Winter is Coming

Incredible. The coronavirus has already been among us for almost a full year. Research shows that the virus may have originated in China as early as November 2019. In January and February 2020 cases spread across the world, most notably in Italy, where the first lockdowns occurred following the successful approach in China. Other countries quickly followed suit. The world changed completely in a matter of months.

Stock markets crashed in February and March, but soon recovered following a sharp decrease of the Federal Funds Rate, increased government support and investment banks presenting their expectations of a ‘v-shaped recovery’. Even though many sectors still lag behind, the technology sector led the stock market to new all-time highs.

New infection cases dropped during the summer, lockdowns were eased and the economy started to recover. However, right now the coronavirus is making a comeback across the world. With earnings season and a lot of uncertainty still ahead, I decided to take a hard look at the current market sentiment. Is it actually the start of a new bull market or is winter coming to the stock market at last?




  • Markets have recovered soon after the crash induced by the coronavirus pandemic. This is likely because external factors make the stock market a uniquely favorable place to invest in right now. These factors are in my opinion mainly the low Federal Funds Rate and low Corporate Income Tax
  • However, with increasing multilateral tensions and increasing coronavirus infection cases, the turmoil in the markets may not be over. Especially since the market is still trading at all-time highs
  • The threats I see in the market right now are (i) sustained high volatility and (ii) a possible long-term negative real interest rate
  • The sustained high volatility may be a result of long-term uncertainty in the markets caused by the coronavirus, the international status of the United States and multilateral tensions (trade wars and Brexit), while the Federal Reserve cannot decrease interest rates much further to put the markets at ease
  • The long-term negative real interest rate may be a result of a long-term low Federal Funds Rate and a possible deterioration of the international status of the United States, including the US Dollar

Nay-Sayers and Permabears

One thing should be clear from the start: I am neither a nay-sayer nor a permabear. I am a rationalist. A neutral view, in my opinion, helps you survive in a market where everyone is jumping on top of each other to get the best returns. Sometimes it is just better to leave the party a little early to prevent a major hangover.  

That is also why this post does not include all metrics potentially pointing to an overvalued market (overvalued markets are also not my point of concern here). For example, many people refer to the total market capitalization to GNP (or GDP) ratio. This is a popular metric also known as the Buffett indicator. This ratio increased to a new all-time high recently.

However, I don’t think it is a suitable metric because, unlike in the past, an increasing amount of profits (value) from companies based in the United States is generated abroad. When looking at the GDP of the United States and a stock market with value generated globally you automatically get a skewed result. Therefore, I will gladly skip these types of metrics.

The metrics I do want to look at are the Federal Funds Rate, the Corporate Income Tax, the VIX and the United States’ credit rating. I also want to look at four scenarios that I see relating to the second wave of the coronavirus. Then, I will show what steps I am taking with my portfolio to prepare for the future developments I currently expect. 

Federal Funds Rate

The Federal Funds Rate is hovering between 0.5% and 1.0%. This makes stocks attractive because, with inflation above 1.0%, investing in US Treasuries will lose instead of make you money. Most stocks still offer a higher yield based on their results over the past few years, which is the main upward driver of stock prices.

The closer the interest rates go to 0%, the more exponential the effect is going to be on the value of stocks, as can be seen in the illustrative ‘perpetuity curve’ above. As interest rates cannot go lower (yes, they can go negative) this would mean that every upward change in the Federal Funds Rate will logically have a similarly increasing deflationary effect on stock prices.

The Equity Risk Premium

Aswath Damodaran showed that the equity risk premium increased in April, which implied that (at least on a relative return basis and looking at trailing twelve months earnings) stocks were still correctly valued. However, as profits have decreased while stock prices increased, the equity risk premium seems to have fallen back again over the past few months (possibly even to pre-corona levels).

The further stock prices rise (assuming constant earnings), the lower the expected returns are going to be. This implies that the risk in the market has decreased lately. This can be supported by the lower Federal Funds Rate, because lower interest rates decrease default risk. The economic recovery during the summer also supports this movement.

The Empty Toolbox?

Yet, if risks in the markets were to increase again (due to, for example, a second coronavirus wave or other external influence) investors may want to require a larger return in the equity markets again. This future increase in the perception of risk may pull stock prices down again. Investors will then look for alternative assets to put their money in, or cash (or even gold or cryptocurrencies) for ultimate safety.

