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Market Comment October 2020 - Chasing Snowflakes in September

Photo by Enes Tekeşin from Pexels

Shares in Snowflake doubled on their trading debut in mid-September after the largest initial public offering ever for a US software company, in the latest sign of Wall Street’s huge demand for cloud computing service businesses. The Silicon Valley company’s stock jumped more than 160% above the IPO price to touch USD 315, sending the company’s market value to almost USD 90bn, before easing to a tad above USD 250 at the close in New York, and where it is still trading.

There are more Snowflakes out there we will see many more high-flying IPOs in the coming weeks and months. This demand for stocks is exacerbated by the very accommodative monetary policy of the Fed and recent shifts in its policy announced last month will be even more supportive of risky assets.

The US central bank said interest rates would not rise in the world’s largest economy until it reaches full employment and inflation hits 2% and remains on track to “moderately exceed” that target “for some time”. This is a major shift: Rather than raising rates once the unemployment rate drops below a certain level, officials will wait until a tight jobs market has begun pushing inflation higher before thinking about tightening policy.

The Fed is currently purchasing US government securities at a pace of USD 120bn per month, with USD 80bn in Treasuries and USD 40bn in mortgage securities. Such massive interventions help to keep rates low and low rates will extend life-support for zombie companies that would otherwise go under due to the pandemic. The move did also reinforce the Fed’s dovishness; in essence, interest rates will remain low for a very long time, perhaps even well after the central bank reviews the progress of its new framework in five years' time.

What are the implications for investors: quite serious! This decision will affect your pension and your investments. Most regulated pension funds either private or public, are required to invest a substantial portion of their assets into bonds. As bonds do not provide any meaningful income any longer, meeting future obligations will become harder still for these pension funds. Either they reduce their future pay-outs, or they need to buy more risky assets such as equities to boost returns.

Private investors face the same dilemma. If we accept that the governments’ policy response to coronavirus is likely to be inflationary eventually, leading to an environment that erodes the value of fixed income, it implies that a large equity allocation is needed at the heart of any portfolio.

The Federal Reserve’s newly revised long-run policy goals enshrine a now familiar pattern of investment behavior: a higher tolerance of riskier assets and higher use of leverage among investors seeking some return

I crossed the Brenner pass from Italy into Austria last Friday at only 1370m above sea level and I encountered the first snow and icy road conditions. Real snowflakes or stock market snowflakes, winter is coming.

Switzerland, October 1st, 2020


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