There is often a lot of talk about how big institutions and Wall St. has an advantage over the little guy. What is not often talked about is how big clunky institutions can’t chase trends and great returns in smaller opportunities.

This is the big advantage you and I have over the behemoths of global finance. Scale was at the forefront of my thoughts when I took a look at the YTD performance of the main 38 asset classes as described by Deutsche Bank.

The upper chart being the YTD return of various asset classes in local currency while the lower chart is those returns in USD. A number of things jump out at me when looking at these returns and thinking where things will be headed in the next 6 months as well as the next year.

Commodities and Fear

The first is the surprising performance of silver. Silver has had a 34% rally in July, posting its best month return since 1979 and placing its YTD return at 36.6%.

What is speculated as being behind this rally? According to Market Watch, a Dow Jones company, it’s the perceived “green recovery” with governments steering stimulus and recovery funds towards projects that are more environmentally friendly. Silver, used in a number of industrial applications and products such as solar panels could potentially be in high demand on the back of such a recovery.

Gold was not far behind, climbing 10.9% in July alone. As far as monthly returns go, commodities had a strong month with Brent oil and copper also posting gains of 5.2% and 5.7% respectively. The move into commodities would seem to reflect a wider bearishness on the dollar and currencies in general, especially after the massive stimulus that rich world governments have thrown at the pandemic.

This was a predictable phenomenon. Much like the last crisis, fear and pessimism dominated in the initial aftermath as well as for the first years of recovery. Interestingly, gold, silver and other commodities fell with the rest of the broad overall market in March as there was a rush to the safety of government securities as equity markets took a dive.

I received a number of questions as to why gold was falling in value in such an environment but the answer was pretty simple: gold demand is driven by the needs of the jewelry industry much of the time when markets are functioning normally. It’s only in times of stress that other buyers perk up and start to move into gold, but it takes time for that big institutional money to move into gold. So the initial drop in commodities was due to the rush to safety while given the massive fiscal stimulus and quantitative easing, it was relatively easy to predict that once investors were back in “risk on” mode, they would start to move into what I call the fear gauge investments such as gold. This was also evident in the silver rally, which is seeing prices almost 100% higher than its lows in March.

Small investors who were able to predict this phenomenon likely took the opportunity to snap up gold and if they were really savvy, silver. Don’t fret if you didn’t, the gold rally lasted for 2 years post crisis last time, about the same time that the news cycle remained depressingly pessimistic. It looks to be a repeat that small investors can take advantage of this time around as well.

No BTC

The other thing that jumps out at me on the returns spectrum is the lack of bitcoin as an investment category. To the chagrin of many traditional advisors and managers, banks can now provide custodial services for bitcoin and other crypto currencies which lends them a strong vote of legitimacy that they lacked in their initial outset.

Bitcoin saw a similar drop and then rally analogous to what happened with other commodities and if it was included in the list of asset classes, would have a YTD return around 66% which would trounce the other asset classes including the silver rally. If you are constructing your portfolio based on the classic risk return trade off which aims to achieve the best risk adjusted return, it looks more and more like there may be an argument for including crypto as a part of your portfolio. The rationale being that it seems to be provided a hedge in volatile times the same way that gold does. It remains an open debate if bitcoin or other cryptocurrencies have any long term value to investors as they don’t seem to provide a stable store of value. For the time being though, they would seem to offer some diversification benefits at the very least.

The Losers

Looking at the losers also offers lessons and view into where things may be headed in the near term.

The story of oil this year has been well documented. After demand dried up in March, the ripple effect reverberated into May as some futures contracts went negative with space for storage running out in parts of Oklahoma. This story was a bit overhyped on social and traditional media as it was essentially a Cushing regional storage issue but the thought that someone would pay someone else to take oil off their hands was an interesting concept for many.

Although both Brent and WTI are finally seeing some returns after they bounce off of their YTD lows, they are still down by 34% and 33% respectively for the year.

Another sector that has gotten less attention for being a loser this year is European banks. The Dow Jones Stoxx Europe 600 Banks Index is down 36% in dollar terms so far this year and their hasn’t been a good story for European banks for years.

Banks naturally benefit from increasing economies of scale but the nationalism of the respective banking sectors in Europe has held the continent back from creating a true cross border, pan-European leader. HSBC is suffering from musical chairs at the top of the house and seems to have been in reconstruction mode for 5 years now. Deutsche Bank is limping along after rejecting its proposed merger with competitor Commerzbank and there hasn’t been a peep about a major cross border merger since the Unicredit-SocGen speculation which peaked two years ago.

So why is it that the Europeans are some of the biggest losers when it comes to returns? If you follow the sector, the have been dark clouds on the horizon for some time and the pandemic only exacerbated these.

1. Lack of Consistent Leadership – A rotating cast of characters at the top of the house has contributed to a lack of consistent strategy for institutions. It takes time to implement a CEO’s vision and a tenure of a year or two may not be able to achieve this. Managing a bank is like steering an aircraft carrier, it doesn’t just pivot on a dime. Recent changes at the top in the last year have included HSBC, RBS, Credit Suisse, ING and UBS although the the latter being a trade at the top as UBS poached Ralph Hamers from the top spot at ING after a long stint there.
2. Low Rate Environment – Negative rates have been a disaster for banks the world over. No bank has been willing to pass these negative rates into their regular retail customers for fear that they will just stash their deposits under the mattress. The alternative has been for banks to take a hit to their income and profits by paying depositors nothing while being forced to pay the central bank to park reserves there. If negative rates were to flow throw the whole economy, it may be a different story but one that may also cause a radical social backlash, imagine large companies and the risk getting a further discount on their debt or mortgage payments while the poor are charged to hold cash. In avoidance of this situation, the banks have taken the brunt of the cost of negative rates.
3. Low Growth Environment – Nothing seems to be growing in Europe at the moment. Populations are shrinking and they are also graying. This means that the customer base is shifting from the accumulation mode of those in their 30’s and 40’s to the asset protection mode of those in their 60’s and beyond. It’s no wonder that rates can be maintained below zero when liquidity is the primary concern of many national pension funds and retirement plan administrators. Throw on top of this Covid, which bankers are holding their breath to see if massive loan defaults start rolling in towards the latter half of the year as stimulus and furloughs are rolled back. All this just makes a bad situation worse which is likely why European bank shares have yet to recover significantly from their March lows.

American banks aren’t far behind. Although well capitalized and having made serious provisions in relation to expected loan losses, banks seem to be at the forefront of the severe slowdown that the “real economy” is yet to see. As an opinion piece in Bloomberg recently pointed out the top 10 tech companies combined are up 37% this year while the rest of the S&P 500 is down 7%. Couple that with the fact that indexes are cap weighted and you have the entire index up slightly for the year.

The issue is that most workers and the economy is not represented by the stock market. Banks have exposure to this underperforming wider sector, it doesn’t seem to be getting better anytime soon.

Hope Prevails

However there is hope. Even though everyone chased gold for 2 years during and after the financial crisis in 2009, stocks have trounced gold since then, which has only now reached back to its previous high set near 2011. There are opportunities to be had in this market both on an individual and collective basis. Emerging and developed foreign markets have been beaten down and the dollar is sliding, Vanguard expects greater returns outside the US for the next decade and I don’t disagree with them.

Source: Vanguard

One to three percentage points return greater over a decade averages out to a 10% to 34% greater return over the decade which is nothing to scoff at. Remaining diversified and invested internationally could be the saving grace for US investors in the coming years given the pain to come.

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