Markets in a world awash with liquidity.
This transcript has been edited to make it more readable.
In our experience, there is only one global capital market, and the direction of developed-world interest rates (led by the United States) tends to set the tone for all markets. So I'd like to offer some comments about that.
Warning signs are flashing!
Investment markets have professional investors scratching our heads. Bitcoin hovering around $35,000… Tesla being valued more than the top eight auto manufacturers combined… retail investors evidently driving asset prices and derivatives markets… and Special Purpose Acquisition Companies (SPACs) raising more than US$78 billion in the USA in 2020, about 50% of all the fresh IPO capital raised during the year. Keep in mind that SPACs are, essentially, piles of capital desperately looking for something to invest in. This harkens back to the disastrous "South Sea Bubble" of the 1720s, and the famous story of a company that went public as "a company for the carrying out an undertaking of great advantage, but nobody to know what it is".
Thus, we find ourselves debating the definitional differences between "bubbles" and "manias". Warning signs are flashing!
A "new investment era" with new rules
A million articles have been written about the recent gyrations in the likes of GameStop shares. While one wants to applaud the little guys ganging up against the hedge funds to level the playing field, I can't help feeling that they are a rebels-without-a-valuation case. And if that particular "crowd-sourced-short-squeeze" wasn't actually a manipulated result of one hedge fund trying to get at another, then future episodes certainly will be.
Arguably it’s a "new investment era" with new rules. Markets may be playing out a debate between the Baby-Boomers versus Millenials and Gen Z'ers. But the history of finance is littered with repeating mistakes. As James Grant has said "Science is a discipline that builds cumulatively: Previous knowledge isn’t forgotten or cast aside — it is built upon. But finance isn’t like that".
In short, markets repeat the mistakes of our fathers and grandfathers. I'm going to bet on the Boomers winning this debate.
We are in a sense all "bond investors" now
Interest rates have been manipulated downward by global central banks in response to the COVID crisis, and this has driven asset rallies - even in the face of economic decline and dislocation and ballooning debt.
I tend to believe the thesis that equities have been (at least partially) driven upward by low-cash and bond yields. Equities have always had exposure to interest rates, through the discounting mechanism. But a 1% rise from a 1% base yield is more substantial than one from a 3% base yield. We are - in a sense - all "bond investors" now, and this demands we pay close attention to global interest rates.
At some point as COVID passes we will look toward normalising - that is rising - interest rates. At first these will be "good news" rate hikes as economies recover. But there is prospect for forward looking inflation forecasts to start rising, and thus forcing the hand of central banks on rates. For a start:
- There are very large stimulus packages for pump-priming, and there is plenty of capital sloshing around the world (which is already causing asset price inflation);
- Covid has simultaneously created a pent-up demand for goods, weakened the efficiency of supply chains, and also shaken out weak competitors across industries - all of which open the field for price hikes.
- Commodity prices have recovered from their COVID-related collapse, with signs of more price rises in core commodities such as iron, copper, oil, and food supplies.
- The Biden administration is about to throw another $1.9 trillion into the US, while the roll-out of mass vaccinations might be largely complete in only 6 to 9 months' time, opening the door to normal economic activity.
- Behind all that, we can't forget the reimposition of tariffs over the past three years - which ultimately is an inflationary force (i.e. tariffs force prices up to the consumer).
Except for either persistent recession, or workers taking the strain via lower wages (which is politically risky), it is hard to see many disinflationary forces.
In sum, it is evident that we need to keep a close eye on the global recovery, prospects for inflation and global interest rates. In any case, betting on volatility seems like a good idea.
Thank you for the opportunity to offer some reflections and thoughts.