The least you can say is that we are living in interesting times. Total government spending, as a percentage of GDP in the US, exceeds 35%. A level only surpassed during WWII. The public deficit in the US is nearing 20% of GDP and nobody seems to worry. On the contrary, advocates of Modern Monetary Theory would like to institutionalize major public deficits.
The current political environment reminds me of the 60’s. (Not that I was already following economic policy in those days, I’m not that old, in fact I was barely born.) Anyway, the democrats who came to power after the election of John F. Kennedy adopted expansionary spending policies. Add to that the rising costs of the Vietnam War, the oil price explosion during the seventies and the stage was set for a skyrocketing inflation. Nixon tried to impose wage and price controls and pressured the then chair of the Federal reserve, Arthur F. Burns into keeping interest rates low, despite rising inflation. Sounds familiar to you? Yep, to me as well. Anyway, it all ended in tears with sky-rocketing inflation and an economic slump and the world got familiar with the term “Stagflation”
As I mentioned in last month’s edition of this newsletter, currently there are two schools when it comes to inflation. One school, currently also the position of most central banks, is that the latest surge in inflation is temporary and once supply-line problems will have been resolved inflation will return to a level of max 2% This because, as opposed to the sixties and early seventies;
- Demographics have changed. More older people spending less and saving more thus reducing demand.
- There is no penury of labor as un-employment still remains pretty high thus reducing the chances of fast-rising pay-checks and wage-inflation.
- Globalization may be slowing but is still on a much higher level as compared to 50 years ago when China was in utter misery following the cultural revolution. Moreover, Taiwan and Korea could increase their production of semiconductors faster than expected.
- Commodity price hikes could halt as Chinese authorities slowed down on stimulating their economy.
I, personally, am not so convinced that inflation is going to return back in the tube where it came out of. Not with central banks and governments jumping up and down on the tube by printing money out of thin air and running huge deficits financed with printed money. Already US companies are forced to pay substantially higher salaries in order to find adequate staff. Add to this rising prices for raw materials including oil, rising costs for houses, services, and I expect substantial wage rises are very likely and here to stay. Also in Europe, I hear sounds of companies that in fact they could increase production if only they would be able to find staff that matches their required profile. There is a gigantic mismatch between skills, required by employers, and aptitudes of the un-employed. Yes, to find a job it takes aptitudes, dude, not an attitude. But who needs a job if you can make almost as much money from benefits whilst binge watching Netflix.
Anyway, whatever the outcome, temporary or persistently rising inflation, for the time being, prices are rising fast and people counting on the return of their savings to improve their lives see their standard of living go down. Fast, very fast. Higher prices, a negative real net return from savings and rising taxes, that are likely to become confiscatory, it all is a fast track to populism and radicalism.
The best antidote for inflation is increasing productivity. However the upcoming tax increases will result in putting a break on productivity growth. The Covid crisis and the consecutive return of big government with large public programs are also not favorable for productivity. Neither is the slump in investments, delays in education and increases in public aid to groups of structural un-employed that seem to settle forever in public assistance.
Add to this prospect the fact that market valuation is very high and you will get my point that I do not expect a return from broad stock markets comparable to the return during the last decade. A return close to zero for many years is a plausible outcome. Moreover, the prospect of central banks getting nervous about rising inflation and the expectancy that eventually, they might consider, maybe, to start thinking of tapering (this is injecting less newly printed money in the economy) could also put a break on stock market prices.
So periods of higher and lower inflation, expanding and contracting economical growth are likely to alternate and of course, expect more “events” on the political and geo-strategical level in the next decade.
Anyway, our governments are drowning in debts and in order to keep the current debt-based economic and political system, based on IOU’s (I Owe You), from collapsing there are only two solutions; either defaulting on debts or inflate them away. The first is messy so our governments will go for the second solution.
Nevertheless, again, an investor always has to consider that his opinion might be mistaken and one should never bet on being right in one’s beliefs. Which is why you should avoid timing the market and always stick with your core portfolio. Whatever your beliefs. As a long-term investor, you should not fear corrections, recessions and crisis. You should welcome them for the opportunities they bring.
