Beyond The Headlines
PERMA-BEAR, NO. BUT PERMA-SKEPTIC?
In a 2016 article entitled “Why Does Pessimism Sound So Smart?” Morgan Housel mentioned the English philosopher John Stuart Mill. It was Mill’s observation,150 years ago, that the individual most admired as a sage is “not the man who hopes when others despair, but the man who despairs when others hope.” At Sicart Associates, as convinced investment contrarians, we agree with Mill’s perception. Pessimists do often appear smarter than optimists because they acknowledge the complexity of situations and thus appear profound. Optimists, in contrast, tend to be perceived as superficial or naïve.
In the last ten years, I may sometimes have come across as a pessimist regarding the stock market. I don’t think this has made me look particularly discerning as stock prices kept rising, but I definitely am not a perma-bear. On the contrary, I consider myself an optimist since I am constantly looking for opportunities to invest, as I have during my whole career through bull and bear markets alike.
“Being Right or Making Money” – This is the title of a book by renowned market strategist Ned Davis, and the question it implies is utterly legitimate. The answer depends on what you desire in life: to make guesses or predictions that will flatter your ego when you are right? Or to build a quiet fortune over time simply by being right a bit more often than you are wrong?
I was reminded of this when looking at the short history of our very small private fund, which we started on April 1, 2020. As a rule, we have eschewed in-house funds to avoid the many potential conflicts of interest between the firm and our clients. But we needed some kind of published indicator of Sicart Associates’ performance. Most of our accounts are custom-managed individually to take into consideration the goals and family circumstances of each client, as well as the tax considerations in their countries of residence. So, we decided to create this fund, which generally mirrors the main investment positions of the firm. Its performance track record is available upon request. At this time, the partners of the firm are its only investors.
The point of this long explanation is that since the fund’s inception, in spite of generally successful stock picking as reflected in the equity portion of the portfolio, we have basically been wrong on the trend of the stock market. Our economic and market views have been cautious and defensive, as reflected in the high portfolio levels of near-zero-yielding cash and presumably-protective positions such as gold. Still, the market has continued to rise to new highs.
The brief existence of this fund makes performance figures irrelevant; nevertheless, here is an overview versus the indices.
Since the fund’s inception, the S&P 500 is up 44.9% and the Nasdaq up 66.8%. While we have beaten these indices with the equity portion of the account as a whole account (which includes cash equivalents as well as gold and small protection derivative ETFs), we were slightly below the indices, net of fees.
However, I believe that being “wrong” in the short term has not penalized us in a long-term perspective. We obviously could have made more money by being “right,” but what I view as our long-term goal of letting compounding work to build our wealth has not been interrupted, as it would have been by a severe loss. And we still have ample “dry powder” to seize future opportunities when they arise.
The “FANGs Are Not the Market, and the Stock Market Is Not the Economy CMG Wealth’s January 15 issue of Steve Blumenthal’s “On My Radar” lists the following statistics of 2020 stock market performance:
S&P 500 Index: 18.40%
S&P “6” equal-weighted: 49.32% (Facebook, Apple, Amazon, Alphabet, Microsoft, Netflix)
S&P “494” * equal-weighted : 4.05%
It is clear, therefore, that if 6 of the heaviest tech stocks are excluded, the remaining 494 stocks in the S&P 500 index do not come close to the “official” performance of the leading US stock market index.
Similarly, the last ten years have amply demonstrated that the economy and the stock market are very different animals. The economy has recovered from the Great Recession of 2007-2009 through fits and starts, further aggravated by the COVID-19 crisis, while the market has experienced a seemingly irrepressible rise, only interrupted by a couple of brief corrections.
The dichotomy between the market and the real economy, especially over short and medium-length periods, is not news. It has been amplified since the invention of the “Greenspan put” in response to the 1987 crash, and that evolved into the “Fed put” after subsequent Federal Reserve Bank chairs adopted similar policies. The principle of these policies is to pump liquidity into the economy at the first sign of weakness. Since the stock market is widely viewed as a leading indicator of the economy, the policy has increasingly meant to pump liquidity into the economy at the first sign of stock market weakness.
But monetary policy is a macro-economic tool, not particularly adapted to stimulating specific sectors of the economy – a dilemma which I once likened to trying to fix a carburetor while wearing boxing gloves. This is a disadvantage in normal times, and it was already felt in the uneven recovery from the 2007-2009 Great Recession. But it really began to create severe imbalances during the COVID-19 crisis, when whole segments of the economy were decimated, such as travel, hotels and restaurants, retail stores, etc., while others prospered, such as internet shopping and do-it-yourself home improvement.
Among consumers, a large proportion of the population had little or no accumulated savings and minimal access to credit when COVID hit. They required basic government help just to survive layoffs or furloughs. For those consumers, the pandemic period was, at best, one of suppressed spending. For the more fortunate ones, who kept their jobs or their small businesses, the inability to travel, visit restaurants, or enjoy weddings and other gatherings resulted in forced additional savings.
