International and Global

The stock market is in perpetual motion

And so the merry-go-round continues. Government debt piles up whilst interest rates sink well below the prevailing rate of inflation. Real yields? A fading memory.
July 2021

It’s not a bad gig. Buy the stock market and central banks and governments obligingly push it ever northwards. At the slightest hint of trouble panic sets in and they fall over themselves trying to find ways to ensure it resumes its upward trend. Being somewhat old-fashioned we naively thought that the stock market was (or, at least, should be) priced according to investor demand and related to economic and stock-specific performance. Such foolishness.

Of course the same goes for housing and the government bond market. In relation to the former, governments often talk expansively about making housing ‘affordable’ but then shovel money in its direction via a creative range of handouts and subsidies (and restrictive land-use strategies) which do nothing but push prices up. ‘Affordable’ should, in fact, mean lower prices. And as for the government bond market – it is many moons since yields were private sector controlled. In Japan, the central bank now owns more than 50% of its own market.

And so the merry-go-round continues. Government debt piles up whilst interest rates sink well below the prevailing rate of inflation. Real yields? A fading memory.

Central bank balance sheets are now obscenely bloated. In the last six quarters the combined balance sheets of the four main central banks have exploded by around 9 trillion US dollars – whilst world output struggles to return to pre-pandemic levels. Official interest rates remain on the floor by necessity – any rise in the cost of borrowing will devastate the already stressed government accounts.

Even without a rise in interest rates simply rolling over maturing debt and funding the annual budget deficit is straining government finances. In Japan, the leader of the pack in terms of government debt (approximately 220% of GDP), the combination of debt maturities and the budget deficit amount to a forecast 60% of GDP in 2021. In the US the equivalent statistic is 50%.

Japan manages to pull off the 3-card trick because more than 90% of its debt is owned within Japan. The US and other countries have no such luxury. In the US, 30% of Treasuries are held abroad – mainly by China and Japan – whilst similar or greater foreign ownership percentages prevail elsewhere.

So, has the great money infusion worked its wonder on global economic activity?

The stimulus has generated a V-shaped recovery in all the leading economies but amongst developed nations only Australia managed to crank GDP above pre-pandemic levels by the March quarter of this year. In other words, the opportunity cost for most countries of the Covid-induced lockdowns has amounted to at least 5 quarters of potential GDP growth (try telling that to the stock market).

In Australia the magic bullet has been iron ore – rather than ultra-clever footwork by the government. Iron ore currently amounts to almost 35% of Australia’s exports by value (up from 20% at the beginning of 2020) and the price has rocketed from $US90 a metric tonne at the beginning of 2020 to around $US210 at the time of writing. Why? China is the simple answer (together with a serious production issue in Brazil). China has pumped vast sums into its manufacturing capacity – all of which generates increasing demand for raw materials. Australia was ready and willing to step to the plate. For around 100 years it was said that Australia rode on the sheep’s back. Now, more aptly, it can be said to ride on the back of an iron ore excavator.

It would be foolish for Australia to overly bask in the warmth of the iron ore induced economic recovery because there is no guarantee that it will last. China is keen to diversify its import sources and Brazil will undoubtedly return to a competitive export position. Additionally, China and Australia are experiencing serious geo-political spats which will not assist in strengthening the trading relationship. China is, by far, Australia’s dominant export destination (around 40% of the total). It overtook that key position from Japan in 2010 and now dwarfs Japan’s trading importance. In combing through export statistics we cannot find another developed nation that is similarly exposed to China. This does not provide great long-term comfort.

Amidst all the Covid-induced pandemonium and the central bank and government responses the ‘world’ average stock market dividend yield has sunk to just 1.8% – comfortably below its long-term average.

In the US the S&P500 dividend yield has tumbled to a measly 1.4%. At the same time the price earnings ratio has leapt to around 30. The infamous Shiller Cyclically Adjusted PE (CAPE) has now moved above 35 – rarefied atmosphere as it has only touched this level on one other occasion in the last 140 years and that was during the Tech bubble at the end of the 1990s. And let’s not forget – this is happening in a world only now getting back to output levels equivalent to those prevailing in 2019.

The logic running through the market is not hard to discern: if bonds yield next to nothing and money in the bank yields nothing or even less why not buy equities which at least provide some income return. Hard to argue with. The only troublesome bit of nettle rash with this argument is that equities can tumble in value and dividends can be cut. Long-term holders then become panicky short-term holders. Our guess is that no more than one or two out of ten investors are prepared to accept some capital depreciation. The rest find it unacceptable. Having managed pension funds for many years we have encountered so many ‘investors’ who are calm in a rising market but start riding the telephone as soon as the market is spooked. Trying to forecast when the next tumble will occur or what will trigger the decline is not a game worth playing. If you get it right once you are not a genius – just very lucky.