So for an investor to maintain its savings in the future which actions to consider?
As I mentioned above, hold on to your core-portfolio, whatever. Shares are a decent protection against inflation as normally the companies, you invested in, will be able to increase the prices of their products and you should benefit from rising stock prices.
Inflation protected bonds, of which the interest rate increases as inflation goes up, are a solution but do not expect miracles. Up until now, these bonds, also called TIPS, went nowhere, despite inflation rising to 4% in the US. As mentioned in earlier editions I would keep minimum 10% of my investments in precious metals (mainly by physically owning gold) and/or precious metals miners by investing in ETF's.
However following recent research of Goldman Sachs, commodities (precious metals and agricultural products excluded) come out as the top performers in making up for inflation. This, contrary to public belief, much out-performing gold and other precious metals as a hike against inflation
So, after a small correction, which could currently be underway, adding a bit to your holdings of global mining and energy ETF’s could be a good idea. You will find examples on the “Investing in ETF’s” page on the website. Oil must be the most hated commodity on earth currently. Do I see an apportunity there? I feel comfortable owing some oil and gas ETF's and some shares of Total or the likes. Nice dividend too.
Why then, do I still consider such a large position in precious metals in my core portfolio? Mainly because I do not trust currencies in our debt-ridden economies, where central banks seem to have turned into branches of the governments’ treasury department and I also see a time of growing international tensions. In addition, Reddit flashy boys and girls cannot manipulate gold. Not even governments. It simply is too big a market and a store of value for too long a period. I will consider getting out of gold when we will have fiscally conservative, investment-friendly governments and hawkish central bankers (think Paul Volcker). No need to say I will stick with my gold for many years to come. If ever gold goes over its previous top of 2.070$ It would be a clear bullish sign. Gold now convincingly crossing the limit of 1.900$/ounce would make me add somewhat to my positions.
Also, even if you are losing money on it following inflation, given the current level of the stock markets, I would maintain a cash reserve in order to benefit from any, sure to happen, future corrections.
Be aware that when you are a retiree or a near-retiree, you investment horizon is much shorter than for those who are younger. Therefore, you have less time to recover from bear markets. If you are over-invested in 100% passively managed funds on the broad markets, dominated by the US tech and growth shares, when a correction-that-lasts eventually will come, you are going to take it full on the chin.
Therefor I rather play safe than sorry and maintain a sufficient position in actively managed funds (I know, hard to know upfront which ones will be effective in protecting us against a large correction but here again I bet on several horses), less volatile dividend and value shares and ETF’s and also some precious metals.
As I have been predicting for several months we recently saw an overdue correction of the most inflated sectors, amongst which the ESG and alternative energy sector. The extreme speculative positions such as SPAC’s (funds where you give money to a fund manager without knowing what he will use it for and with only one certitude, that is that he will get better from it) and crypto currencies seem to have deflated somewhat and that is good news.
As economies are re-opening and companies seem to have a lot of pricing power I do not see corporate results taking a hit in the immediate future. Bar some major international crisis it could well be that any corrections in the near future continue to be short-lived and present opportunities for adding to existing positions.
Who are we to contradict with the flow of the money? Again, please be warned; do not go running after hypes. Plenty investors that invested, at the top of the market, in the ESG hyped shares are still licking their wounds with losses of up to 20 to 30% or more. Just have a look at the hydrogen shares.
When you read plenty articles in the press and get plenty invitations for webinars on a sector that is presented as a sure win for the future, become wary and steer clear. You may one of the Johnny-come-lates that buy shares from the smart money at the top of the market.
I would advise all investors that desire adding somewhat to their investments, to read again the page on how to build a core portfolio.
Currently we are all enjoying the re-opening of our societies after the Covid crisis. Stock markets muddle through without a clear direction. Europe finally catches up in vaccinating which reflects in its markets. All is quiet on the Western front. Let’s hope it is not the silence before the storm.
In the meantime, plan for an exciting summer with beautiful trips, even at current inflated prices, enjoy your life and stay positive.
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