Of Fear and Fatigue

Dear friends,

“We have nothing to fear but fear itself,” said Franklin D. Roosevelt at a time when perceptions were changing as rapidly as they do now. Once again, fear runs rampant. Fear of being infected, fear of job loss, fear of a market crash or losing out by not being in the market, fear of environmental degradation, fear of saying what we think, fear of losing our cherished democratic traditions, fear of where our utterly corrupted politicians, legislators and central bankers will take us. And, finally, fear of what kind of world our grandchildren will have to live in.

Many of us manage to hold fear at bay, at least temporarily— usually by convincing ourselves that we’ve done our best to prepare for uncertainty ahead. Or, even better, by accepting that the future, to a remarkable extent, is simply unknowable.

Yet, even when fear recedes, there is fatigue. In my case, I feel tired, far more often than I should be. Not physically exhausted like I was after my Himalayan treks or after climbing one of Colorado’s major peaks. No, I’m mentally drained. The combination of severe misjudgments, understandable mistakes and acts of plain stupidity, both by politicians and medical authorities, leaves me stunned. Yet the pandemic is only one source of my weariness. Even more bewildering is the echo chamber of competing media narratives. I’ve convinced myself that there is no institutionalized news outlet left that is not engaged in outright manipulation of the most transparent kind. Still, remarkably many people I know—mostly of the intelligent and caring kind—embrace even the most crudely concocted story lines, provided they fit their particular biases. All of this is disorienting and exhausting, and makes me wonder whether notions like personal liberty and a government serving the collective will of the citizens are things of the past.

Financial Markets

So what does that have to do with financial markets, the topic to which my commentaries are devoted? Quite a lot, actually. When people call me to inquire about our services or discuss their portfolio, their questions are invariably motivated by fear. “If I keep my positions, am I not a risk of taking a whopping loss?” some ask. Others are in the opposite corner. “I’m sitting on a lot of cash right now, but I’m not earning a return on it. What if the market keeps climbing?”

While those two lines of inquiry are far from unusual, what is very different from the past is the backdrop. Specifically, the scope of the global economic contraction is far beyond what today’s investors have ever seen, as is the amount of liquidity and debt that are created by the world’s central banks and governments.

So, what do I think is going to happen next? You may be disappointed with my response. Not wanting to join the ranks of the economists and market forecasters who tell you with beguiling certainty that we’ll have this or that kind of a recovery, or that the S&P will top out next Thursday, I confess to being agnostic on the subject. After some fifty years of bungled policies that have been allowed to unfold into utter unsustainability, economic and social policy forecasting has become futile. My only prediction is that meteorologists, the very folks who used to be pitied by most professionals, will shine by comparison.

This is probably the right moment to refer to William White, the distinguished former Chief Economist at the Swiss-based Bank of International Settlements, commonly referred to as the central banks’ central bank. Here are two things Bill White said in a recent interview:

“They [the central banks] have pursued the wrong policies over the past three decades, which have caused ever higher debt and ever greater instability in the financial system”.

And, more concisely: “We [the central bankers] know much less about the economy than we think we do.”

At a time when “experts” in every field spout their very specific beliefs with such fervour, the honesty offered by White, a central banking veteran of fifty years, is inspirational. I guess one of the lasting benefits of the COVID-19 pandemic will be that it has exposed so many purported experts as mere mortals, uttering what are, at best, educated guesses. So, forward we march—humbled by the fact that we have to individually decide what is true, what is nothing more than wishful thinking, or what is propaganda deliberately designed to mislead.

An Agnostic’s Strategy

Now, not knowing where things are headed doesn’t mean you shouldn’t have a strategy. Ours is to stick with our current allocation of roughly 45% in equities. By now everyone knows that the stock market expects additional trillions of liquidity to support it—even if the central bankers mend their errant ways, governments will likely provide massive fiscal stimulus. Yet, stocks are also richly valued, especially when seen against the dismal economic background. That opens up the possibility of another setback, possibly one that could be far larger than what the “experts” hold possible. In this climate, stock selection will be more important than ever.

An asset class we’re staying away from entirely are bonds. Our negative view is largely due to record low yields, which offer investors zero compensation for rapidly growing default risks. As William White puts it in his recent interview, the two most likely outcomes to the current mess are, “higher nominal growth—i.e. higher inflation—or try to get rid of the bad debt by restructuring and writing it off.” Both would be toxic to the bond market.

Mr. White’s thesis is also why we are holding gold. The yellow metal handily outdid all asset classes into late summer, but has recently taken a haircut. In the context of our approach, such volatility works in our favour. Because we continuously adjust our 15% allocation, we pared back our bullion holding into strength and are now repurchasing at lower levels. We remain very confident that gold’s bull market has much further to run.

Finally, we have a 40% cash reserve—a truly counter-intuitive bet. Not only do most investors see cash as an excessive safeguard that deprives them of participation in a buoyant market, but there is also a longer term question that looms. Given the trillions of liquidity that are being created, doesn’t it seem logical that faith in money as a store of value will dwindle? While we take both these points seriously, we view our cash hoard as a tactical necessity. No, we’re not earning any return on this part of the portfolio right now, but when equity valuations return to justifiable levels we’ll have some arrows in our quiver. In the context of the past decades, our view that cash is an important asset class (a tenet that’s widely disparaged by next-gen investment managers) has invariably served us well. We feel confident that it’ll be the same this time.

The World We Live In

Finally, a few words about the current political environment. Like the economic narrative, the political chatter is focused on hope. Consider how similar the messages are: “With the vaccine around the corner, we’ll soon return to normal,” and, “With Biden in the White House, America’s wellbeing (and, by extension, the world’s) will soon be restored.” Really?

Personally, I see the current economic, social and political backdrop as extremely challenging. The global economy still has to navigate what may yet become the hardest part of its slowdown and adjust to huge permanent losses in areas like employment and consumer spending. Social tensions are likely to continue or escalate further, as neither government, nor central banks, nor employers can restore preCOVID conditions. And, geopolitically, President Elect Biden’s ministerial entourage suggests that America’s forever-war is virtually guaranteed. Of course I hope I’ll be proved wrong, ideally on all three fronts.

My best wishes to all of you!

Peter Cavelti