The junkie becomes ever more hooked.

The junkie becomes ever more hooked

For today’s investor there are broadly two options:

Option one: Markets are fundamentally overvalued. Markets are betting on the over-optimistic assumptions of: a V-shape recovery from the corona-crisis, the race for a vaccine well advanced and until it becomes widely available, the world will just soldier on without major outbreaks that would cause massive increases in the number of deaths.

In this option, these assumptions are judged as too optimistic and major outbreaks of the disease (the famous second wave) combined with a fallback of company results will lead to a re-test of the March lows.

If this option is the correct one, markets could correct and wipe out most of the gains from the March 2020 low point onwards or even, in worst case, of the market cycle that started around 2009. Investors should be prepared for a 10-year period in which returns from shares would be zero or even negative in order to bring valuations back to normal and for the economy to recover to pre-corona levels. Back to the 1920’s or the 1970’s thus.

Option 2: As long as the music plays, you should not leave the dance floor. Central banks and governments are willing to launch giant stimulus packages and inject massive amounts of liquidity in the financial system whenever a panic on the markets appears and/or economic data worsen. Authorities will “Do whatever it takes”, which could include negative interest rates, helicopter money (the central bank prints money and the government distributes it to the citizens in order to relaunch spending) and even central banks, following Japan’s example, could resolve to buying shares to prop up the stock markets.

Believers in the second option state that, following massive interventions by central banks, ever more money is chasing a finite amount of assets thus explaining the current boom market in about everything. Interest rates will stay low for as long as we can possibly see so TINA (There Is No Alternative) will support markets as investors, pension funds still want a return on their investments. Consumers are spending less and saving more out of fear of uncertainty so consumer price inflation is not to be feared and growing debts are not a problem.

As a result investors can count on a safety net and should stay in the markets and any, small, correction is a buying opportunity.

For an individual investor this is a serious dilemma.

Both sides have valid arguments and the choice you make can determine your lifestyle for the decade to come. Make a wrong choice and you could well be without a return from your savings for a very long period. No pressure.

What to do?

In my opinion, a successful individual investor is a muddle through guy. This implies he never bets completely on one option as then his or her choice could be the wrong one, with a dramatic outcome for his personal life.

When markets appear expensive, and I must admit this is the case now, you take some chips of the table, secure some gains but never go out of the market completely. I have sold some individual shares but did not reduce my positions in ETF’s. I sold some investment funds that were lagging lately, but again, only a small portion. I continue to hold a considerable cash position.

In the short term, I expect volatility to remain high. Many people are sitting on positions they bought since March and have a nice profit, they would like to secure and any bad news could well lead to a correction. Indeed, many positive assumptions are priced in the market and negative news on the virus, spinning out of control in some countries, new lockdowns, economical figures worse than expected, could trigger a correction. On the other hand, if new outbreaks of the virus stay under control, and so far it looks this way, any good news about a vaccine could also support market optimism and make the investor, who sold the majority of his or here’s positions, bang his or her head against the wall.

Investor mood is, in my opinion, pretty optimistic, small, new investors have entered the market and this is not a good sign. As the saying goes: when you hear people talking about stocks at your barber’s sell out immediately. We are not that far yet but still. This is more a time to lighten your holdings than to massively add to them. But again, do not sell a too large part of your core portfolio. So far, in the fight between the poor economic data, pulling the market down and the flood of cash pouring into stocks, pushing the market up, the cash has won and it could well continue to do so in the future. Any investor selling shares today to take a profit will tomorrow look at his cash and then wonder, where to put it. The day after tomorrow he will have concluded his best chances for a return are in the market and he may well buy again.

Do not sell your best performing shares but rather separate from the laggards that have large debts.

In the medium term, I am more optimistic. Investors have been pre-conditioned. Both after the financial crisis of 2008, the 2018 correction and last March, any correction was a great buying opportunity so FOMO (Fear Of Missing Out) and TINA (There Is No Alternative) should do their work also now and the rally in everything should continue after a short-term correction. Many investors have not committed all there cash in the current crisis and feel they, again, missed a great occasion. So expect them to start buying at the next correction. As long as returns on bonds and saving accounts remain close to zero, shares, even at inflated valuations of 20 or 30 times their profits, will remain attractive. Also, as fear of the corona will disappear, expect people to make some relief spending that could relaunch the economy faster than we now expect. The worst outcome for the markets, medium-term, would be delays in an effective vaccine being developed and the virus still dominating our life for years to come. Then un-employment would increase massively and medium-term could look grimmer. Nevertheless, let us count on human ingenuity and not go for that possibility. So medium term looks brighter and we could have still a couple of good years ahead of us if no new cataclysm, major terrorist attack or geo-political crisis comes to spoil the fun. Inflation is, in my opinion, not going to appear before the mid of the decade, as companies and private persons could, in first instance add to their savings and consumption will remain subdued.

But do not forget, markets are as dependend on the central banks steadily increasing the money supply as a junky is on his dealer.

Bottom line: never fight the FED, so as long as the orchestra is playing, keep dancing but stay close to the exit. I would certainly keep some cash and increase investments in precious metals.