Given the trajectory of the Federal Funds Rate after the Great Financial Crisis, it is reasonable to assume that interest rates will stay near 0% for quite some time. With an increased inflation target, negative real interest rates may become a long-term threat. As I wrote in my piece on gold, this may be a bullish argument for gold. However, as deflation is also a risk with a shrinking economy there are also still risks associated with holding this precious metal. In my opinion, inflation is much more likely than deflation in the long-term.

At some point the risk/reward relationship becomes unsustainable and investors will try to find yield (or safety) elsewhere, while the Federal Reserve cannot decrease interest rates much further than the current levels. That scenario may lead to large market turmoil and especially high volatility, which the Federal Reserve may not be able to tone down this time. This brings us to the VIX.

The VIX (Volatility Index)

When stocks are no longer an attractive option in terms of risk/reward, investors will even leave the stock market. In my opinion this drives the volatility we have seen over the past months. As if there is an angel and a devil on Mr. Market’s shoulders, the market wants to go up very badly when it goes down, but when it is up it is very keen to take a break again. Investors need to be in the stock market, even when they sometimes do not want to.

This sustained volatility can be seen in the VIX, a volatility index invented and maintained by the CBOE. Over the past decade, the VIX has been low because markets have been in a relatively calm bull market. In times of crises and rising uncertainty, investors are not sure what direction the markets will eventually move into on the mid- to long-term, driving the VIX upwards.

Currently, the uncertainty seems to persist as much as it did during the Great Financial Crisis, with the best medicine for the really huge spikes being the drop of the Federal Funds Rate to near 0% (compare the image above with the image below for the clear correlation between the two).

Afraid of Heights?

The big difference between the Great Financial Crisis back then and the coronavirus right now is that the current crisis is still ongoing and markets are still near all-time highs, while during the Great Financial Crisis this was (time-wise) about the moment where markets bottomed and started to recover. Without the remedy to further drop interest rates, the Federal Reserve may have pushed itself in a narrow and tight corner.

Next to the fact that volatility has not been this high with markets near all time highs for so long, it is also remarkable to see how fast the stock market recovered, and how high the actual bottom of the market has been.

When strictly looking at the S&P 500, the crashes of 2000 and 2008 needed about 6 years each to fully recover to their all-time high price levels (remember the 2007 high was above the 2008 starting point in the charts shown here), while the current crash only needed a few months. Additionally, the crashes back then had similar lows between 500 and 1,000 points. The current crash did not go below 2,000 points.

With the VIX still up high, we may not have seen the last spike in volatility during this crisis. When that happens, we need to hold tight because the Federal Reserve will not be able to calm the markets at that point – aside from really large and heavy asset purchases. My expectation is that such a downward move would turn the markets into a storming sea where only the true pirates (read: traders) are able to thrive.

Corporate Income Tax

The corporate income tax rate in the United States is currently 21% flat after the drop from 35% in 2018. This is the lowest corporate income tax rate for the United States since the 1940’s. Let’s consider an example with easy numbers to see the effect this has on profits and stock valuations.

Imagine a stock is trading at a 10x P/E. The earnings before tax (EBT) are $100 Million. With a 35% flat tax rate, the stock is valued at $650 Million. The corporate income tax rate drops to 21% resulting in an increase in the value of the stock of 21.5% to $790 Million. While this tax decrease may increase the value of the stock market in good times, the downside of a stock is still $0 since companies that make no profits or go bankrupt cannot be taxed (and taxes therefore do not matter for the ultimate downside). Hence, the downside risk (and thus volatility) increases with lower tax rates.

Global Operations, Lower Taxes

Globalization and the internet enabled companies to do business across the globe and to simultaneously export their tax money to more favorable tax nations. As a result, while the corporate income tax rate in the United States is 21%, effective tax rates of companies in the S&P 500 are often much lower.

The OECD warned that there is no deal in sight on a digital services tax. When this tax does not arrive, countries will tax digital companies on their own initiative. This can lead to further trade tensions, especially between the EU and the United States. The technology stocks that lead the stock markets to the new all-time highs may be caught in the crossfire.

Other multilateral tensions can also have a large negative impact on the business environment. On the one hand there is a hard Brexit coming up at the end of this year. On the other hand there is the trade war between China and the United States. With the shift to renewable energy being accelerated, it would be more devastating to have some of the OPEC countries added to the mix as well. Hopefully, it will not come that far.

Are Low Taxes Sustainable with High Debts?

If multilateral tensions were not enough to put the low tax environment, enabled by a global network of operations, at risk there is another elephant in the room: the government debt of the United States. An increase in the corporate income tax rate may become inevitable with the government debt to GDP ratio almost as high as in the post-war era, especially when powerful external factors force the United States to do so.

