Has the end of the "Everything" rally arrived?

In April 2024, not only American, European and German share prices reached new historic all-time highs, but also the price of gold, Bitcoin, Chinese government bonds, American house prices and, unfortunately, US government debt. In view of the sharp rise in interest rates, the difficult economic situation in Europe and Germany and the continuing poor geopolitical situation, these developments cannot be taken for granted.

First, let's look at the crisis metal gold. Chart 1 shows that among the important commodities, only gold has reached a new record price. Commodities not shown in the chart, such as food, iron ore, copper, uranium or aluminum, are also currently well off their historical highs, which they often reached shortly before or after the financial crisis (2008 to 2009) (source: US Federal Reserve Bank of St. Louis).

The gold price rose from 2007 to February 2022 when US real interest rates (yields on inflation-linked US government bonds) fell, e.g. from 2007 to 2013 and from 2019 to 2021, and vice versa (chart 2). This makes perfect economic sense, as inflation-linked US government bonds with a current yield of 2.2% p.a. are more attractive than interest-free gold bars. With a yield of -1% p.a., the opposite is true. Nevertheless, the gold price has responded to the sharp rise in interest rates on these bonds from -1% p.a. in 2021 to the current +2.2% p.a. with a strong increase of over 30%. Chart 3 shows the extent to which the gold price has deviated from its usual 15-year correlation with US real interest rates - if this were still valid, the gold price would now have to be less than USD 1,000. It is possible that the start of the war in Ukraine in February 2022 triggered the collapse of the previous correlation. The already highly indebted governments in Europe and the US (see chart 10) were suddenly faced with high additional financial burdens due to the need to rearm their own armies and support Ukraine. This may have raised doubts among some investors about the long-term creditworthiness of sovereign debtors - a gold bar may not earn interest, but it cannot be inflated away or go bankrupt. Perhaps this is precisely why some central banks have been buying a lot of gold since 2022 (chart 6).

Before the yield on inflation-linked US government bonds had a close correlation with the gold price from 2007 onwards, the real performance of US government bonds (interest rates + price changes ./. inflation rate) had been an opposing factor influencing the gold price since 1969 (charts 4 and 5). When investors suffered high real asset losses with US government bonds, such as in the 1970s, they apparently fled to gold in anticipation of further losses and vice versa. The competition between government bonds and gold is also evident here.

Compared to inflation-linked government bonds, gold is currently not particularly attractive, but only for investors who have no doubts about the creditworthiness of the USA. Compared to US equities, on the other hand, gold has been cheap for years. After the price of gold had increased twentyfold in the 1970s up to January 1980, gold had become very expensive; one ounce of gold (approx. 31 grams) could buy five times the US S&P 500 equity index (peak of the red line in chart 7). In April 2024, you would get less than half an S&P 500 index for it. Compared to US equities, gold is as cheap as it was until the early 1970s or since 2014. With such a favorable valuation, the expected annual price increase of gold until 2034 is around 10% p.a.

Another factor that should help the gold price in the future is the US dollar. Since the liberalization of the gold price from 1968, a falling dollar against the euro has usually been associated with a rising gold price (green fields in chart 8 - a rise in the red line means that you have to pay more dollars for one euro; the purchasing power of the dollar then falls). However, the dollar is currently clearly overvalued (blue line in chart 9). A phase of overvaluation (previously 1985 and 1999/2000) has been followed by an appreciation of the euro over the next 10 years (red line, right-hand scale) and vice versa. The appreciation potential of the euro against the dollar is currently around 3.5% p.a. until 2034.

One factor for the capital markets that is currently completely underestimated is the exploding national debt of the USA as a percentage of national income, which has now slightly exceeded the previous historical record since the founding of the USA (121% in the last year of the Second World War) (Figure 10). Since 2000, this figure has risen from 56% to 122%, while the eurozone has managed a comparatively moderate increase in debt from 69% in 2000 to 90% in 2023. After the election of a new US president on November 5 at the latest, the US government will have to address the issue of consolidating public finances. This could then trigger the long overdue recession following the sharp interest rate hikes up to October 2023 (see the capital market outlook from February 2024, which you can find here ), which is likely to weigh on the US equity market.

In addition, the enormous debt of the US government explains the sharp rise in the price of gold shown in chart 2 despite higher yields on inflation-linked US government bonds. The loss of confidence in the US as a debtor appears to be greater than the economic policy uncertainty in the US and Europe due to the wars in Ukraine and the Middle East. The corresponding indices for these two regions show astonishingly low values, at least until March 2024 (chart 11).

In view of the foreseeable future sharp rise in the burden on public finances - not only in the US - the rally in the gold price is likely to continue, as governments will need the help of the printing press more frequently in future (see the November 2023 Capital Market Outlook, which you can find here ).

The gold price is also receiving support from another region. In a world where interest rates have risen sharply since 2021, there is one notable exception, namely the economic superpower China. There, prices for 10-year government bonds have reached a new high and interest rates a record low (chart 12). Following the bursting of the historically unique real estate bubble (see capital market outlooks from November 2021(here), September 2022(here) and June 2023(here)), the Chinese are suffering from a considerable loss of confidence (chart 13), which also extends to the domestic stock market (chart 14). Chart 11 shows the conspicuous economic policy uncertainty in China in an international comparison, although the time series is only available up to November 2023. Unpleasant statistics are no longer published in China, although this is more likely to help Xi Jinping stay in power than to solve the problem.

Chinese investors are having a hard time in this environment. Given the enormous vacancy rates - estimates range from 65 to 120 million vacant apartments (see the above capital market outlook) - real estate purchases are no longer popular, savings deposits are not risk-free, as the vacant apartments were financed by banks that are at risk of high loan defaults, and share purchases are also not an option given the weak performance of the Chinese stock market (purchases of foreign shares are becoming increasingly difficult for Chinese investors, source: Business Insider from 29.1.2024). According to a recent statement by investment bank Goldman Sachs, which raised its price target for gold to USD 2,700 per ounce in April, the Chinese are now increasingly buying gold.

