Some Thoughts 08/03/21

This is a highly edited bunch thoughts I have been sharing in coffees and emails with friends of mine over the last two weeks.

Markets

Firstly, I do not believe the market is in bubble territory. Are some assets overvalued? Most certainly yes (looking at you Afterpay and Tesla), but overall, the market discounts the future, and with the level of central bank interference as well as fiscal stimulus means that we can pretend the main-street economy will, at some point, catch up to the markets.

Furthermore, and to the point, it has become common knowledge that the market is in “bubble-territory”. I would hazard a guess that if it is common knowledge that we are still questioning if it really is frothy then we still will see markets grind up. We saw mania in late Jan early Feb, but on the whole, it has been linked to certain names and not to the markets as a whole.

There is probably a second post to be said on what is happening in the crypto/NFT/bitcoin space though. My quick thoughts are, perhaps bitcoin and other tokens are acting as a release valve for traidtional markets.

An interesting counterpoint to bring out is that Jeremy Grantham thinks we are overvalued, but instead of institutional bagginess we are seeing bagginess in retail speculation. Something that is quite different from 2000 and 2008 (link). Jeremy Grantham has called the top more than once. But calling it early is almost indistinguishable from being wrong.

Furthermore, the dry powder that private equity has and other insto’s have, is enough to really move the markets (example) not just grind them up. We are seeing bond yields come up, and equities slowly fall. Meaning that money must be sitting on the sidelines for a larger pullback. Timing is notoriously difficult, and any movements by the central banks will be a signal to those with cash. Those moving to cash are making the guess that the vaccine rollout will not be smooth and the economy will not catch up quick enough to asset prices.

Inflation

The biggest challenge that investors have at the moment is not the bubbliness of markets, but of inflation. I have been an inflation hawk for the majority of 2020 (proof). This is linked to rates which by bond vigilantes or whatever are somehow going up despite the best efforts of the RBA/ECB/The Fed.

There are many reasons to think that inflation is coming. I will list the reasons in terms of time horizon.

Short: in the short term the worry should be on how supply lines have been traumatised by COVID and those lucky to not be unemployed have saved money and now want to spend it. This is the best reason to expect short term inflation to go up. At one point though, economics 101 would expect things to reach an equilibrium. Consumers will get the products they want, and businesses will supply them. Overall, ceteris paribus, you could maybe expect inflation to go back to levels seen before COVID.

Medium: the current movement towards globalisation has ended. This should not be a surprise to anyone reading the news. The fractionalisation of supply chains and of technology will lead to higher prices as no longer will companies have the chance to go to the lowest bidder for labour. Labour costs have been kept down through globalisation, but it is unlikely that geo-politics will allow unfettered movements in the factors of production (the exception being capital). The blocs currently talked about are China, the EU, and the US.

Long term we have an aging world (data). An aging world means that savings will need to be spent on medical care and consuming. When we have fewer people working and more people consuming, we have inflation. A great book on this can be found at this link.

For the sake of completeness, the counterfactual does exist. The productivity gain by technology and a movement of workers to cheaper regions due to the work from home phenomenon may help keep inflation low over the short to medium term. Furthermore, where we have seen strained supply lines (semiconductors) the amount of money being spent to fix these issues would mean a glut of supply in the future. There is also Africa as a frontier to exploit in the production of goods to help solve the long-term aging issues (link), but you could expect at one point, like other advanced economies, for the continent to age.

Lastly, we are seeing inflation in commodity prices, house prices, and the expectation in yields. There is a good question there if it will show up in CPI data. Gold is down, but most industrial metals are up (YTD, Trading Economics data). Will those costs be passed on? In the short term, there may be reasons why suppliers can't pass on costs to consumers. It may actually be costly to firms to pass on any extra expenses (more here).

MMT

Is inflation always a monetary issue? No. It is a supply and demand issue, only sometimes it is easier to call it a monetary issue than address key causes in the underlying economy (labour, income, and amount of goods produced). A key worry in some corners of the markets is Modern Monetary Theory (MMT). Is MMT inflationary? Maybe. They seem to view government spending as having no end except through how resources are used. If resources are misallocated and inflation begins, then MMT-people would say that less government spending is needed. If inflation does not exist then the government can continue to spend. Ergo, MMT will only be inflationary if misused (link to a talk on this).

There is a good reason that MMT is being discussed seriously in some circles. There is political expediency to making sure the economy is humming along, and those zombie companies don't die. A second GFC type event has the ability to cause massive and irreparable harm to social structures. Asset prices are too important to be left alone.

Assets

This is all a long-winded way of saying, markets will probably come down slowly, rather than burst. In this case, as I have argued before, owning real assets is the key to getting ahead.

Markets can either be driven by narratives or by numbers, do we care about fundamentals or the stories? I strongly believe as the year goes on, numbers will start to matter more. That means investors will need to care about moats, brands, patents, land, and fixed assets.

Lots of food for thought.