As I write, this will be the 9th Ein Harod Family Office BLOG since the pandemic. This is not an attempt to forecast future events which are unknowable nor is it a recommendation to purchase a security or make an investment.
Trees do not grow to the sky
Investment success is to position your capital to profit from future developments. With so much uncertainty this is a challenge.
When momentum drives investors’ sentiment then ‘trees euphemistically can grow to the sky’! Last week with a decline in equity prices negative -5% on the S&P 500; negative -4.7% MSCI All World Index and negative – 4.1% Euro Stoxx 600, showed that they do not.
Following a rally of +54% for the S@P 500 since the March lows, it was inevitable that investors take profits on any bad news. Last week there was plenty as news of a second wave of the pandemic promoted investors to take money off the table. Markets reflect human behaviour and emotion and are never rational.
What is further challenging investors in the current economic climate is that price discovery in the credit market has been made practically impossible following the Powel ‘PUT’ (The Fed bailing out corporations with weak balance sheets). I write as an ex credit analyst. The Fed Chair Powel has charted a verbal course for interest rates to remain in the zero -25 bps band until 2022. But no one seriously takes the Fed at their word!
They and other central banks have forsaken any semblance of fiscal rectitude and are comfortable increasing ‘moral hazard’ which will define the coming decade unless there is a seismic event to reverse their policy. Servicing of existing debt and unfunded liabilities is problematic and will be so for years to come. Current monetary policy in the long term is destroying the purchasing power of the USD Dollar. If the money supply is increased by 50% the purchasing power of money decreases by 50% given that demand and supply remain constant. This is inflationary. Too many dollars chasing too few goods.
Senator Connally famously said at the Bretton Woods conference in 1944 that the US Dollar ‘is our currency, but your problem’. Now it seems as if the Fed is saying it is our money and our problem as they are the de facto global lender of last resort.
Liquidity to insolvency
Central Banks have no ammunition left apart from cutting interest rates and buying equities, emulating Japan. It would not surprise me if the Federal Reserve Act is amended by Congress. The Fed by sleight of hand has recently been buying ‘junk’ debt from corporations. In the midst of this uncertainty and speculation we know that the ‘die is cast! Not just for the Fed but for all four major central banks. However, it may be a long time before the effects of the failure of collective responsibility comes through to move the inflation needle.
As investors we have to play with the hand we have been dealt and think about the unintended and intended consequences of policy makers action. The Fed by its action has increased ‘Moral Hazard’ amongst institutions to take more risk not less.
OECD economic estimates negative -6% GDP growth in the US for 2020 rebounding by 5% in 2021.
Estimates for growth in the global economy are predicting a declining growth rate of negative -6% at the end of 2021. Allowing for a second wave of the pandemic the growth rate would decline to negative 10%. This by any stretch is a severe economic blow. We do not yet know the full extent of the demand side shocks to the economy or how consumer confidence has been affected. Visa is already reporting a significant downturn in consumer spending and an increase in the use of debit cards. They herald this as a permanent change in consumer spending. A deleveraging in the private sector will support deflationary pressure on the economy. This is particularly relevant in the US where consumer spending is around 70% of GDP.
The markets seem to have priced in that not only will a vaccine be discovered by the end of 2020 but that it will be produced in sufficient quantities and distributed efficiently. This is anything but certain.
Don’t Fight the Fed
Since the lows of 23rd March, the S&P 500 has rallied 45%. The 200-day moving average is close to $3,000. European equities underperformed the US and have lost -17% YTD gaining at their peak 25% from March lows. But will this money pumped into the market by the Fed, ECB and BOE be enough to stimulate people to spend money and produce an economic recovery this year? I think not. Our all-weather portfolio is positioned for a long and slow recovery with a weakening US Dollar and near-term deflation or stagflation.
Is this time different?
The investment legend the late Sir John Templeton said, “the four most expensive words in investment history are This time is different”. But he added the caveat that 20% of the time it may be and that investors must be flexible and contrarian. As Warren Buffer likes to tell us ‘The price of a stock tells us nothing about a stock’ and can in fact be misleading. As the overall return on capital declines the amount that investors pay in costs from their capital increasingly gains importance.
Preserving capital or the purchasing power of capital will require investors to employ an unconventional strategy for allocation of capital. Our all-weather strategy is unconventional and seeks to preserve the purchasing power of capital through the economic cycles of deflation, stagflation and inflation.
It’s not stimulus
During the great recovery in the US since the recession of 2009, productivity has been flat, and the velocity of money has shown little increase. Productivity and the velocity of money are sound indicators to measure the growth of an economy. The story of the last 10 years in the US has been a buoyant stock market whilst record low unemployment, fiscal incentives and record liquidity from the Fed has neither increased productivity nor earnings growth.
It is wrong to refer to central banks pumping liquidity into the economy as stimulus. It has failed to stimulate economic growth. However, it has avoided a recession with keeping interest rates artificially low and creating record amounts of money but at the costs of exacerbating the very thing it was trying to prevent.
With the outcome of the Brexit negotiations still uncertain particularly in the area of financial services, trade and defence, sterling is paying a price but could be the beneficiary over the long term. As campaigning in the US general election now starts in earnest in the US markets could be in for a torrid ride.
This is not the time to be engaging with the market or devising an investment strategy. That homework should have been done a long time ago. Creating money cannot convince people to spend, it is too early to know how the trauma of the pandemic will affect people’s lifestyles.
Retail demand could be affected for longer than we would want. Many families and businesses have been caught out with insufficient savings relying on short term credit to fund a lifestyle. This may need to get worse before people have the desire and discipline to save again.
Another risk to be aware of is a potential escalation of EU and US trade tensions. Germany, France, Spain, and Italy have collectively proposed a new level of tax for multinational companies of at least 12% to 15%. The US is already expressing concern about digital tax laws which was the catalyst to slapping tariffs on China. France has aggressively defended the EU’s position sparking further ‘lively’ future discussions. Tariffs and a trade war are initially deflationary and then become inflationary as countries retaliate in force. No one wins. See the Smoot–Hawley Act in the US.
The US employment myth
In the age of the gig economy (people using IT and working several jobs not making a declaration) economists still have not worked out how to measure employment. So, figures are far from accurate. How was it possible before the pandemic to have record low unemployment with little or flat productivity and little earning growth with a low ‘velocity of money’ (the number of times a Dollar changes hands in a given time period)?
The data shows after close scrutiny that most of the jobs created were in the hospitality, tourism and the construction sector and were relatively low paying unskilled or semi-skilled.
We should approach government employment figures in Europe and the UK with the same scepticism. Employment figures are at best a lagging economic indicator and are a guide to what has happened. Markets are now extremely vulnerable to bad news and investors would be well advised to balance both their short and near-term expectations.
Jeremy Blatch TEP
Royal Institute of International Affairs (Chatham House)
The Age of Deleveraging by A. Gary Shilling
Mastering The Market Cycle by Howard Marks