The world has changed since my last editorial late last year. The change is significant and lasting, even as recent equity market gains might suggest otherwise.
I don’t recall many six-month periods after which the world felt as different as it does today. The period around 9/11 was one such time. As a foreigner living in the U.S., I felt first-hand some of the restrictions implemented in the name of fighting terrorism: hours-long waits to get processed at JFK Airport, more red tape in sending money overseas, and a queasy feeling that the U.S. was no longer as open to immigrants as it used to be.
Once a government tastes expanded powers, don’t count on it to give them back. While terrorism on U.S. soil has receded as “fear number one”, the government has found other justifications for keeping in place many of the “temporary” powers authorized after 9/11.
The unprecedented nature of the coronavirus crisis has let governments around the world taste unprecedented powers. In Switzerland, compliance has been high due to relatively low political divisions and the general attitude of the people that, normally, the government does not interfere much in people’s lives. The shutdown measures worked (new daily cases are near the single digits), and I have confidence that Switzerland will go back to being Switzerland. I am not so confident of that in some other countries, where political divisions are higher and the government’s role has tended to expand over time.
Of particular note to investors are interventions by the Federal Reserve. While I cannot predict the ultimate consequences, it would be foolish to believe in an absence of consequences. Such absence would render everything we know about recessions, money, interest rates, debt, etc obsolete.
Long-held views on inflation were tested mightily long before the coronavirus hit. Low consumer price inflation following the Fed’s balance sheet expansion during the financial crisis of 2008 now appears to give credence to the view that inflation is dead – and even the Fed’s latest, multi-trillion interventions may not resuscitate it. I’m not so sure.
Could it be that we have a highly unusual combination of higher inflation expectations and near-record-low long-term interest rates, with the latter manipulated down by the world’s central banks? This might explain equity gains in the face of a deep recession. Investors’ belief in an inability to “fight the Fed” on long-term rates has resulted in many of those same investors using near-record-low discount rates in their valuation models. It is plausible that long-term rates would be higher without central bank intervention. This would negatively impact valuation multiples, which remain far above historical averages.
What is an investor to do? While betting on higher T-Bond rates may be tough as it means “fighting the Fed”, investors absolutely can – and I would argue, should – use materially higher discount rates in their valuation models. Investors may also want to start orienting their portfolios toward inflation-protected equities and commodities.
The latter offer fertile hunting ground at the moment as they have been out of favor for a long time. Are we really to believe that commodities are irrelevant in a world of growing consumerism and even mercantilism? Countries appear willing to go to the brink of war to protect their commodity supplies, yet those same commodities are available in the open market at historically low prices.
I do see one set of commodities the value of which may erode materially: fiat currencies. Paper money is the only commodity that may be produced in infinite quantity at no lifting cost. And governments have been doing precisely that – printing money (while using euphemisms and clever central bank accounting). In the second half of 2019 we learned that the Fed’s balance sheet cannot be shrunk, even in economically benign circumstances. Believing that the Fed’s recently expanded balance sheet will be shrunk in the future is a delusion.
Sean Stannard-Stockton, President and Chief Investment Officer of Ensemble Capital Management, recently wrote a terrific article on the “next normal”. Sean argues that typical discussion of a “return to normal” is misguided. He shares thoughts on the “next” normal, arguing that, “While the Coronavirus will reverse some trends, it will also accelerate trends that were already in place.” Sean contrasts “obvious” from “less obvious” insights, giving investors food for thought in terms of investing in quality businesses, many of which enjoy inflation protection due to pricing power.
According to David Barr, President and Chief Executive Officer of PenderFund Capital Management, “The key point in this business environment is to focus on the compounder side of the equation, and that’s what we’re doing… We instituted work-from-home, and on our first conference call, people were having a hard time getting in mostly because circuits were overloaded. Work-from-home is putting larger demands on networks, so the providers are going to have to increase their network speed. There are companies out there which optimize networks for this sort of thing.”
MOI Global’s special event, Intelligent Investing in Crisis Mode 2020, surfaced many insights and ideas for investing in the “next normal”. I encourage you to listen to the sessions and read the transcripts contained herein.
I am also pleased to bring you our latest interview with Seth Alexander and Joel Cohen of the MIT Investment Management Company. If you manage a fund and are open to partnering with a long term-oriented allocator, I recommend reading this interview. MITIMCo is clearly on the hunt for great investors.
Our team has also created a transcript of the recent Berkshire Hathaway annual meeting. Please feel free to download it here.
While we have postponed some offline events due to the coronavirus, our long-standing online presence allows us to add value to members in this difficult time. Thank you for your continued trust.
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