The Big Picture Issue 16

In the short term the market is a voting machine in the long run a weighing machine.

Benjamin Graham The Intelligent Investor


Share prices in Global equities commodities and Bitcoin continued to rise over the quarter albeit with increased volatility. Investor speculation as to whether asset prices have been inflated into a bubble which will inevitably burst or given low historic interest rates continues. Negative real yields on cash and bonds continues to be the challenge for savers.

Our investment case is that the probability of a spike in inflationary demand in some sectors as the global economies start to reopen is real but that the perceived fear of substantial inflationary pressures as those experienced in the 1970’s is unfounded in the short term. Trillions of liquidity injected into the economy in the longest recovery since a depression following the crash of 2008 and interest rates held artificially low, has only managed to produce pockets of inflation in some sectors with a negative velocity of money (the rate in which money is exchanged in an economy). Individual entrepreneurial excellence has been unable to counter collective stupidity, resulting in asset price inflation without wage inflation. Consumers have therefore experienced an increase in living costs as the price of some staple and necessary goods and services has increased whilst overall prices have remained flat or decreased. I will further explain our rationale in the equity paragraph.

We expect to see an inflationary spike in some sectors, as economies recover, but the overall economic trend in the US and Europe, following Japan, is deflationary until the ‘output’ gap of the economy is rebuilt. In Spite of the recent announcement of the US Fed Chairman that interest rates would remain unchanged until 2023, with the increasing level of deficit spending and public funded and unfunded liabilities the four main Central Banks have no choice but to keep interest rates low. The US has an economy valued at around 80 Trillion USD any rise in interest rates would raise the cost of servicing the debt and deficit spending to a level that would plunge the economy into a deep depression and destroy the solvency of banks, something that the Central Bank is mandated to protect. This is also true of Europe and Japan.

Lower Equity Returns

Investors can expect equities to deliver substantially lower returns over the next decade than the last as P/Es revert to the mean. Understanding market cycles is fundamental if investors are to achieve their desired investment outcomes and not be panicked by sharp declines in market prices and resultant ‘bear markets’ which can take time to fully recover.

The current long term debt cycle and the shorter business cycle of rising equity and commodity prices driven by central banks monetary policy can continue as long as the Central Banks continue with their current policy however investors should be prepared for a sharp repricing of assets should that policy change or an unexpected event occur. Prices will revert to the historic mean which given the all-time highs reached in many indices the fall may be dramatic.

Diversification of market and business risk in a well thought out investment strategy and the discipline to stick to it is the only safeguard to irrational behavioural errors. The belief that you can time the market and know more than the market, which is made up of all investors and speculators, is delusional. No one can time the market with any degree of accuracy, and no one knows anyone who can! The cost of being out of the market over time is far greater than not being in it and severely impairs long duration investment returns.  Our investment philosophy and strategy are predicated on the belief that optimum risk adjusted investment long term returns will be achieved for most investors by accepting the market rate of return and market risk by indexing for the core of their investment strategy and staying the course. The discipline of rebalancing against a target asset allocation will ensure selling high and buying low and enhance returns. However, this practice will require strong mental fortitude and conviction in the allocation of capital and strategy in times of severe movement of market prices which we are likely to experience. The Shiller P/E ratio shows that investors should prepare for a decline of 30 – 40% in equity prices in the US and Europe for valuations to return to the historic mean.

Emerging From Covid

Perhaps due to cultural, social, and political differences the Asia Pacific region has emerged from the pandemic faster than the US or Europe. The world went from panic in March of last year to hope through the summer to fatigue during the autumn as the lock downs and restrictions continued. It is too early to gauge the economic damage as large parts of global economies have been and still are shut down. Our view is that as the figures emerge and Governments pressure populations to be vaccinated, we will see an increase in insolvencies and unemployment as stimulus support ceases. Payments hitherto frozen, like mortgages and insurance will need to be paid. Tax deferral may also be amended as the tax offices will seek to aggressively tax to replace lost revenue. The EU has just confirmed an amendment to its Tax code DA37 which in an effort to increase transparency for the public now tax digital platforms operating within the EU member states or if registered there will tax their foreign activity. Operators are now required to report sales volume, income, business activity and jurisdictions. This information will be automatically exchanged between member states tax offices. By Q3 2021 a proposal will have been made to tax all Crypto and Fintech activity registered in member states irrespective of where their revenue streams arise. Investors should assess returns on capital invested on a net of tax basis.