For businesses, most of which had access to cheap borrowing, the high level of economic uncertainty dissuaded many from investing that money in long-term opportunities. They often preferred to buy back their own shares in the stock market, buoying both their reported earnings and the major market indices in the process.
The net result of these trends was that much of the liquidity created by the central bank (through either money creation or lower interest rates and easier credit) was either not received or not used by large segments of the economy.
“Liquidity” is a somewhat elusive notion that may describe either ownership of liquid assets (cash and other very short-term, saleable investments) or easy access to cash through borrowing. My observation, over the years, is that liquidity created by central banks tends to flow as in communicating vessels: it enters the financial markets first, boosting the price of financial assets, but eventually finds its way into the “real” economy. When the real economy accelerates and requires more liquidity to function, the financial markets’ “vessel” empties, depressing the price of assets such as stocks and bonds. Hence the paradox, and the explanation of the dichotomy between the economic and the stock market performances.
The net result of easy-money policies, from the “Greenspan Put” to QE (Quantitative Easing) and now ZIRP (Zero Interest Rate Policy), has been to constantly prop up stock valuations without allowing the market to “purge” itself of excesses during more propitious economic times. This failure has been aggravated by the shape of the economic recovery.
While it was initially debated whether the recovery would look like a V, a W, or even a square-root sign, the consensus of economists seems to have settled on a K-shaped recovery. I am not sure how economists write their Ks, but this appellation is meant to describe an economy in which two different parts behave at very different paces. There is little doubt that investors whose assets have appreciated significantly in the last ten years have done much better than workers who depend on a salary or savers who must live on a fixed income.
With interest rates at zero percent or lower, there develops a frantic hunt for alternatives, marked by diminishing regard for safety considerations. Traditional income investors first crowded the High Yield (formerly known as “Junk”) space. Then they moved to “credit” and distressed vehicles with higher risk and fewer covenant protections. That is without counting many derivatives-filled products invented by mathematicians at the service of bank marketing departments.
On December 14, 2020, Financial Times editorial, Mohamed El-Erian argued:
“Nothing is more reassuring to an investor than the knowledge that central banks, with much deeper pockets, will buy the securities they own — particularly when these buyers are willing to do so at any price and have unlimited patient capital… The result is …seemingly endless liquidity-driven rallies regardless of fundamentals.” El-Erian concludes that while investors will continue to surf a highly profitable liquidity wave, for now, things are likely to get trickier as we get further into 2021.
Steve Blumenthal of CMG Management Group Inc. recently had a conversation with William White, the highly respected former Chief Economist of the Bank for International Settlements (a.k.a. the central banks’ bank).
Mr. White, who warned of the Great Financial Crisis of 2007-2009, famously believes that debt creation facilitated by central banks in recent years has materially weakened the world’s financial system and made it unstable. He argues that traditional remedies like saving more or engineering faster growth to facilitate repayment are not practical today because one might throw the economy back into recession and that already-high debt levels are likely to hamper growth anyway. This leaves two options: inflation, which raises nominal rather than real growth and thus makes repayment less painful as the value of money shrinks, or debt restructuring and write-offs. White advises a combination of these two, and they may also shape the eventual outcome.
Shades of the 1970s
As I was finishing this paper, I came across an editorial by John Authers, formerly head of the “Lex” column and chief markets commentator for the Financial Times, and now a senior editor at Bloomberg. He mentioned a name almost forgotten today except by economic historians: Nikolai Kondratieff. In the 1920s, this Soviet economist documented the existence of a cycle of about fifty years (47-60) in commodities prices, which he eventually labeled “the Long Wave.”
Like many of my Wall Street contemporaries, I spent quite some time in the mid-1970s studying the Long Wave as inflation was accelerating. Now I vividly remember the 1974-75 global recession and bear market in stocks (which, for a while, was attenuated for our clients by the foresight of my then-mentor and later partner Christian Humann, who had invested heavily in commodities and gold a few years earlier).
The more I think about the current situation, the more it reminds me of the early 1970s, coincidentally about fifty years ago. Of course, there are many differences between the two periods, but (as Mark Twain may never have really said) history may not repeat itself, but it often rhymes.
So when clients ask me about the future — which, as a rule, I don’t predict — I answer that with effective vaccines and massive infrastructure projects, it makes sense to anticipate a strong economic recovery within a couple of years, but that this may result in a drying-up of liquidity for financial markets, and ultimately, lower stock market valuations.
January 27, 2021
The information provided in this article represents the opinions of Sicart Associates, LLC (“Sicart”) and is expressed as of the date hereof and is subject to change. Sicart assumes no obligation to update or otherwise revise our opinions or this article. The observations and views expressed herein may be changed by Sicart at any time without notice.
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs, and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.