Is the genie out of the bottle?

Is the genie out of the bottle?

Have you been buying groceries recently? Is it only me or has your food bill also gone up? In articles I read from US authors, I get the same message; food bills are on the rise.

So would we be heading for inflation after all? Would the fiscal and monetary injections by both governments and central banks finally lead to a surge in prices? It may well be because, as opposed to the monetary expansion after the financial crisis of 2008-2009, this time the newly created cash is more likely to enter into the real economy. When the US government gives the un-employed 600$ weekly, often more than they made in their job before, this money is likely to be actually spent.

Inflation is also psychological. Somehow, people seem to be expecting higher prices in future. So, yes, in my opinion it could well be that the genie has left the bottle sooner than we all expected.

The world also moves away from a free markets and globalization towards state interventionism. That will lead to more protectionism and higher trade tariffs. Globalization is often cursed upon by the people and held responsible for plenty of evils of our modern society but it also led to consumers being able to buy consumer products at prices our parents would not even have dreamt of. An IPhone made in the US will probably be much more expensive than one produced in China.

Governments are hoping for inflation to pick up because this is the only way to keep public and other debts somewhat under control without massive spending cuts and/or tax increases that would get politicians out of their job. So do not expect any interest rate hikes, the traditional weapon of central banks against rising inflation, to occur any time soon.

The world is thus heading for MMT or Modern Monetary Theory. A philosophy that is particularly popular with left wing politicians but in practice, since corona, embraced by most countries.  MMT states that countries can issue ever more debts without any consequence (meaning without interest rates going up) because central banks can simply print ever more money and buy the debts. In doing so they avoid the law of offer and demand leading to higher interest rates on government bonds.

Amongst the many drawbacks of this policy is the miss-allocation of capital and lower productivity as many flawing corporations will, artificially, be kept alive thus preventing the normal capitalist process of survival of the fittest, which leads to a dynamic economy and higher productivity. Think about the former Soviet Union.

So for the individual investors, we all are, what would be the consequences of higher inflation and what action to take?

For investors with large amounts of savings on savings accounts and fixed income bonds the results would of course be catastrophic. Real returns of their savings would be largely negative.

For shares one would expect the outcome to be less dramatic as companies can increase their prices and thus profits in line with inflation, right? In theory, yes but as I outlined before in this blog, a higher inflation would lead to higher discount rates for future profits and with shares prices already stretched this could lead to stock markets going nowhere for many years.

(For those who found the previous sentence a bit complicated; when you calculate the profits of a company expected in future years you reduce the expected profits in, let’s say 2021, by the rate of inflation. You will indeed not be able to buy the same goods with 100 euro of profits you will receive in 2021 as you will be able to do so with 100 euro today. And the value of a company, for an investor, is the amount of added up future profits. So higher inflation leads to less future profits, thus to lower share prices.)

In order to justify the current, high, stock market prices the corporate profits and cash flows would have to increase rather than diminish. Given the current uncertainties on how complete the economy will recover from corona in the coming years, I see no large upward potential for broad markets.

In addition, I have the impression that a potential victory of Joe Biden in the US presidential election is not priced in in the current stock market levels. Amazon, Alphabet, Apple, Facebook and Microsoft together make up almost 23% of the S&P500. A democratic president and congress could lead to more anti-monopolist legislation being envisaged which could be, short- and mid- term, negative for these shares.

Of course, the negative yield on bonds and cash would lead to more people turning to shares, that at least give some form of return but, in my opinion, do not expect important, if any, return of major indexes for many years to come. The current valuations are just too high and the after-corona era presents still too much uncertainties.

So the obvious answer appears to be: invest in gold.

Many investors seem to be of this opinion and gold, recently, has had a scorching run that took it to over 2000$/ounce. Gold mines and little brother, silver, have also participated in the bull run.

However, what troubles me now is that I read articles about how everybody should own gold a bit too often. Never a good sign when a product is being plastered as the obvious choice.