Forecasting tells is more about the forecaster than it does about the future.

Warren Buffet

The Bond gurus are now smiling again as US 10-year treasury yields, the benchmark for global credit. have risen from 0.50% to 1.5% (Bond yields move inversely to prices). This move has been dramatic with prices at the long end of the treasury curve, the 30-year Bond declining by 14% this year. 

It is dangerous to substitute your own research for opinions of so-called Gurus who have been made into investment celebrities courting their own cult following on social media. Equally damaging to successful investment outcomes is much investment newsletter editorial whose business model is to sell newsletters at the expense of investors capital! Selling newsletters requires captivating narratives. Recommending investments that appeal to speculative desires is unlikely to enhance overall long-term returns.

Celebrity ‘Gurus’

Close scrutiny of the Gurus and their all too readily accepted opinion on future events which is unknowable, shows that the amount of money they made to give them Guru status, has been made by overcharging for investment management and advice at the expense of the return on capital of investors. Further study reveals that in all cases the annual compound outperformance of returns is built on years past in less challenging times and performance in recent years in most cases has been mediocre to poor. Most, if not all, report their returns on a time weighted basis which mis represents the actual investment experience of investors. If investors fail to understand this, they set themselves up to be victims and are unlikely to achieve optimum investment returns over the long term. As behaviour psychologists teach, trying to decide when to cross the road in heavy traffic is a decision based on probable outcomes and there is never an exact or correct time to cross, simply a relative result which can be fatal. As Tom Wolfe writes in his classic the Right Stuff.’ in the context of the test pilots of the first jet engines of the 60’s

There are Old Pilots and Bold Pilots but no Old Bold Pilots

Trading volumes show speculators taking the largest short position against US treasuries in market history on the expectation that inflationary pressures will grow significantly. Our view is that this is misplaced and that Bond yields may fall again back to their lows with possibly negative nominal yields.

Central Banks Cannot Produce Inflation

So, is this important and what is the evidence to support our investment case? As I have written in previous newsletters the global economy is weak, not robust. In Spite of unprecedented liquidity from the four main central banks productivity and the velocity of money has remained negative. Wage inflation as a result of economic growth has not happened. The huge wall of money issued by the four central banks has kept the economy from a severe depression perhaps worse than that in the 1930’s but has not produced sustainable economic growth. With the effects of globalization ended under the Trump administration, the pandemic has put more pressure on distribution supply lines increasing what economists call the ‘output gap’ driving down inflationary pressures. Since the financial crash of 2008, Central Banks have kept interest rates artificially low effectively taxing savers by forcing them into risk assets with greater tax revenue potential.

The US Treasury, the deepest most liquid market in the world and the German Bund, the safest paper in Europe both give investors a negative real yield (nominal interest minus inflation) guaranteeing that investors will lose capital unless interest rates fall further. A very poor investment proposition, unless prepared to forgo capital appreciation in return for the safety of nominal capital invested with the Government or speculating on the direction of interest rates. The CPI index is a poor indicator of inflation as it does not include social security payments nor investments so does not factor in asset price inflation of the past 12 years and nor stimulus check payments for Covid relief.

The Economic Money Multiplier

As I have dealt with in previous newsletters due to the Fischer equation, having reached the tipping point of excessive debt to GDP an increase in the money supply does not produce inflationary pressure. The tipping point is 90% debt to GDP where for every US Dollar of liquidity created by the Fed results in 30 cents of productivity.

The US debt to GDP in 2016 was 107% at the end of 2020 it was 125%!

