A New Portfolio for the New Era
The virus-induced crisis we are living through bears the potential of shifting our perspective, making it more challenging to concentrate on the underlying currents and the trends that will shape the future. But that is of course the most important task of any long-term investor, regardless of the turbulences and noise of the moment. After all, Aristotle himself reminds us: “It is during our darkest moments that we must focus to see the light.” In an effort to help investors navigate today’s chaotic environment, we recently published a Special Report titled “On the Brink of a New Era - Are You Prepared?”. In the report, we analyze the big picture, politically, economically, and socially. We share our views on the “why’s” and “how’s” you should consider for protecting and growing your wealth in this “new era” we are headed into.
Today's unprecedented challenges - enormous debt, a recession, the COVID pandemic, a contested election, and the potential for more civil unrest in America, to name just a few - render such considerations absolutely necessary and very interesting, but also very complicated.
How will the U.S. elections influence our future? What are the risks for investors?
What are the consequences of excessive debt? What can governments realistically do to reduce it?
What are the critical implications for your wealth planning and asset allocation decisions?
How would you answer these questions? Have you considered them at all? Or, has the steady drumbeat of CNN & Co. dampened your senses and distracted you too much?
The news media are supposed to be about informing the public. A society needs reliable sources of information to function well. The purpose of the news media – the so-called “fourth estate” – is to supply that information reliably and effectively.
One of the reasons we often find ourselves wallowing in incapacitated confusion is the failure of the news organizations to fulfill their obligations to our society – to inform the public about the facts, as opposed to pulling the wool over our eyes with propaganda or keeping us distracted and confused with the circus act of excessive sensationalism. That applies to all realms – politics, culture, science... and to investments too.
Looking for crumbs of certainty
In the BFI Special Report, we outline the big picture and point out the elements that are important. And, from all the uncertainties, we select those factors and trends that look reasonably probable in the future. That is the approach I think you need to take in life in general, even more so with your investment strategy. You will never have all the information you need to make your decisions. However, if you can gather enough facts that are fairly certain and verifiable, you can derive the “crumbs of certainty” from there and come to relatively solid ground.
So, what are the crumbs of certainty worth considering?
More debt, more deficits. Under the premise (or the excuse) of the coronavirus pandemic, we expect the extensive deployment of monetary and fiscal stimulus to continue for an extended period, leaving a lasting imprint. Amid all the uncertainties, one thing seems clear: we are likely to be in a period of elevated leverage for some time to come – debt, and debt everywhere!
Inflate or Die. The implications of a high-debt world are that governments will continue growing this debt, more and more. With a growing role and economic presence of the government, the private sector will be crowded out and real growth will be stifled. All the “relief” and “support” measures that involve more and more government interference, are poison, not medicine. Ultimately, the bill will be paid by the people. The weakest, the poorest, and the most vulnerable among us, those that the government is pretending to save, will suffer the most. Nevertheless, at this point, what options do governments have, other than monetary (and fiscal) inflation? The name of the game is INFLATE OR DIE. Unless interest rates are kept low, the world, and less developed economies, in particular (Emerging Markets), will be hit the hardest. This was the backdrop for the speech by Kristalina Georgieva (Managing Director of the IMF), declaring a NEW BRETTON WOODS MOMENT. Debt will continue to grow. However, the burden of this debt will be eased thanks to a prolonged period of low interest rates, courtesy of the world’s central banks – until that “game” does not work anymore.
QE4 Treasury purchase in perspective ($bn)
WSJ, The Daily Shot
Most of the evil in this world is done by people with good intentions.~ T.S. Eliot
Fiscal policy is back. Central banks’ direct manipulation of “risk-free” markets was taken to a new height in the 2008–09 financial crisis. However, during the coronavirus crisis, central banker interventions took them even deeper into the workings and pricing of risk assets. The liquidity, for the most part, has only supported the asset markets. But central bankers are no longer alone. Fiscal policy is back. Governments will not let a crisis go to waste! They have joined the “money-creation game” via the fiscal channel. This adds to the danger of inflation; until we get there, as mentioned, debt will continue to rise.
Bonds are no longer safe. Meanwhile, we are at the end of secular cycle in interest rates. For the past forty years, the world, like a drug addict, has become accustomed to lower and lower rates, i.e. cheaper and cheaper financing. Interest rates can’t really go any lower. They can be suppressed though, and as we know from Japan, there is the possibility that they could be suppressed for a long time. This of course means that forecasts for fixed income returns are dismal. The low starting point for yields translates into a bleak outlook for bonds, and as long as this situation holds, the resulting elevated valuations for equity present a headwind for general stock markets. Careful selection and active management will replace buy-and-hold. Passive investing will not produce the returns of the past decade. There may still be some brighter spots found in emerging market debt, but the risk-return outlook is skewed unattractively to the risk side. Therefore, for more attractive returns and promising wealth preservation, the attention needs to be shifted to alternative assets instead.
More of the “progressive” ideology and policies. While the closer alignment of monetary and fiscal support will distinguish the next cycle from the last, many important issues transcend business cycles. Issues such as climate change, aging populations, and technology adoption continue to affect economies and asset markets, and in some cases may have been made even more acute by the upheaval of the pandemic. Toxic ideas and policies undermining the values, the culture, and the supposedly inalienable rights of citizens in western societies are spreading fast. Attacks on free speech, free enterprise and free competition are on the rise and seem increasingly successful. The further dismantling of free markets and capitalism, and its replacement with conformism, collectivism and censorship, unfortunately seems difficult to stop. Thus, we should expect more of it and prepare for the consequences.
Shaping a portfolio for the new era
With these considerations in mind, we must admit that what was safe yesterday is no longer safe today. And, although stock markets can be expected to benefit further from a variety of factors, the downside risks are growing, while the upside potential is shrinking. Downside risk management needs to be an integral part of your strategy.
Most investors have, by saving on the costs of downside protection, e.g. the hedging of stock exposure via put options, fared better without it over the past decades. Now, however, given these big picture changes, we are looking at a new era. Unless you accept the changed landscape ahead and prepare properly for it, your exposure to unwelcome surprises grows exponentially.
Admittedly, there are a lot of moving parts, but, ultimately, once you recognize those nuggets of certainty, the structuring of your portfolio becomes more straight-forward. In most of our client portfolios, we include the following asset classes: stocks, precious metals, and alternatives. We have very little fixed-income and we hold government bonds only for liquidity purposes at this point.
We are looking closely at commodities and will start investing in them soon. Moreover, we are very selective on specific sectors, continually rotating our portfolio for incremental optimization.
Finally, at BFI Infinity, we generally mitigate the downside risk of our stock exposure in our client portfolios via active downside protection measures. Moreover, many of our clients also hold physically allocated gold and silver, stored in high-security vaults with Global Gold Inc, as a counterbalance and safety net against a crisis in financial markets and the global banking system.
For a more in-depth and differentiated overview, I invite you to read our Special Report: “On the Brink of a New Era - Are You Prepared?”. And then, if you’re interested, please call us for a personal conversation to assess your specific circumstances, needs and objectives.
This is not the time for complacency or procrastination!
“I can scarcely contemplate a greater calamity that could befall this country, than be loaded with a debt exceeding their ability ever to discharge. If this be a just remark, it is unwise and improvident to vest in the general government a power to borrow at discretion, without any limitation or restriction.” ~ Brutus