A few days ago, upon hearing my views on the state of the world, a friend told me I was too cynical. His comment made me think. Among other things I asked myself whether I tend to view my life in negative terms. Not at all, but what about the world around me? Here, I realized, it much depends on scale. Interactions with family and close friends, co-workers, neighbours and members of my community are generally upbeat and rewarding. And so are my encounters with individuals I don’t even know: waiters, cashiers at grocery stores, gas station attendants, people taking a walk in the park.
Sadly, the experience usually deteriorates when things get bigger. Once an organization reaches a certain size, it gets harder to relate to. The individuals at the service level remain just that—individuals—with all their quirks that make them so unique. Yet when it comes to the institution as a whole that distinctiveness disappears. Quirks are displaced by features that strike me as loathsome. Where individuals can be colourful, institutions seem to come only in dull shades of grey; responsibility gives way to arrogance; dysfunctionality is papered over by hollow marketing images.
There are exceptions, of course, but far too many sizeable constructs, from government agencies to corporations and even charities, transport me into a space of cynicism. It might be different if I were twenty. After all, the way things are at present would then be the only thing I have ever experienced. But age has given me context. I’ve lived in times when leaders were more accountable and when ethics weren’t only defined by what is legal and illegal. In other words, I have something my grandkids don’t have: comparison.
How can we maintain sanity, on a strictly individual level, while also doing something about the rot that is, to many of us, now so transparent? Stepping back for a couple of hours a day and reflecting on what is still wholesome works for me. Where I find shelter is in nature and in creative pursuits. And equally, through exposure to what is still deeply honest in the human
realm—such as sharing experiences and goals with family, friends and in community circles. Of course, the ultimate personal aspiration is as the proverb suggests: “Be the change you’d like to see in the world”. Conversely, the most self-destructive path is to get emotionally attached to a given narrative, its biases to be conveniently and continuously confirmed by a favourite media source. Ouch!
Things Are Moving Fast
The duplicity around us has been allowed to deepen for many decades, but hidden behind massive economic growth and wellbeing (strictly in our part of the world) it was largely unnoticed. Now, that countless policy platforms, from agriculture to education to health to monetary and fiscal systems, are failing all at the same time and governments conveniently attribute the problem to Covid or Russia, the corruption stares us in the face like never before. Can seeing that and rising against it really be defined as cynicism? And if so, is it wrong to be cynical when recognizing and expressing how much around us is corrupt?
Things are moving fast. I could write about what happened two weeks ago and it would appear outdated. I could say that if the Federal Reserve had started hiking rates when it was the right thing to do to, it wouldn’t face the current dilemma. But that would be “old hat”. By now everyone understands that the Federal Reserve and other central banks are hiking rates during an economic slowdown, just as they were cutting rates during an expansion. And the Fed, many of my readers would point out, is not alone in creating vast amounts of liquidity during boom times—others, like the European Central Bank or the Bank of Japan have acted even more recklessly.
Considering the past half-century’s lineup of central bankers is an exercise in frustration. Out of more than a hundred operatives in the world’s top monetary authorities that I’ve observed during my time in the investment business, only half a dozen stand out as capable and responsible. The rest disgraced themselves as clueless apparatchiks. Yet, once their terms ended they reliably landed jobs and garnered speaking engagements that secured them millions. Bernanke, who forecast in summer of 2007 that economic improvement was imminent and who shortly after oversaw a bailout of half a trillion dollars to rescue some of America’s most poorly managed institutions, did even better: his actions earned him this year’s Nobel Prize for economics. Do we need more evidence of systemic rot?
“The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost.”
Ben Bernanke, Nov. 21, 2002
Regrettably, central banking is but one example of our many systemically unsustainable policies. The result: we’re destined to witness continued chaos on numerous fronts—notably not caused by the pandemic or the Ukraine War, but certainly accentuated by them. Moreover, as winter arrives, shortages and hardships will be felt more acutely, while social reactions will become far more visible.
“We need the United States to sit at the table to promote the peace process in Ukraine,” said French President Emmanuel Macron the other day. The U.S. quickly brushed this notion aside, instead vouching to extend its military support and thus prolong its proxy war, with ever more devastating consequences for the Ukrainian population. Worse, the Pentagon’s updated National Defense Strategy further elevates the risk of escalation, stating that the U.S. will maintain “a very high bar for nuclear employment” and will no longer rule out using these weapons “in retaliation to a non-nuclear strategic threat to the homeland, U.S. forces abroad or allies.” Early this week, Washington pressed ahead even further, revealing its intention to deploy a fleet of nuclear- capable B-52 bombers to Northern Australia. “Having bombers that could range and potentially attack mainland China could be very important in sending a signal to China that any of its actions over Taiwan could also expand further,” commented a spokesperson for the Center For A New American Security, a think-tank founded by Michele Flournoy (Under-Secretary of Defense under Obama), notorious military contractor Booz Allen Hamilton, and Kurt M. Campbell (coordinator for Indo-Pacific Affairs in the Biden Administration).