2000 $ appears to be a ceiling that gold is now struggling to overcome. Short term, gold is certainly somewhat overbought and a lot of investors now own gold, goldmines and silver through ETF’s which, upon hesitation, can be sold by pushing a simple button on your computer.

I expect gold to somewhat digest its recent run in the short term. Mid and long term I still see potential for further increases of the gold price. After all the gold market is a small market as compared to bonds and shares. Total investments, worldwide, in gold are around 2.800 billion with 108.000 billion for bonds and 88.000 billion for shares. A small shift in allocation of investments away from bonds, shares or cash and into the gold market could lead to important price increases.

Any communication by the authorities, for example by the central bankers in the Jackson Hole conference this week, that they would favor a somewhat higher inflation, could pave the way for a further increase, taking gold again over 2000 $.

But a prudent Individual Investor has convictions but never invests his entire capital following these convictions. He always takes into account the possibility his convictions might be wrong.

So, yes, a prudent individual investor needs, in my opinion, to have a considerable position in gold and gold related investments (I would think up to 20% of a portfolio) but I would gradually add to this position, not take profits now but do no overdo it.

Do not neglect investments in other promising, future oriented sectors.

I see possibilities in countries like China that is clearly developing a long term strategy in order to dominate future technological standards. This while the west appears in disarray and appears not to have such a comprehensive strategy. Whilst China dominates more and more technologies of tomorrow such as artificial intelligence, transport a. o., the western media and politicians are squabbling about whether black Pete can still appear next to Santa Claus. Well, I suppose everybody has his priorities.

Russian stocks appear reasonably priced and will profit from another movement, I see appearing on the horizon. Investments into oil and other commodities exploration have been cut back for a while now. The world is all about big data, the Green Deal a.o. right? Try warming your house with big data next winter, I wish you the best of luck.

Yes, the world is going to get greener and tremendous opportunities will arise from engineering companies in this field. (Have you noticed the recent run of Alfen on the Dutch market by the way?)

But it is not going to happen overnight. The existing energy sources such as oil and gas are still going to play an essential role for many years and big progress in their environmental impact can still be made.

The carbon footprint of a small to medium diesel engine car appears to be less that the one of a battery-powered car over its entire lifetime. The progress into environmental friendly policies is not always going to be there where we expect it.

Also inflation leads usually to higher commodity prices so the cycle of under-investment leading to higher prices of commodities could well re-appear. Maybe not short-term but I would not write them of mid- and long-term.

Technology will be here to stay and expect more local production to lead to more robotisation, so do not neglect funds, ETF’s and shares in this domain. But think beyond the obvious, Nasdaq dominating shares, which were the big winners of the corona epidemic. Thinc also engineering and actually making stuff.

Please continue to build a balanced portfolio. You may change some accents but do not switch it around entirely out of fear or greed. Our purpose as investors is not to strike it rich overnight but to improve our life by getting a decent return from our savings.

Personally, I did not let corona stop me from travelling. A planned road trip to the US could not take place but I made some smaller trips in Europe which were just fine.

A small parenthesis mainly for Belgian readers:

Whilst travelling I could not help noticing though how prices in Belgium are substantially higher than in surrounding counties. I have also been following somewhat the negotiations for a formation of our new government and I am appalled by some proposals. In Wallonia, only 37% of the workforce works in the private sector. This is creating revenue with which to finance the welfare system long term. 21% works in the public sector and 41% does not work at all. The politicians now seem to want to generalize this situation to all of Belgium by further punishing private investments. I see Belgium becoming the Baltimore of Europe where the future generations are being sacrificed for the short term interests of a class of politicians without any long-term vision on the challenges of the world of tomorrow. Belgium risks becoming an outlet for foreign companies whilst fading away in a generalized state of inertia and lawlessness. Think Venezuela without the oil if we continue down this path for several years.