to have a severe impact on global wealth and GDP growth for years to come. And the country not only faces economic hardship in a way unheard of in almost 90 years, it also needs to address even greater damage done to its political credibility and leadership at home. With social unrest and lawlessness having spread from coast to coast, and with state and local governments issuing new laws by executive orders without adhering to legislative due process, a legal system with equal justice under the law is in jeopardy. Furthermore, by not having protected private property during multiple riots across the country, distrust and uncertainty in the business and investor community have grown exponentially. Every economist and legal scholar knows that the protection of private rights and property is paramount for a functioning, free society. Needless to say that such domestic policy issues in combination with a severe economic downturn and out-of-control government spending have diminished hopes for a resilient recovery and put the future stability of the U.S. dollar at risk. As of 2019, it had taken the American Republic little less than 250 years to accumulate over 22 trillion dollars in debt. However, it took the country only a few months since the outbreak of the Coronavirus pandemic to catapult that number to 26.5 trillion just by July this year. And new “stimulus” packages are already on the way, likely to add a few more trillion dollars to the country’s excruciating deficit before the end of the year. Hence, no matter from which angle one looks at the problem, it seems to have become unavoidable for the U.S. dollar to undergo a significant adjustment in value and to suffer a serious loss in purchasing power. All these are direct consequences of an unprecedented increase in government spending, at a magnitude never thought possible before, combined with rapidly falling productivity as well as evaporating economic demand.
Hence, it is our continuous view that the United States will experience a time of prolonged recession with deflationary tendencies at first. We further believe that it is likely for the recession to last beyond the second quarter of next year and that the initial period of deflation and economic decline will be followed by a moderate to high inflationary environment, resulting in an accelerated devaluation of the U.S. dollar. In our opinion, this will lead to a further increase in gold and silver prices over time, propel the value of commodities in dollar terms, including commodity driven currencies such as the Australian dollar and the Norwegian kroner as well as strengthen safe haven currencies, the Swiss franc in particular.
While we expect the worsening economic situation to primarily affect the “working poor” as well as what is left of the “middle class”, with unemployment to further increase and more businesses to permanently close, we do not foresee any major stock market correction before November. This mainly due to the unconditional support of liquidity provided by the Federal Reserve System and other major central banks in Europe and Asia. The liquidity injections are likely to prevent stock markets from adopting to the grim economic reality in the short term but might make the overall situation much worse in the mid- to long term. We also believe that we could see the stock market’s performance to be disconnected from the underlying economy for quite a while. As far as an economic rebound is concerned, we think that some European and Asian economies will outpace the United States and find their way back to pre-Coronavirus levels quicker. It is our view that the structural economic and political issues in combination with an unprecedented deficit and a deteriorating currency will continue to weigh heavily on the chances for a sustainable recovery in North America.
When it comes to asset allocation, we recommend to stay neutral in equities for the growth and balanced oriented investor and underweight for the more risk-averse market participant. We recommend to be overweight in precious metals as well as alternative investments and stay neutral when it comes to fixed income exposure for each risk and investment profile applicable. Geographically, and in regard to sustainable long term growth potential, our focus is set on emerging markets. We prefer Asia with an emphasis on India, Vietnam, Thailand, Malaysia and even though unpopular, we are still convinced that China is holding the key to long term economic growth over next two decades. As far as developed markets go, we keep investing in Australia, Switzerland and the Nordic European countries, as well as in Germany and the United Kingdom, but on a more selective basis. Regarding currency denominations, we are staying away from USD and EUR cash and only invest in USD and EUR denominated stocks of internationally diversified blue chip and technology companies with solid balance sheets, plus some investments in short term USD denominated but only investment grade rated bonds. Our mid- to long-term currency preference is the Swiss franc, including according cash positions for the conservative investor. Sector-wise, we are in favor of technology and luxury brands, pharmaceutical and chemical companies, food and beverage conglomerates (without the hospitality sector), private equity and top-tier financial corporations, as well as telecom, utility, and some selective energy stocks. We consider relatively high and sustainable dividend yields of stocks issued in otherwise low-yielding currencies attractive as well.
The next big questions mark, that will have a significant impact on the future development of the stock market as well as the economic recovery process in the United States and abroad, is going to be the November election. It also will push a key issue as far as global economic stability is concerned into one or the other direction: The future relationship between China and the United States. In our opinion, it is unavoidable and just a matter of time for China to become the world’s largest economy and the next global military power. The key question will be on what terms such a shift is going to take place. Ironically, the nation that introduced the principle of “one country, two systems” has started to streamline its domestic structure in order to become more coherent politically and more competitive economically. At the same time, and to the contrary, the United States seems to have become more socially, politically, and economically polarized than ever before in its young history. What used to be the most powerful homogenous economic region in the world has been broken-up and divided into different economic landscapes, driven by political color. It has become a confusing patchwork of almost daily changing micro-climates where investors and business communities are challenged by mandatory quarantines across state lines, with states, counties, and cities that are open for business on the one hand and those that remain closed on the flip; the ones that allow their citizens to mix and mingle freely for that after-work drink and those where people are still confined to the four walls of their homes and depend on curb-side pick-up for meals and drinks, with mandatory mask requirements and strictly enforced social distancing rules. All these different developments will leave their marks and have already lead to even more division between Americans economically, socially, and politically. It has also pushed many states to the brink of bankruptcy and accelerated the pace at which more and more people seem to be leaving the coastal cities on both sides of the country and keep on moving to the Midwest and the South, primarily Texas and Florida. Elon Musk’s latest decision to move his new manufacturing plant to Austin, after Toyota already had transferred their headquarters from Torrance, California, to Plano, Texas, is only one more example.
For better or worse, the future of our western civilization will heavily depend on the political and economic leadership in China and the United States as well as the type of diplomacy and relationship those two countries are going to conduct between each other. It truly is a tale of two countries and nothing more but our wealth, standard of living, and peaceful co-existence within a free and functioning society are at stake. If there has ever been a time where having an offshore account to internationally protect and diversify financial assets has been paramount, this is the time.
Oliver E. Hohermuth, Principal & Chief Investment Officer