This can easily be evidenced by looking at the ‘velocity of money’. The US congressional budget office’s figure for current inflation is 1.6%. Whoever ever compiled that does not buy their own groceries! A study of economic history shows that due to different supply and demand factors in different sectors of the economy and social groupings it is possible to have inflationary spikes during times of disinflation (downward pressure on prices) and deflation (falling prices) where we are now. Caused by excessive debt, a negative money multiplier, demographics, and technology. The rich will not experience inflationary pressures from Life Assurance as they do not need it, but they will on a case of vintage Marques de Murrieta Castillo Rioja or their next supercar, yacht, or piece of art. The less well-off will experience inflation on consumer items and services but will not be concerned with luxury goods and services which they cannot afford.

They all benefit from deflation caused by technology as they buy cheaper smartphones, computers and speak via video across the globe for free as the network effect of Fintech has driven down the cost to practically zero. Millions have also benefited since John Boggle’s legacy of the Not-for-Profit investment company Vanguard in 1976 of paying just 0.05% pa to participate in ownership of shares of common stock in the 500 largest companies in the US, which sparked a bidding war driving down costs of mutual funds and ETFs.

However, this does not mean that inflation pressure is not real across some sectors of the economy. A careful study of all economic data globally, which we do on a weekly basis, is necessary and revealing.

Disinflationary Pressures

Why is it important? The global economies, with the exception of a short time in the 1970s when developed countries equities tumbled in the grip of stagflation, have had 40 years of benign inflation. Central banks and Governments have become obsessed with inflation as they fear deflation. Inflation is bad for prices of common stocks (equities) and commodities in the short term as governments put up interest rates to cool the economy which increases the cost of capital for businesses putting pressure on profit margins. However, Governments of the US, Europe, UK, and Japan are now so indebted that they cannot afford to increase the cost of servicing the debt and more central bank liquidity is not inflationary. Japan is unique in one respect that the Japanese unlike the US own their own debt.

However, what could change this suggested scenario? Armed conflict by proxy between the superpowers, which should not be altogether ruled out or a re-examination and amendment of the Federal Reserve Act of 1913. Again, as I explained in last quarter’s newsletter, the Fed cannot print money; it is a convenient euphemism. Under the current administration the treasury secretary is a labour economist and believes as she has stated publicly in ‘universal credit and income’ Congress has authorized as a temporary measure the payment of social security checks directly to the people.

Oversold Bond Market

There is nothing so permanent as a Government declaring something temporary.

Milton Freidman

We saw this in the aftermath of 9-11 when airport security was temporarily brought in, we still have it today. Should either a disrupting event take place like armed conflict or should in the current US administration there be the political will to amend the Federal Reserve Act of 1913, then the central bank will be able to give money directly to the people which will lead to a spike in inflation and possibly hyper – inflation.

Without that contingency and If examined carefully, which we do regularly, the data in the US simply does not bear out the expectation of a spike across the board of damaging increasingly high inflation. As long as Central Banks keep ‘euphemistically’ printing money and banks are reluctant to lend, asset prices will continue to inflate as money goes into the stock market at the expense of jobs and the real economy. Unless their policy changes during this administration.

Stimulus checks for Covid and as the vaccine roll allows economies to open increased demand will result in an inflationary spike in some sectors but the effects of technology and demographics are disinflationary. US treasury Bonds are oversold with CPA machines programmed to sell down any rally. Our view is that the combination of the inability for governments to service existing debt and deficit spending with an increased interest rate, coupled with the expectation of inflation which is not supported by all the economic data will result in lower treasury yields in the US and higher prices and in Europe flat yields on the German Bund. We hold a modest position in nominal inflation – protected US treasuries in our USD strategies and nominal German bunds and inflation protected treasuries in our Euro strategies.

Corporate bonds are increasingly declining in quality through leverage. This together with a callable option is not reflected in the rating nor price and present a poor risk reward outcome. Since the Fed backstopped the high yield corporate bond market last March price discovery has been removed and mispricing difficult to ascertain.