In the long term, I am more pessimistic. The focus of central banks, ever since FED’s president Volcker in the eighties, has been on combatting inflation. Since 2008 this policy has been more and more abandoned and the corona-crisis buried it 10 foot deep. And, indeed inflation has not risen. Not even after massive money printing by central banks. The newly printed money did not lead to a massive spending spree by consumers and globalization, technology and politics kept price increases at bay.

But, by the mid of this decade, inflation could well rise from the grave.

Politics and labor relations are changing. The shift in power, accelerated by corona, from business to government, from capital to labor and even more to the mob on the street is going to be inflationary. I see a lot of anger in the world right now. A lot of the deflationary forces in the developed world are based on people producing food, clothes, any products at very low prices. Meat in Germany, veggies in Spain, anything in Asia has been getting cheaper for decades because people were willing to produce them, in often precarious working conditions, and at a low salary. I recently bought chicken meat in a German supermarket at around 2.50 euro per kilo. I could not help wondering, how on earth, can this be a profitable business? There is no margin for any further price cuts here. We really believe that robotics and automatization are going to drive prices ever lower?  Do not bet on it, big tech companies, which have pushed competition out of the market, could well start to cash in on their quasi monopolies. Higher taxes on their turnover will be passed on to the customer. Rest assured.

Central banks and governments will continue to inject cash in the system and run ever bigger deficits that do not matter because debts are eternally at a zero interest rate? This without debasing the currencies? Prices of assets continue to rise, retirees, officials and people on an allowance are assured their pensions, salaries and allowances will be paid in the future? They will to some extent but I see many angry people wanting a bigger piece of the pie. I see more and more people blaming capitalism, the elites, whomever, for anything and if they do not receive the lifestyle they think they are entitled to, they will revolt and start smashing things up. Politicians know this is not positive for their re-election chances so they will do what they are best at: pay them off with taxpayer’s money. This will become inflationary at some point.

Who is still asking for governments spending cuts after the corona virus? How much people still make the link between welfare and thriving private companies to finance it? I grew up noting that communism lost the cold war because central planning economy was no match for capitalism.

I now see a massive increase in government spending of which a lot will be spent, as in the former Soviet Union, on unproductive investments and on buying off favored groups, (read: voting public).

This is not how long term wealth is created.

Capitalism is also about letting un-productive companies go bankrupt. In the current, zero interest world these companies, often under pressure of unions, become zombie companies that are kept alive on an infusion of public funds. If you manage a business and you were not smart enough to build up some cash reserves, if you leveraged your company to the max in order to make share buybacks and to obtain nice bonuses then, when hard times come, you should pay for it and not expect governments or central banks to bail you out.

Therefore, in my opinion, inflation will return, not from consumers but from government taxes and policies.

Add to that the current slump in investments in commodity exploration, which will eventually lead to a decreasing production of oil, uranium, copper and other commodities and this also could contribute to inflation.

For indebted business and especially governments, inflation will be the only way out to keep entitlements and debts payable. Even in case of rising inflation, governments will put pressure on central banks to maintain interest rates at near-zero.

Thus, as inflation would be left to run wild, this could bring us back to the Weimar republic of the 20’s where the middle class lost its savings to rampant inflation, decided it had nothing more to lose and the rest is history. Add to this rising racial tensions and the long-term future of the West could indeed be very gloomy.

The West has been in a crisis before, think of the seventies, which can also be considered a lost decade, with left-wing radicalization preventing long-term growth. (Think of the UK in the seventies) However,in the seventies, Western nations only had Japan as a direct competitor. Half of the world, including China, was barely surviving behind the iron curtain. This time, it is different. The West is in a close technological race with plenty of dynamic developing countries. We cannot afford a lost decade without becoming a Disneyland for Asian tourists. Somehow, I see the United States still maintaining a relatively strong position in tomorrow’s world. As Warren Buffet said: Never bet against America.

I am less optimistic for Europe to maintain its position as a leading economic player and to protect its expensive welfare state. We lack the culture of public investment as a basis of our welfare state. We counted on the banks and governments to take care of this. This is no longer going to be sufficient. I see too much complacency and trust in governments. Let us hope that by the time the public realizes this, it will not be too late for Europe.

So what would I do?

Short term, be very careful. I personally do not believe we are going to re-test the March lows. A correction as from 10 to 15% should be used to start nibbling again.

Medium term, further use corrections to add to shares. Do not neglect technology, health, companies with a decent cash flow and a wide moat. Think also about some investments in commodities such as oil, gas, copper, uranium that may benefit from rising prices following under investment. Yes, value shares have never been cheaper as compared to growth shares but this could remain so for a bit longer. Longer term, value will come back with a vengeance of course. But maybe not just yet.

Long term, I would keep a sufficient buffer in cash and precious metals. Bitcoin and other crypto currencies? I do not know enough of it and heard too much stories of people losing their entire investment to go there. I would nevertheless stay invested in the stock markets for a considerable part of my portfolio because, who knows, maybe central banks and governments are smarter than expected and will be able to manage and reduce the current debt mountain or kick the can eternally down the road. This whilst maintaining a reasonable economic growth. However, I would invest in solid, worldwide active companies that have a strong balance sheet and a unique position on the market with a wide moat around it. This through ETF's, funds and directly in individual shares. In a storm, you want to be in the strongest boat.