In the meantime FOMO (fear of missing out) seems to be more prevalent than ever. It is standard human nature to be most uncomfortable if others are making money and you are not. The Covid-lockdowns have bred a new phalanx of home-based market traders who are all instant experts. Fundamentals? An anachronism. It is reminiscent of the 1990s Tech bubble – wild speculation fuelled by equally wild stories about immense riches to be made by companies that started in business a week earlier. Almost anything with dot-com attached to its name rode the wave – which, for most, came crashing back to shore.

Is the stock market it in a bubble? Yes. Will it buckle under its own over-valued weight? Undoubtedly, as overvaluation is always corrected. This could start tomorrow or it could take years since the normal rules of valuation have been suspended by the ‘gaming’ of the system by the central banks. Bubbles, of all kinds, are inevitable when interest rates are set at zero.


We have often written about the role played by productivity in the economic growth equation – it, and workforce growth, are the two magical ingredients of economic expansion. The problem is that productivity growth has been poor for many years, with no sign of an improvement. In the chart below we have ended the growth comparison at the end of 2019 to avoid the pandemic-confused statistics generated during 2020. The point being that between 2014 and 2019 productivity growth – everywhere – was abysmal. Even in the prior years the stats are not all that flattering. Combined with a declining rate of workforce growth (ageing population) it means that overall economic growth has been unimpressive.

Now let’s take a look at real GDP growth in the world’s major developed economies since the turn of this century. Even allowing for the growth hiccup caused by the shut-downs in 2020 the data is still anything but stellar. Only two countries have achieved average compound growth above 2% whilst one (Italy) has not grown at all!

If we backtrack to the end of 2019 – pre-pandemic – the average annualised growth rates since 2000 of the four major advanced economies – the US, Japan, UK and Germany were, respectively: 2.03%; 0.72%; 1.70% and 1.29%. Not exactly a case of shooting the lights out – and, we suspect, inferior to the estimates of most ‘experts’. For those interested , the growth rate of Italy over that 20-year period was a tiny 0.30%. Is this global experience about to be bettered over the next 20 years? We doubt it. The world’s ageing population will continue to bear down on growth whilst productivity, the elusive elixir, seems locked into a tediously slow level of improvement.

Electric Vehicles

The hype around electric vehicles continues. In 2020 the global electric vehicle fleet passed the 10 million mark. A decade ago it was zero. China takes up the biggest slice of EV ownership (48%) followed by Europe and the USA. In parts of Europe electric vehicles accounted for significant percentages of new car sales in 2020. For example, in Norway they made up 75% of sales, over 50% in Iceland, 30% in Sweden and 25% in the Netherlands. Governments around the world spent US$14billion on purchase incentives and tax deductions for electric cars in 2020. (Data from the International Energy Agency).

Now, regular readers will be aware that we have always been skeptical of the green credentials of electric vehicles. But sometimes crazy stuff happens. We have no doubt that if we move forward five or ten years the graph of electric vehicle take-up will look similarly spectacular to the one above. Politicians have grasped this nettle with alacrity. It is a bandwagon with no turning back.

As an investor don’t forget about all the ingredients that go into battery manufacture – they are in for quite a journey. The International Energy Agency estimates that a typical electric vehicle requires six times the mineral inputs of a conventional car.


To be or not to be.

The market is getting itself in a lather over the possibility of a sustained inflation pick-up. Is it real this time around or another temporary spike? Let’s have a look at some of the recent inflation action around the world.

The stand-out is the US with the CPI bouncing well over 4% on a year-on-year basis. It is little wonder that nerves have frayed and mutterings have commenced in the Federal Reserve and other central banks about an earlier than expected increase in official interest rates.

The first and obvious point to make is that inflation collapsed during 2020 so that any pickup from very low or even negative numbers looks remarkably strong on a year-on-year comparison (the so-called base-effect). Nevertheless there are other factors at work – ongoing supply shortages being foremost together with emerging labour supply problems. The money pumped into the global economy is chasing too few goods – classic demand-pull, whilst some workers are finding life more comfortable receiving government hand-outs than re-joining the workforce. The lack of international travel and the consequent low supply of itinerant workers – be they fruit pickers or cappuccino frothers – is creating a demand/supply imbalance with inevitable pressure on wages. Add it up and you get an inflationary spike. In the US, durables, non-durables and services inflation have all surged from low levels.

Nevertheless, we recognise the temporary nature of much of the above. The helicopter drop of money will inevitably taper. The global supply chains will pick-up as the pandemic’s impact weakens. International travel will resume and inexpensive casual labour will again become available. Who knows, some workers may even tire of sitting at home.

Our guess, and that’s all it is, is that inflation will subside to the relatively low levels that the world has experienced in recent years. However, and this is the key point, be it a permanent inflation uptick or temporary, interest rates are far too low. The economic distortions caused pre-pandemic were significant thanks to absurdly low interest rates and nothing has changed. The efficient allocation of capital relies on competition for that capital. If money is plentiful and virtually free, the allocation mechanism fails. An economy needs money to cost more than the prevailing rate of inflation. We hope we live to see it.


