Imagine, if you will, a man wakes up from a year-long induced coma—a long hauler of a higher order—to a world gone mad. During his slumber, the President of the United States was impeached for colluding with the Russians using a dossier prepared by his political opponents, themselves colluding with the FBI, intelligence agencies, and the Russians.
A pandemic that may have emanated from a Chinese virology laboratory swept the globe killing millions and is still on the loose. A controlled demolition of the global economy forced hundreds of millions into unemployment in a matter of weeks. Metropolitan hotels plummeted to 10% occupancy. The 10% of the global economy corresponding to hospitality and tourism had been smashed on the shoals and was foundering.
The Federal Reserve has been buying junk corporate bonds in total desperation. A social movement of monumental proportions swept the US and the world, triggering months of rioting and looting while mayors, frozen in the headlights, were unable to fathom an appropriate response. The rise of neo-Marxism on college campuses and beyond had become palpable.
The most contentious election in US history pitted the undeniably polarizing and irascible Donald Trump against the DNC A-Team including a 76-year-old showing early signs of dementia paired with a sassy neo-Marxist grifter with an undetectable moral compass.
Many have lost faith in the fairness of the election as challenges hit the courts. Peering through the virus-induced brain fog the man sees CNBC playing on the TV with the scrolling chyron stating, “S&P up 12% year to date. Nasdaq soars 36%.” The man has entered The Twilight Zone.
– Dave Collum, “2020 Year in Review”
Perhaps the strangest occurrence during a year of strange happenings was the extraordinary rise in the share price of Tesla, which at the time of writing had installed Elon Musk as the wealthiest man on the planet. Here is a summary of what the author and veteran markets commentator James Grant, author of Grant’s Interest Rate Observer, had to say on the matter:
- Tesla was recently changing hands in the stock market at 1,000 times net income and 135 times enterprise value to EBITDA (earnings before interest, taxation, depreciation and amortisation)…
- … but more than 100% of its trailing 12-month adjusted “earnings” come from government-related regulatory credits, as opposed to operating income
- At the same time, there are now $17.6 trillion of bonds out there priced to yield less than zero…
- One has to wonder at the sort of logic that institutional investors are using as they buy instruments priced at these kinds of multiples. They are buying and selling “as if Benjamin Graham had never lifted a pen.”
That mention of Benjamin Graham should give us all reason to reflect. Benjamin Graham, as longstanding subscribers will know well, was the original “godfather” of value investing – the very man who taught Warren Buffett the principles of successful investing, as opposed to speculation. So it is ironic beyond measure that Warren Buffett’s very own holding and investment company, Berkshire Hathaway, has now been overtaken in market valuation by… Tesla itself.
Tesla is only the most notorious example of manic overvaluation within the generally overvalued market that is the US. I recommend you take the time to read Jeremy Grantham’s latest essay for the US fund management firm GMO, “Waiting for the last dance”:
The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.
These great bubbles are where fortunes are made and lost – and where investors truly prove their mettle. For positioning a portfolio to avoid the worst pain of a major bubble breaking is likely the most difficult part. Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in.
But this bubble will burst in due time, no matter how hard the Fed tries to support it, with consequent damaging effects on the economy and on portfolios. Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives. Speaking as an old student and historian of markets, it is intellectually exciting and terrifying at the same time. It is a privilege to ride through a market like this one more time.
By the time 2021 comes to an end, I suspect many investors will be using words other than “privilege” to describe their experiences of the year.
I have lived through a number of manic markets during my career – along with the resultant busts. 1994 was a particularly bad year for bonds, for example, after the US Federal Reserve unexpectedly raised rates – but the pain of that year for credit markets now looks like a blip in comparison to subsequent events. 1998 brought the Asian financial crisis and the collapse of Long-Term Capital Management. 2000 brought us the first dotcom bust. 2007 ushered in the global financial crisis, and things have never been quite the same ever since.
As Dave Collum points out throughout his magisterial annual summary of 2020, things have got distinctly strange in the US (and, of course, elsewhere) given the widening gulf between tech stock winners and the health of the “real” economy on the ground.
My strong suspicion is that 2021 will be the year when certain financial chickens come home to roost. One of them will be debt rollovers. As the fund manager Otavio Costa of Crescat Capital pointed out last year, “a tsunami of $8.5 trillion of US Treasury bonds will be maturing by the end of 2021. Monetary stimulus will have to be astronomic to cover this.” The economist David Rosenberg, on a related theme, opines:
The Central Banks are going to go into a new, non-conventional toolkit called debt monetization. They will lose control of the monetary base, and then we will go into a situation where, even with technology and with ageing demographics in the industrialized world, we will be talking about inflation again. That might come in the next 18 to 24 months, and gold is going to skyrocket.
