Between the coronavirus, trade war and more, financial markets have had an extraordinary six months. What’s next?

The year has so far been one where narrative finance, rather than a command of economic or financial fundamentals, has guided asset prices
There is no reason the third quarter should be as extraordinary as the first two, but it would take a brave investor to bet on it being uneventful

Richard Harris

Published: 3:00am, 3 Jul 2020

Why you can trust SCMP

The investor’s world is never a quiet one. Uncertainty reigns supreme, which makes the financial markets so interesting. The Hong Kong market peaked just as we went into the Lunar New Year holiday and it seems like we’ve never come out. The past six months have been the most extraordinary in my 40-plus years in the business. What do the next six months have in store?

We began the year by saying 2019 was spectacular for investors and that the markets would find an excuse to slow down. No one expected the dominant financial narrative for 2020 to be the coronavirus.

The year has been one where narrative finance, rather than command of economic or financial fundamentals, has guided asset prices. This market narrative began with a little local difficulty in Wuhan, serious to Hongkongers trained on severe acute respiratory syndrome but which global investors thought would quickly die out.

After all, China destroyed its economic plans for 2020 by amazingly locking down its economy. That local narrative grew to a medium-sized story about the global supply chain slowing production in parts of Europe. One of Europe’s weakest economies, Italy, exploded into the consciousness with a medical crisis, but it still took a vital four weeks for investors to spread the now-globally contagious financial narrative.

Stock market investors capitulated on March 23 and the narrative mutated into one of recession, unemployment and deflation. Central banks and governments around the world injected a massive dose of liquidity into their economies, consisting of money printing, handouts, corporate subsidies, takeovers and job protection at any price. A separate narrative strain was the oil producer row that led to a day of negative oil prices.

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The main strain morphed into a financial narrative of overstimulation, loose money, unsustainable sovereign debt levels, a collapsing economy and worsening China-US trade relations. These were ignored by investors, but each one is sure to lie dormant and infect economies in years to come. The market focused on the sub-narrative that free money will always be available and end up in the stock market.

Hence, the half-year of two quarters, one very bad and one looking good. They nicely follow “Harris’ Law of Quarterly Reversals” – mentioned previously in these columns – which states that the mood of the stock markets changes at the end of every quarter.

The uncertainty of markets is such that it may be a week before – as it was this time – a month before, a month after or sometimes not at all. Uncertainty is the joy of the investing game. If it worked all the time, I would be sitting on a beach with a drink with an umbrella in it.

The French mathematician Pierre-Simon Laplace imagined an all-knowing being who in December would have invested in the US dollar, bonds and gold while shorting equities and commodities. Only Laplace’s demon would have expected the yield on US Treasury notes to fall from 1.9 per cent per year to a record low of 0.64 per cent.

Those falling yields meant bond prices went up 15 per cent, making their investors happy. Gold saw a healthy 18 per cent jump in the first six months, beaten by bitcoin which rose more than 27 per cent. Strangely, currencies were almost mute, doing nothing.

Over the half-year, the Hong Kong, Shanghai and the US S&P 500 indices lost 15, 2 and 4 per cent respectively. Amazingly, the Nasdaq tech index was up 12.1 per cent and the Dow Jones was down 9.6 per cent – a nearly 22 per cent differential – which shows how much tech stocks have moved against industrials.

Many of these assets had their lows on different days, with gold, Treasury yields and bitcoin dipping a week before the stock market lows. Laplace’s demon would have had all his money in the VIX volatility index, which began the year at 15, peaked at 83 and is at 30 today. It would have sold at the peak on March 16.

What’s in store for the second half of 2020? According to the financial random walk theory, there is no reason the third quarter should be as extraordinary as the first two. Will Harris’ Law of Quarterly Reversals remain intact? It would take a brave investor to bet on it being uneventful.

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The narratives of the first half of the year have yet to fully play out. Good news about government help is out of the way; bad news about economies and companies will continue to flow. Even so, investors are buoyed by the fact that the damage is done and by the knowledge that further virus waves should be handled promptly.

If you feel lucky, buy more tech and growth industrial equities. If you don’t, buy gold. If you don’t know, diversify – raise cash in dollars, yen and Swiss francs and spread it between banks and jurisdictions. We in Hong Kong live in interesting times, especially as we say goodbye to our unique kind of unbounded capitalism to move into the unknown era of national security.

Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, banker, writer and broadcaster and financial expert witness

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