If after rigorous analysis a company is worth investing in, then owning the common stock is likely to present more attractive outcomes than owning the debt unless having expert knowledge and being able to ascertain mispricing of credit. We prefer to own common stocks as the core of our strategy through indices. We do not own any corporate bonds in our investment strategies.



GDP growth, much touted by Government’s economists, does not translate directly into profits. Products sales respond to different cycles. Most of the time economic growth dominates the sales process rising strongly when GDP growth is strong less so when growth declines. However, the linkage between economic growth and company profits is not efficient nor perfect. In financial and market cycles most excesses on the upside and the inevitable reactions to the downside, which tends to overshoot, as a result of exaggerated swings in prices. The pendulum of investor behaviour oscillates between greed and fear; excessive optimism and pessimism; tolerance of risk and aversion to risk; credibility and scepticism; faith in value in the future and insistence of value in the present; and between the urgency to buy for fear of missing out in a rising market and panic to sell in a falling market. By and large common stocks in the long run produce returns in line with the sum of their dividends and the trendline growth in corporate profits on the historic meridian line of mid to high single digits. When they return much more than that for a while, returns are likely to prove excessive. In essence borrowing from the future increases the risk of owning stocks. We are in this cycle now. A downward correction is not only in order but necessary. Long term investors who understand this and stay the course will see this as a buying opportunity. In an increasingly volatile market if you are not a contrarian you will be a victim.

Increased Volatility

The stock market does not produce information, it provides a buying and selling facility. Our investment strategy of regularly rebalancing against our strategic asset allocation target allows us to optimise desired risk adjusted returns by buying more shares when prices fall and taking profits when prices rise strongly whilst more importantly ensuring that the market risk remains in line with an individual mandate.

March 2021 has been as damaging to the US equity market as the single day decline on March 23rd, 2020 at the outbreak of covid.

In the span of a month there were 8 days with losses of 3% or worse including 4 drops during a day’s trading of 5% or worse. There were also 7 daily gains in excess of 6% and of 3%. Out of 21 trading sessions only one did not have a price movement of less than 1%. As this volatility is likely to continue investors must embrace this or become a victim of behavioural errors.


Equity markets in Europe have recovered strongly from an oversold bottom due to ECB monetary policy and covid relief checks. Europe has been plagued by political infighting amongst EU member states and a relatively poor handling of the pandemic crisis. The economy was weak going into Covid and has been further weakened by economic shut down. However, European stocks have been supported as in the US by monetary policy which has resulted in asset price inflation whilst wage inflation has remained flat or negative. As long as the ECB keeps creating liquidity asset prices will continue to rise. As in the US the stock market is disconnected from the real economy. This quarter has seen some signs of a recovery in confidence with the Euro Stoxx index returning 39.89% over 12 months and 8.27% this year.

We hold an allocation to European equities in our euro investment strategy.

Emerging Markets

Emerging markets have benefited from a weak US dollar and have emerged faster from the pandemic. They were also experiencing less severe economic lockdown. In general, with the exception of some Chinese stocks and technology giants. Common stock valuations are lower than the developed markets. Returns on stocks since the pandemic have been strong and have contributed to the MSCI global index returns of +5.46% 3 months and 41.9% 12 months.

Supply lines are being restructured as a result of covid and the collapse of globalization. A shortage of semiconductors has led to a decline in auto production. China has a 43% weighting in the MSCI EM index and was the first economy to be shut down in the pandemic and the first to recover. China is the only economy with positive GDP for 2020 and a positive real interest rate. The move away from globalization under the Trump administration and the pandemic has made some nations more distrusting of China. The risk to global supply already disrupted is geopolitical. Taiwan is the main producer of semiconductors under US licence and is a constant target of the Chinese media threatening invasion and a red line for US foreign policy in the region. SE Asian economies has a weighting of 66.6% in the MSCI EM Index. Several independent sources report that China needs another 2 years to reach the same level of semiconductor construction and quality as Intel. With the world being concerned with the pandemic China has been leveraging its soft power built up through decades, particularly in Africa which is rich in the natural resources China needs. The global supply of cobalt required to make batteries comes from Congo.