Five years ago China abandoned its one-child per family policy. The policy had been in place since 1979. The 2016 relaxation had very little impact on the country’s birth rate. Now the Politburo has announced an increase in the permitted number of children to three per family. A similarly muted impact is expected as Chinese parents appear concerned about the costs of a larger family group. And after 42 years of restrictions they have grown accustomed to small families.

China has a population problem – not too many but potentially too few. The population is rapidly greying and workforce growth is about to cease. Increasing the permitted births to three per family is far too late to correct the problem. A declining pool of workers afflicts many European economies and is now set to afflict the world’s most populous country. China’s total population is expected to start a slow decline within the next decade.

In common with many countries China will now rely entirely on productivity growth to kick the economy along – and, as in many countries, it is also slowing. From the 1990s through to the early 2000s the growth of real output per employed person (productivity) tended to bob around 8-12% each year. However, since 2010 it has been on a declining trend and now 5-6% is closer to the mark. The chances of China repeating its average real GDP growth of the last 40-or-so years have gone. Welcome to the advanced world.

Covid-19 Update

The global Covid case-load continues to fall despite the not infrequent scares about new strains of the virus. It seems that the penetration of vaccines (and herd-immunity?) is impacting favourably. 2021 has experienced two case-load peaks – one in January and the other in April. The latter has much to do with the massive spike in cases in India – starting in March and topping out in May. At that point India’s rolling 7-day case average exceeded 400,000. It is now around 50,000.

The medical experts catagorise 99% of cases throughout the world as ‘mild’ – a description that also applies to India. Despite the massive number of cases in India the deaths per million rank it somewhere around 100th on the global list. Even accounting for under-reporting – let’s say we treble the number of deaths – it lands around 60th on the global ranking. India’s total population is just touching 1.4 billion. With these numbers even a mild infection will inevitably effect a lot of people.

The vaccine roll-out has been erratic throughout the world. In terms of the percentage of the population with at least one jab the OECD reports that Israel tops the global list at more than 60%. Following closely behind are the UK, Hungary, Chile, the US and Canada (all around 50%). At the bottom of the vaccine ranking table we find South Africa, Japan, Indonesia, New Zealand, South Korea, Columbia, Russia, India, Mexico and Australia – all close to 10% or less (percentages correct at mid-May).

A fresh debate has erupted in relation to the origins of the virus. The accepted wisdom that it escaped from a Chinese ‘wet-market’ is now being credibly challenged by the view that it leaked from a lab in Wuhan. We may never know the answer as the Chinese authorities have not always been forthcoming about the early days of the virus.

Be it a leak or not it is important to ensure lessons are learned in relation to the handling of the pandemic – as this will surely not be the last. Shut the world economy down for a period – or not. Masks – or not. Offices – or not. Schools – or not. International and domestic travel – or not. And so the debates rage.

Every ‘emphatic’ view encounters an equally strong number of counter views. This is not just about medical science. It is also about economics and the very real human damage caused by multiple lockdowns and restrictions. A critical and non-political evaluation of the response to this ‘mild’ disease needs to commence.

The Final Word

Have you heard of meme stocks? If you haven’t join the club. They only recently entered our consciousness when GameStop (US listed) witnessed some pretty crazy price and turnover antics driven by day traders on social media platforms – Reddit, Twitter, TikTok and so on. There have been several examples but one of the latest to hit the mania headlines is AMC. This is one of the largest movie exhibition companies in the US and has truly depressing financial results. Just a few months ago it was a breath or two away from bankruptcy (it may still be). Nevertheless, having started the year at US$2 it now sits around US$58 with a market capitalisation of US$30 billion. Turnover and day-to-day price action has been little short of extraordinary.

It seems that to qualify as a meme stock it is important for it to be totally lacking in investment fundamentals. In the AMC price run-up the company even issued a press release stating: “We believe that recent volatility and our current market prices reflect market and trading dynamics unrelated to our underlying business.” Nevertheless, the company, quite understandably, grabbed full advantage of the mania by issuing around US$580m of new stock in early June. This was on top of other sales that have netted a total of around US$1.2 billion in the current quarter. Not bad for a company flat on its financial back.

So Covid strikes again. Bored sit-at-homers have embraced day-trading and jabbed money into the market into an array of stocks that no self-respecting investment analyst would consider twice. When, however, the stock goes up over 2000% , as is the case with AMC, they care not a whit for fundamentals. Some have made plenty of money – and we hear about those – but we do not hear so much about those who have lost.

For many it seems that investing has turned into the latest party game. It is not really new however – the only new thing being the term – meme. We watched similar events in the great Australian nickel boom at the end of the 1960s, we saw it in Japan in the late 1980s, in the Tech bubble at the end of the 1990s, in the subprime mortgage debacle of the mid-2000s , and so on.

Every bubble ends with much hand-wringing, some tears and a vow never to be caught-out again – until the next time. Human nature is human nature. Repetitive. We think it likely that the central bank-sponsored boom that we are currently living through will, in time, be written about in similar terms to the booms/bubbles referred to above. Enjoy the experience but don’t confuse extravagant returns and investment acumen.


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