As stock markets, particularly in the US, continue to soar upwards, I thought it might be useful to summarize our views and forward-looking assessment of the current environment. Briefly put, the first half of 2020 was a tale of two very different quarters. January through March was characterized by significant falls across almost all global equities, as markets were severely battered by the impact of the coronavirus towards the end of the quarter.

The US declined by 20%, while Europe fell by 26%. Asia was slightly less impacted, with Japan and China witnessing falls of 18% and 14% respectively. In stark contrast, the second quarter was surprisingly buoyant, as markets forged ahead, driven by the twin catalysts of massive monetary and fiscal stimulus—not to mention the hope for an eventual cure for COVID-19. The continuing lack of attractive alternatives to stocks was also a significant factor in the rebound, as US equities made up almost all the ground lost in the first quarter.

Technology stocks were particular beneficiaries of these trends, with gains in the 38% range over the second quarter, while more conservative, value-oriented stocks rose by a relatively modest 14%. Partly due to the heavy technology weighting in its indices, the US as a whole forged ahead compared to the rest of the world, with the S&P gaining 20%. In contrast, Europe gained only 3%, while China, which appears to have the virus at least partly under control, surged by 19%. By the end of the second quarter, the market capitalization of the NASDAQ had grown to be almost equivalent to that of the entire rest of the world.

For both growth versus value stocks, and for the US compared to the rest of the world, this relative outperformance represented the continuation of a multi-year trend. For instance, over the last five years US equities have grown at an average rate of 11% pa, while Europe grew by 3.6% and Japan by 1% a year. Over the same period, in the US, growth stocks (often tech companies) were up an average of 14% per year, while value-oriented stocks gained 6%. Because of this, the price to earnings ratio of the growth portion of the S&P 500 now commands an extraordinary premium of close to 80% over the value index—almost three times the average over the last 20 years.

There are, of course, some justifications for these two phenomena. Corporate earnings in the US, partly propelled by tax cuts, have outstripped profitability in much of the rest of the world. Tech companies have generated outsized profits. Nonetheless, with price to earnings ratios and other valuation metrics looking extremely stretched for both US and tech stocks, at some point prices will have to face a correction.

The COVID-19 crisis obviously represents a massive political and economic risk for the entire world. So far, the US is failing to keep up with its global competitors in terms of dealing with the problem. The country has not shut down to the same extent as countries like Germany and Korea. As a result, American businesses continue to face the wrath of the pandemic, with more cases and more deaths than anywhere else in the world. America’s decision to prioritize the economy over public health may well end up backfiring in the remainder of 2020. On top of that, the political environment remains confused, with the incumbent president raising questions about whether he will accept the results of the upcoming election.

On the global front, economic stimulus has kept things moving forward for the moment. But given the uncertainties regarding the course of the virus, and its impact on employment and corporate earnings, it is hard to believe that stock markets will be able to continue their upward momentum for long. Thus far, government stimulus around the world has generally kept economies afloat. But there is a cost to using government subsidies to prop up consumer spending. They may buy us time, but they potentially undermine public faith in currencies (witness the surging price of gold), and are generating huge deficits—which, if inflation and interest rates eventually begin to tick upward, will be hard, if not impossible, to repay.

In short, while our somewhat conservative approach may seem cautious in light of recent market surges, given the multiple challenges we are facing I continue to believe that it is the correct course. Though we have by no means abandoned stocks, which continue to offer the best long-term source of performance, our long-held mantra of diversification by geography, by asset class, and by sector should provide some downside protection in a market which I believe has gotten ahead of itself. The use of alternative strategies, including investing in precious metals, as well as a hefty fixed income component, requires patience, but given the headwinds equity markets face it will remain an important part of our asset allocation strategy.