Just imagine the world where the United States loses its power and needs to recover its debts by increasing tax income. The United States will only grow angrier at foreign nations when they are taking some pieces of the large profit pie of the Silicon Valley technology darlings.

Negative Outlook for the United States and the US Dollar

While many respectable government bonds in the Western World are rated AAA by the rating agencies (the highest rating possible), the United States saw its AAA reputation crumble over the past decade.

Standard & Poor’s already lowered the rating of the United States back in 2011 and has never put it back to AAA since (ironically, the cause to do this back then were budget deficits). Fitch changed its outlook for the United States from neutral to negative as recent as July 2020. In my opinion it is a significant signal that even the rating agencies start to put the powerful United States on a lower pedestal. What I know for sure is that disputed elections and civil unrest will not do the credit rating any good.

This is especially a large problem for a country like the United States, which has been able to operate in a very privileged position in the global economy for almost a century. Where other countries need to keep their budget deficits limited, the United States has always been able to simply print more of their own reserve currency. When this luxury disappears, the global financial system will be shaken at its core.

No Alternative, No Worries?

This will not happen soon though, as there currently is no viable alternative to the US Dollar. Other countries would need to become inventive to use Gold, Bitcoin, or their own trust systems and currencies to find a better alternative, while pulling the United States down to their own level in the process. This may be a case of mutually assured destruction, where countries may decide to keep things the way they are.

Whoever may win the upcoming elections (Biden or Trump), each of them will have a hard decision to make. The United States can either cut back on stimulus and increase taxes to improve its financial position while risking the economy in the short-term, or it can continue on its current path (without improving multilateral relationships) while risking its privileged leadership role in the global economic system.

Coronavirus Scenarios

The coronavirus is ever increasing its presence in the Western World, mainly due to increased testing capacity. While the vaccine trials turn out to be less successful than anticipated and research for treatments is also paused, the spread may only accelerate during the winter, while decreasing the public’s morale. Remember that in March and April, we were entering spring (at least in the northern hemisphere). Right now, we are early into winter with the headwinds only becoming fiercer.

In my opinion we can plot the future impact of the coronavirus in four quadrants, based on the actual impact of the virus on the public’s health (which is still questioned by many) and the measures imposed by governments. This results in four scenarios.

Scenario 1: High impact on health and no measures

When governments do not impose strict measures and the impact of the coronavirus in the winter turns out to be high, this will result in a public health disaster. The outcome for the stock market and business environment will be negative long-term, with possibly a positive impact on the short-term. Given the statistics, I think it is safe to say that the coronavirus more likely has a high than a low impact on public health (of course still with a lot of unknowns). In my opinion, the United States is especially vulnerable when Trump wins the election, as he will likely opt for as little measures as possible.

Scenario 2: Low impact on health and no measures

When governments do not impose strict measures and the impact of the coronavirus in the winter turns out to be minimal or fading, business can continue as usual and both the short-term and long-term implications are positive. However, on a global scale I do not think this outcome is very likely. If Trump wins the elections, this gamble may have an unexpected favorable outcome for the stock market and the global economy.

Scenario 3: High impact on health and severe measures

When governments do impose severe measures and the impact of the coronavirus in the winter turns out to be high, this will be a severe blow to the economy both short-term and long-term as the public will fully focus on fighting the virus again. This scenario can possibly be a domino push to the other factors mentioned in this post. I think this outcome is most likely when Biden wins the elections, as he likely wants to show what he is capable of in fighting the virus from the start.

Scenario 4: Low impact on health and severe measures

When governments do impose severe measures and the impact of the coronavirus in the winter turns out to be low, this will be a public farce as the measures would be unnecessary. As mentioned before, I do not think this is likely. However, it is still a possible outcome to consider. In my opinion this scenario will also have a negative impact on the economy both short-term and long-term.

In short, I do not see a way in which a resurgence of the coronavirus will have a positive impact on the economy and the stock market. If the cases and death rates pick up severely and the election in the United States becomes heated, the stock market may become a scary place.

Portfolio Implications

You probably have been waiting for the actions I am taking with my investments. Well, here they are. It is mainly a matter of allocation, as I am not planning to walk away from the stock market altogether right now. At the moment, I am preparing my portfolio for different scenarios and I will gradually take steps depending on how the world around us develops. The trends I am preparing for are negative real rates on the one hand and high market volatility on the other.