India a 11% weighting in the MSCI EM Index is a sleeping economic giant and is recovering relatively well considering the size of its population from the pandemic. India, the world’s largest democracy shares a border with China and is a natural trade and political ally for the US against the expansionist ambitions of the Chinese communist party. A weakening US Dollar has been supportive of EM equities. The index has risen. We hold an allocation to Emerging Market Equities in our investment strategies.


US REIT index has recovered strongly showing a 6 month return of +16% from the lows of Oct 2020 which unlike the risk-free rate of treasuries is a positive real yield of around 1.5% (nominal dividend yield of 3.6% – 1.6 inflation) Non-traditional sectors like independent storage, online warehousing. Health care, data storage, and data towers have performed strongly and form 40% of the US index.

Europe has fared less well with the index returning 17% over 12 months. REITs in Europe are more concentrated on traditional sectors of real estate both in the commercial and residential sector. REITs display equity and bond-like characteristics and give investors a high level of present income, low transaction costs and act over the long term as a hedge against rising inflation. REITS with economies of scale have outperformed bricks and mortar real estate producing around 15% pa average returns over the last 20 years.

Rent delinquency amongst REITs have been surprisingly low during the pandemic. This however could change as we move into a time of insolvencies and government suspension of social security payments.


The US Dollar Index began to strengthen, having been weak during 2020 moving from a 2021 low of 012.68 on 31.,03 to 110.73 on 31,03.

This resulted in an unrealised forex loss on non-US currency positions.

USD – AUD declined during 2020 to a low of 1.26 22/12 to 1.31 03.04.2021.

GBP – Euro gained from a low of 1.08 on 13.09.2020 to 1.17 on 01.04.2021.

USD – Euro strengthened from a low of 0.82 on 04/01/2021 to 0.84 on 08/04/2021.

We do not allocate capital to currencies but seek to diversify forex risk by maintaining target allocation of 25% exposure to forex as dictated by the underlying securities.



The Gold price moves on fear. The current concern is the central banks competitive devaluation of money (FIAT) and the destruction of purchasing power over time. The Gold price is directly correlated with the US 10-year treasury yield which has risen this year from 0.50% to 1.50% through speculators selling and shorting US treasuries on a perception that inflation is rising (price moves are inversely correlated to the yield). This has driven down the price of Gold producing a negative return – 0.56% this year. However, the investment case for owning Gold is stronger than last year and is undergoing a cyclical price decline in what is the third secular Bull market in Gold since 1971. As long as the main central banks continue to create liquidity the price of Gold will be much higher in the next 5 years. We have an allocation to Gold Bullion and Gold mining stocks in our investment strategy.


The price of Bitcoin has continued to rally this year. Adoption for allocation of Bitcoin as a treasury asset for CEOs and Boards of companies has driven the price higher. This is not the same narrative of retail investors that produced the bubble which burst in 2017.Bitcoin has established as a brand and towers over other Crypto tokens in terms of adoption and capitalization. The risk is Political. The regulators are uncertain how to treat it? As a security or a commodity. As corporate adoption grows and boards hold Bitcoin as a long-term capital preservation asset to replace short term treasuries and cash, regulators will be forced to regulate. Regulation will allow institutional boards to hold Bitcoin also as a treasury asset and Banks to provide custody. This will eventually have the effect of decreasing volatility.

Nevertheless, Bitcoin is a speculative asset which is still in the early stages of adoption and has the potential to produce 10X returns in the short time. Speculators and investors however need to remember that a parabolic rise in price is never permanent and the price of Bitcoin could well halve before continuing to gain more adoption. We have allocated capital to Bitcoin in our investment strategy owned as a securitized electric traded note (ETN) listed on the Stockholm stock exchange and held by our custodian.

Jeremy Blatch TEP
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