It IS Different This Time
Skerritts View - July 2017
One of the first things that you learn when you embark upon an investment career is the phrase coined by Sir John Templeton, “the four most dangerous words in investment are “it’s different this time”. Leaving aside the question of whether the abbreviation of “it is” constitutes one word or two, we wonder whether the saying needs to be updated in the aftermath of the Financial Crisis of 2008. Perhaps now, the most dangerous belief in investment is the failure to understand that, yes, it is different this time.
We’ve mentioned in previous months that the world has been very slow to understand the new framework within which we live, due primarily to the fact that most economists, politicians, fund managers, policy makers and people who write investment commentaries such as this all learned their trade during the two and a half decades leading up to said crisis, studying the same theses and listening to the same tutors before marrying each other, living in the same districts and frequenting the same eateries and socialising at the same watering holes, having had their “normal” shaped by the longest and biggest credit boom of all time. When that credit bubble burst in 2008, many have been waiting for their “normal” to reappear. Those who are so entrenched in their beliefs of what constitutes normal, and cannot adjust, will have a long and increasingly uncomfortable wait. Some, and there will be a few “names” among them, will not survive with their business models.
Indeed, on July 10th, Bloomberg ran the headline “Markets No Longer Make Sense to Macro Managers” and describe the position of one fund manager who, “after three decades focusing on things like economic trends, currency moves, politics and policy, has been confounded by markets shaped by low volatility, algorithms and more. He finally gave up and closed his fund.”
“I felt the intensity of following markets at a time of increasing political and economic confusion very hard,” said the founder of Potomac River Capital. “My entire career had centred on an understanding of monetary politics and I had trouble getting my head around it.”
In a nutshell, he failed to understand that it’s different this time.
As an aside, if you want a clue whether someone “gets it” with the new environment in which we live, listen out for anyone using the word “normalise” – as in “we expect rates to begin to normalise in the next few months”. These people are still entrenched in pre-2008 beliefs.
The new normal isn’t particularly new anymore – we’re nearly a decade on – but we’re still getting to grips with what it means for investors. Certain things have become clear though.
Low interest rates have tended to lead to quick recoveries from market dips and corrections. Money being money, it will look for a return. With cash rates so low (even after a couple of rate rises in the US), with bond rates so low and with inflation struggling to make any kind of return above 2% pretty well anywhere in the world, every time equities fall in value, they become good value again quite quickly. As long as the equities that you were buying before a correction make sense as investments, they will make even more sense to own again once they become, say, 10% cheaper than they were before the correction occurred. Consequently, markets make what is termed as a “V” shaped recovery. Even the great crash of 2008 saw markets recover within a year. Since then, liquidity provided by the Central Banks has forced institutions to buy equities, propelling markets to ever-higher levels.
It is a natural fear as an investor to be wary of a record high, with reason as it seems that the direction can only be down in the short term, but the idea of capitalism is for markets to achieve constant growth. It is time, not timing, that is the greatest ally to an investor.
If you can buy and own stocks that the world wants, you’re on a winner. Old school investors tended to allocate their portfolio geographically, but it makes sense to us to allocate along sectoral lines. As a result, our portfolios are full of sectors such as cyber security, robotics and automation, healthcare and biotechnology, and areas associated with an ageing population. It doesn’t really matter to us where in the world these companies are listed. However, we see the return of the European consumer and so allocate to European Smaller Company funds, as well as Japanese Smaller Companies which, as with their European counterparts, tend to be more domestically focussed.
One of the consequences of the credit crunch of 2008 is the emergence of a two tier economy. The median worker feels increasingly worse off as their wages stagnate and, for years, they feel as though they are wading through treacle as the lack of inflation keeps wage rises to a minimum. In fact, the whole workplace has changed drastically with an army of freelancers, self-employed, part-timers, renewable contractors, project workers replacing the nine to fivers that typify previous generations. Of course, if you are in these categories, you are not normally best placed to demand higher recompense from your hirer, and so wage growth remains stunted.
For a significant minority, however, they have never had it so good. If you have little or no debt and a steady income, you’ve rarely had more disposable income in your life as in recent years – and it is a multi-year phenomenon. This is why hotels are full, restaurants are thriving, airlines are full, and auctions in tangible collectibles such as high end watches keep hitting new record turnovers. Luxury brands are confounding the old school investor who scratch their heads as to why they seem to ignore stretched valuations on a stock level, but the market for them is thriving.
Passive funds are flying, as investors of all sizes continue to buy regardless of the valuations of what lay within their packaged investment, concentrating more on the entry cost of the package itself. Since 2008, the investors’ experience is largely one of assuming that things can only go up, get cheaper to buy, and despite the odd bump in the road, deliver a total pot that swells in value as if by magic. It’s all pretty easy and agreeable. So what could go wrong?
So what do you do when the level of global debt has stretched so far that it becomes impossible to pay it back without the Central Banks stepping in to do it for you?
Why, after a brief pause for reflection, you borrow more, of course. According to the table below, global debt has never been so high as it is today. What may this mean for the rosy scenario that we’ve painted earlier in this piece? We’ll look at this next time.
These are our views, as always, and don’t constitute advice in any way.
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