One other truth that can barely speak its name is the loathsome way in which Big Tech has attempted to delegitimise (ie, cancel) the remaining days of Donald Trump’s presidency. Notwithstanding the fact that President Trump has a tendency to annoy precisely the very best people, he remains the US president, and is deserving of some respect – especially if you happen to suspect that the assault on the Capitol last week was the last throw of the dice of a contemptible and now desperate leftist cause resorting to “false flag” shenanigans.
Both Big Tech and Big Media have shown alarming tendencies to editorialise and politicise, over-delivering their core services. The negative impact on the so-called FAANGs (Facebook, Amazon, Apple, Netflix and Google) – whether from regulatory pushback, or advertiser boycotts – may yet be profound. I expect that this year will be a tough year for Big Tech, end of story. I may, of course, be wrong – which is why I never attach undue significance in isolation to big “macro” hypotheses.
How to be positioned? The Price Report model portfolio, and its overall asset allocation, give you my best thinking about maintaining a sensible balance of risks and potential returns. Jeremy Grantham offers the following advice:
As often happens at bubbly peaks like 1929, 2000, and the Nifty Fifty of 1972 (a second-tier bubble in the company of champions), today’s market features extreme disparities in value by asset class, sector, and company. Those at the very cheap end include traditional value stocks all over the world, relative to growth stocks. Value stocks have had their worst-ever relative decade ending December 2019, followed by the worst-ever year in 2020, with spreads between Growth and Value performance averaging between 20 and 30 percentage points for the single year! Similarly, Emerging Market equities are at 1 of their 3, more or less co-equal, relative lows against the U.S. of the last 50 years. Not surprisingly, we believe it is in the overlap of these two ideas, Value and Emerging, that your relative bets should go, along with the greatest avoidance of U.S. Growth stocks that your career and business risk will allow. Good luck!
The eurozone may, this year, finally become the flashpoint so many of us have been expecting for so long. The financial analyst and historian Russell Napier makes the following observation:
The governments of the euro zone have taken to the job of money creation with the same alacrity as everyone else, the only problem being that the money creation for the 19 sovereign states is supposed to be centralised at the ECB. We have now entered a world where commercial bank balance sheet control and thus money creation is devolved to 19 sets of politicians, with 19 differing political agendas; there will be no single monetary policy for the euro zone. The pursuit of financial repression at the sovereign state level in the euro zone is entirely inconsistent with the operation of a single monetary policy and thus the continued operation of a single currency. Every developed world country has the same problem and they will all seek the same solution, but in the euro zone the implications are of a different magnitude. The attempt to create a single currency, that all but bankrupted the financial system before COVID and has pushed unemployment to astronomical levels in some states, must now end if debts are to be inflated away. If one monetary policy to rule them all did not work, there is no way one financial repression to rule them all can.
But as we know, political projects die hard in the eurozone. The earliest formative experience of my career in the City was the pound sterling’s forced ethnic cleansing from the European Exchange Rate Mechanism (ERM) in 1992. That taught me that whereas central banks can kick around stock and bond markets more or less with impunity, the one market too big even for central banks or governments is the foreign exchange market. So I expect big foreign exchange rate volatility during the year ahead. (Make sure you own gold and silver.)
Given the nightmarish insanity of 2020, who really knows what 2021 will be capable of? My biggest concern, apart from the risk of a significant US stock market correction, is inflation. Suffice to say, I firmly believe this is a time for trying to ensure capital preservation in real terms over dreams of seemingly effortless short-term capital growth. The watchwords for all investors should include diversity; safety; stability; independence; permanence… and, again, gold.
As regards The Price Report model portfolio, the following three holdings currently stand out for me:
- Dunn WMA Ucits Fund. If financial markets get sustainedly choppy this year, systematic trend-following funds offer a realistic chance of making positive returns, because such funds are perfectly happy to sell markets short. Most conventional funds are constrained simply to sheltering in cash when things get rocky – ie, they can’t actually profit meaningfully from downside breaks or lasting bear markets.
- Central Fund of Canada/Sprott Physical Gold and Silver Trust. This is a one-stop shop offering exposure to physical gold and physical silver (on a roughly 50%/50% basis), listed on the NYSE and Toronto stock exchanges. Gold and silver remain my favourite crisis and inflation hedges.
- Baillie Gifford Japanese Smaller Companies. I still think Japan is one of the most attractive stock markets in the world, and it happens to have had a particularly good coronavirus crisis. Japan never locked down, nor obsessively tested asymptomatic people. Focused on smaller cap companies, this fund is more domestically focused so should be less vulnerable to the vagaries of fickle foreign investors who tend to concentrate on larger cap stocks.
Above all, be sure that you know precisely what you own, and why you own it, and what could plausibly go wrong during any periods of perhaps prolonged market stress. Then simply buckle up and enjoy the ride!
Until next time,
Tim Price is director at Price Value Partners and manager of the VT Price Value Portfolio. He is also the author of Investing Through the Looking Glass: a rational guide to irrational financial markets. He welcomes your feedback and any queries. Please email them to tim@southbankresearch.com.