Sell Stocks: Suez ($SEV.PA) and Veolia ($VIE.PA)

First, I got rid of cyclical stocks that were, in my opinion, not trading at a discount. I think Veolia is quite fairly priced right now, while I see some negative developments ahead. Veolia did quite a high bid on a minority stake in Suez, for which it needs to only further increase its debt. Suez sees this as a hostile takeover, so it will take Veolia quite some effort to complete this. As a result of this move Suez shares appreciated in value by over 50%, putting the valuation at a level I did not expect this soon. Given the downside risk, the market developments and the upcoming fights with Veolia (and possibly market authorities) I chose to take the profits on these stocks and leave them on the watchlist for later.

Stop Loss (Overweight) Stocks: HelloFresh ($HFG.DE), Nano-X ($NNOX), Boskalis Westminster ($BOKA.AS), EBARA ($EAR.F), Signify ($LIGHT.AS)

Some stocks had quite a run. Their positions became a little too large for my portfolio. Therefore, I decided to put a stop loss on a part of my holdings in these stocks. The rest I intend to hold long-term. I already sold 40% of my holdings in EBARA and put a stop loss on 30% to 40% of my positions in Boskalis Westminster and Signify. I put stop losses on two price points on all my holdings of HelloFresh, simply because if the stock will underperform in the short-term in a stay-at-home economy, I do not see a place for this stock in my portfolio for the long-term. My stop loss on Nano-X is unchanged, as I already had this in place at my initial buying price (this is truly a speculative position).

Hold Stocks: Nikon ($NKN.F), Bell Food Group ($BELL.SW), Publicis Groupe ($PUB.PA)

Nikon, Bell Food Group and Publicis Groupe are on my list for further research to make a final decision on. Long-term I still see a place for these stocks in my portfolio, so right now I intend to keep my holdings unchanged. I do have to admit that I added a little bit to Publicis Groupe after they gave an update on their Q3 performance, which was really to my satisfaction. I also added to my Bell Food Group position at the beginning of the month to build it out into a normal position in my portfolio.

Buy Stocks: Unilever ($UNA.AS), Ahold Delhaize ($AD.AS), Flow Traders ($FLOW.AS)

There are some stocks I currently want to increase my exposure to when they cross a certain price point. I already added to my Flow Traders position to prepare for more volatile times with a part of the proceeds from Suez and Veolia, and I put buy orders out for when the price crosses through some lower limits (I expect the price to possibly decrease after they announce their Q3 earnings). Ahold Delhaize is close to a point where I am really keen to significantly increase my holdings, because they will really be able to benefit from new lock-downs through both their regular positions in the grocery market as well as their online propositions. I expect Unilever to be negatively impacted by lockdowns on the short-term, but that will really only be an opportunity to increase the long-term position I already have.

Asset Allocation

My asset allocation changed slightly as I put the proceeds from the sale of Suez and Veolia equally into Gold and Flow Traders. I intend to increase my cash holdings with my monthly savings going forward so I can benefit from opportunities when they present themselves in a more volatile market environment.


No one can predict the future, but as we are all active managers of some sorts (at least partially) I think we bear the responsibility to limit our downside risk on the short-term to ultimately benefit on the long-term.

I am really curious what you think about the upcoming months and whether you think the steps I am taking are wise. So what do you think: is winter actually coming, or will George R.R. Martin never finish his book?

2 thoughts on “Winter is Coming

  1. Great article again!

    You really reminded me Pikety with Capital in the 21st century.

    I see trend of social unrest, mainly due to the increasing wealth gap, as unreversible.

    The things that you point out are only increasing the wealth gap. Hence populism is on the rise (see US and the UK as an example)

    Having dark thoughts and having said that: I still believe we’re better if by being invested in the stock market over then next 50 years 😉

    Liked by 1 person

    1. Thanks again. This one took some time because I also really wanted to think about the implications for my own portfolio. It was a hard decision to sell Veolia and Suez, but I am now actually glad I did it

      I heard a lot about Pikety, but never actually read it. Guess I have to add it to the reading list

      Personally, I do not see this as dark, but necessary thoughts. There are multiple ways to interpret the data. Human society is just too complex for one singular outcome. I like to believe all these factors and indicators are the result of people trying to do good, and new actions will be taken to make the wrongs right again. It will be a sequence of actions, and we will just be small individuals in the whole of society. The conclusion for investors in my opinion is to make sure you are not caught up in a wrong portfolio balance. In the long-term, I agree with you – key businesses with cash generating assets will never go out of fashion


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