In the USA, on the other hand, domestic shares were in high demand and reached new highs in April (chart 14). This is not surprising in economies that have been growing for many decades, such as the USA, but the example of China, which is known to have achieved particularly strong economic growth in recent decades, shows that the correlation between a growing economy and rising share prices is not a law of nature (chart 14).

It is not the record US share prices that are worrying, but the excessive valuation in every dimension. Chart 15 uses the example of dividend yields to show that US equities are unusually unattractive both in relation to their own history since 1953 and in comparison to the equity markets of other industrialized countries since 1969. Only during the technology bubble at the turn of the millennium and in 2021 at the end of the era of extremely low interest rates did US equities have a dividend yield as low as today.

US equities are now also too expensive compared to the most important domestic alternative investment, long-dated US government bonds. From 1979 to the late summer of 2020, both the US S&P 500 equity index and a portfolio consisting of 30-year US government bonds increased thirty-fold (chart 16). Yields on these bonds then rose from their record low of 1.2% p.a. to 4.8% p.a. today, meaning that investors have suffered a total loss of 50% since 2020, including interest income. However, equities have risen by a further 56%, resulting in an extraordinary difference in performance.

Our long-term forecast model (chart 17) shows that the expected return on the US equity market is below 0% p.a. until 2034 (chart 18) and thus far below the interest rates on long-term government bonds.

Finally, US equities are also expensive compared to gold (chart 7).

Added to this are foreseeable economic problems. The US economy is currently massively doped. For 56 years, the unemployment rate had initially fallen significantly for years before recessions and then remained at a very low level for around two years (chart 19). In these two years before the start of the recession, the average government deficit was never higher than 5% of national income (red line at the start of the recessions (gray bars)). This time, with very low unemployment, the average new debt of the last 2 years is over 8% of national income. Such high deficits cannot be sustained for much longer in view of the already record-high national debt (chart 10).

Due to the very high valuation of US equities, both in comparison to their own history and to investment alternatives (other equity markets, US government bonds or gold), the equity boom in the USA should soon come to an end, especially as the risk of a recession is also high if the next US government adopts a somewhat more solid financial policy.

If you want to try your luck with the strangest "asset class" since the tulip bulb in 17th century Holland, Bitcoin (see Capital Market Outlook from April 2021, which you can find here ), you should bear in mind that there has been a close correlation between US technology stocks (index: NASDAQ 100) and the price of Bitcoin for several years (chart 20). Technology stocks are by far the most expensive sector of the global stock market (chart 21). This is also likely to apply within the US stock market, whose extremely high valuation is due to the high proportion of technology stocks and leads to low earnings expectations. However, if technology stocks fare less well in the future than they have so far, e.g. because the artificial intelligence euphoria deliberately overlooks some dark spots (high costs, infringement of copyrights), Bitcoin could also suffer. It actually only consists of dark spots (extremely high power consumption, only very limited usability as a means of payment except for capital fugitives and tax evaders, 100% market share in the extortion money demands of cybercrime, ...).

In contrast to US equities, neither European nor German equities are overvalued compared to their own history or to the other major equity markets, as an international comparison of share prices to companies' gross profits shows (chart 22). Unlike in the USA, government bonds in Europe are no competition for equities, as the expected return on European equities, for example, is almost twice as high as the yield level of 10-year government bonds in the eurozone (source: ECB Data Portal) at just under 6% (chart 23), which largely corresponds to the overall European interest rate level. The potential for further price increases is much higher for European and German equities than for US equities - the rally is not yet over here.

Finally, we look at residential real estate in the US, which has reached a new historic high (chart 25) despite a massive rise in interest rates on 30-year mortgage loans from 2.7% in December 2020 to currently 7.2% (chart 24). The reason for this is that many Americans have taken advantage of the low-interest phase to lock in the low interest rate for the 30-year mortgage loans common in the US, which is possible in the US without a prepayment penalty. However, you are not allowed to take these loans with you when you move to a new home. As a result, people prefer not to move out, so that there are hardly any second-hand houses on offer and anyone who absolutely needs a new home has to pay scarcity prices.

However, the current combination of record home prices and high mortgage rates is unlikely to be sustainable. The US Federal Reserve publishes a feasibility index for house purchases, which includes mortgage interest rates and house prices. This index was particularly low both at the end of the 1980s and before the subprime crisis from 2007; house prices were high, as they are now, and so were mortgage rates (chart 26). In both cases, this was followed by below-average or even negative house price development (green arrows in chart 26). This is likely to happen again now - the house price rally in the US should soon come to an end, especially if there is a recession.

Conclusion: The "everything" rally is unlikely to continue forever for US equities, Bitcoin and US residential real estate. By contrast, the price of gold and equities in Europe and Japan certainly have further upside potential.

Finally, our key statements from the April 2021 Capital Market Outlook, which you can find here can be found here:

Three years ago, we analyzed historical bubbles in the equity markets and concluded that in 2021 only the US market was overvalued, both relative to the other major equity markets and to US government bonds. However, the expected return of US equities was only around 1% p.a. lower than that of bonds (in 2024, the difference is 6% p.a. in favor of bonds). As a result, both US and European equities had suffered price losses of around 15% by the fall of 2022. To date, despite the euphoria surrounding artificial intelligence, Europe has outperformed the US equity market with price gains of 25% since April 2021. Another topic was Bitcoin, which we considered to be absurdly overpriced three years ago and which then actually collapsed from USD 60,000 to USD 16,000.

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You can also download the capital market outlook here.