Now, I’ve never been a fan of Henry Kissinger, but his recent perspectives on America’s path resonate deeply:
”We are at the edge of war with Russia and China on issues which we partly created, without any concept of how this is going to end or what it’s supposed to lead to.”
Henry Kissinger, August 2022
To America, a continuation of the Russia-Ukraine confrontation will economically and socially have relatively mild consequences—unless it escalates into something much bigger, such as a cyberwar or even a nuclear exchange. For U.S. allies in Europe the reality is very different: the price to be paid will be brutal, even if the war remains contained to Ukrainian territory.
This lack of proportionality will manifest on other fronts too. China, relentlessly pushing its zero-tolerance Covid policy, will face continued economic challenges, some of which will make themselves felt abroad. Yet here too, the impact on the U.S. will be more tolerable than on some key economies in Europe and elsewhere.
Given the sacrifices European Union politicians and some of the continent’s national leaders demand of their subjects, I doubt that the citizens will quietly acquiesce. On the contrary, my belief is that social tensions will sharply escalate this winter, which will in turn aggravate disagreements between EU countries. The growing gap between the French and German positions is a vibrant example, as are the past week’s demonstrations against EU positions in Prague, Paris and elsewhere—all woefully underreported by the mainstream media. Unfortunately, much damage has already been done.
Financial markets are trying to sort through this array of complex economic dynamics, as well as the prospect of ongoing inflation pressures and the responses by key central banks. The top- down realities are easy to define: the two major forces that made decade-long deflation possible, productivity growth and globalization, are stuck in reverse gear, while irresponsible monetary and fiscal policies are fueling price pressures on many fronts and threaten to cause a collapse in debt markets. When viewed from the bottom-up it looks far more complex, with geopolitical realignments and sharp variances in existential circumstances (by geography and social class) manifesting themselves in countless ways.
Prepare for Various Outcomes
For the past two years our overall strategy has been, “Be prepared for various outcomes”. We see no reason to change that. The daily offerings of specific forecasts may be helpful to disciplined traders, but to investors they are of no use. The simple truth is that no one has a clue of how this will play out.
Having offered this rather sad assessment, let me briefly comment on each asset class:
Stocks still represent our largest allocation. We don’t have high expectations from equity markets, but at least ownership in a corporation is a real thing and represents more than someone else’s promise of repayment. The key lies in disciplined stock selection. You want to own companies whose position within their industry is secure, which can reliably generate positive cashflow that, in turn, enables the payment of dividends.
Within the equity segment, we are now considerably overweight Canadian stocks. The Canadian dollar has fallen sharply and inflationary periods have historically been kind to this resource-rich, export-oriented economy.
Bonds make up a much smaller portion of our investments. Yes, governments can always print more money to service and repay its debts, but doing so aggravates inflation pressures, which represents a negative for bonds. The bond positions we hold are of very high quality and very short duration.
Our sizeable cash hoard keeps enabling us to outperform, a pattern we expect to continue. Our definition of cash has become less dogmatic—as the result of more attractive yields we’ve committed part of our reserve to CD’s (in Canada GIC’s), with staggered maturities to maintain a high degree of flexibility.
We continue to hold on to our gold position, largely because central banks are too far behind the curve in their fight against inflation. Historically, the metal has performed well during both inflationary and deflationary periods. Chances that we will end up with years of ‘stagflation’ (continuous price pressures in a stagnating economy) are rising and should help gold to a sharp recovery. During the past year, the metal’s price has slightly increased in Canadian dollar, Euro or Swiss franc terms, has gone up a lot in Japanese yen, but has been under considerable pressure when expressed in U.S. dollars—which brings us to the topic of currencies.
The U.S. dollar may stay at elevated levels for a bit longer. For years now, we’ve been warned of an inevitable and imminent dollar crash. Our own perspective, all along, has been that yes, a gradual replacement of the dollar as the world’s reserve currency is clearly underway, but the transition to a new order will take time. For the moment, interest rate differentials and economic differences are still dollar-friendly.
I keep being asked about real estate, another asset that’s not someone’s liability and thus deserves attention. While this is not my area of expertise, I’ve noticed over the years that property values depend on
When it comes to bubbles, the one just behind us ranks big. For a compilation of bubble intensity in the world’s major cities, see the chart above, courtesy UBS. (Spoiler alert: in terms of property prices, my city appears to be the world’s most overvalued).
Best regards,
Peter Cavelti