Play for the recovery!
It’s easy to forget how bleak January 2009 felt. The GFC had just taken place. Lehman’s no longer existed. No one really knew what would happen next.
Finance gurus, who had become fabulously wealthy riding the asset management bull market since the early 1980s, said similar things to what they are saying today. Stanley Druckenmiller predicted a “lost decade for equities.” Howard Marks called for extreme stress in credit markets, and Ray Dalio, after generating some alpha for a change in 2008, pushed his gold strategy to every asset allocator on the planet.
Inflation would be the key issue during the 2010s, they said. The government was spending too much money! The US was fast becoming a Weimar state! Interestingly, the financial titans of yesteryear went on to repeat this mantra in 2012, 2016 and 2019. They were, of course, wrong each time!
In 2009, they even laughed condescendingly at the economist, Paul Krugman, who argued that instead of inflation, we were heading into a period of prolonged falling prices. It turned out Paul Krugman was right (isn’t he always?) and the bearish commentary on equity markets was all nonsense.
In the following month, the Chinese started printing money and a broad-based global recovery took place. The 60-40 asset allocation worked perfectly well for the next 9 years until the autumn of 2018 (Northern Hemisphere), when Jerome Powell made his first mistake.
Clever sounding bears make you miss opportunities.
At the lows of early 2009, the key thing to realize was people were going to get up and go to work. And there were plenty of levers the governments of the world could pull. That was it. You could pontificate about historical analogies all you liked but understanding that made all the difference.
Unfortunately, old crusty bears love to pontificate about historical analogies. That might be a function of age or wealth. The author hasn’t worked it out. It wouldn’t be such a problem, but old crusty bears are the people who get invited to investment conferences. They are the people who dictate the narrative.
The author attends those conferences these days and can see first-hand what happens. We live in an age where information is everywhere, but it’s amazing how we still need to be told what to think. The investment management industry is no exception.
A common feature of any conference these days is the panel discussion. Unfortunately, they tend to be a waste of time. Few original ideas are discussed; only old ideas are repeated. It is a problem across the broader investment community, including niche areas like venture and crypto, which presumably should be about cutting-edge differentiated thinking. Unfortunately, that is not the case.
Critical thinking is often parked to one side. It’s much more comfortable for everyone to stick with the narrative handed down to them by people like Jeremy Grantham (above), or heavens forbid, Marc Andreesen. There is comfort in saying things like “higher for longer,” “this is the 1970s,” or “every company will become a fintech.” If you parrot that kind of thing, you fit in and get invited to the next drinks party. If you don’t, people look at you funny. If you buy into the consensus, however, it also means you can massively underperform.
The Opportunity Cost of Capital.
Curiously, we celebrate people who want the world to end. Listening to people like Ray Dalio, Peter Shiff or your average Zero Hedge “journalist,” however, can result in major opportunity cost for your capital. It’s not just individuals, who end up sacrificing return potential. It’s also the big asset allocators of the world.
Norges continues to make it clear that it will invest in private equity in a big way soon. As with any asset allocator, who has drunk the David Swensen cool-aid, it is perfectly reasonable to invest into a private equity fund, which returns 25% IRRs plus. Such a strategy should help Norges get the returns up on its funds, which have been markedly lower than that.
But here’s a question to mull over. Why don’t they, instead, just buy 20% of Space X, which should be IPO’ing next year? It might help them generate some significant alpha for a change.
The Saudis can be criticized for their timing when backing Masayoshi Son and Softbank, but their intent was correct. We live in an era of exponential returns. Backing high growth opportunities comes with risk but it also comes with significant return potential.
There are implications for large pots of capital, like the funds managed by Norges, returning low single digit returns, when the global economy is not growing fast enough. And what is the worst that can happen anyway? The great people of Norway will just have to work for a living in future generations. The author has met enough third generational trust fund kids now to know working is not just about the money. It is often about self-respect. It wouldn’t be that bad, no?
Human Beings and Negativity Bias
You can’t blame the sorry state of affairs in the investment industry all on the opinion leaders. It wouldn’t be an issue if the general public or investment professionals were not receptive to all the doom and gloom. Everyone still listens to a Chicken Little like Michael Burry, despite the fact he has really only got one trade right.
Getting one trade right once in your career doesn’t make you a GOAT. It probably just means you’re a weirdo and were a nightmare for LPs at one time. Didn’t he GATE his investors btw? Isn’t that just wrong always?
In contrast, people ignore the fact, or just don’t know, that David Tepper (above) and George Soros made much more money playing for the recovery from 2009-2012 than Michael Burry ever did. Such performance didn’t warrant a movie with Christian Bale, as being constructive doesn’t appeal to human being’s negativity bias. We all have a tendency not only to register negative stimuli more readily but also to dwell on such events. It’s so much easier to look for the bad in things, than the good.
Perma-bears suck.
This newsletter thinks it’s a mistake to be a perma-bear unless you want to sell newsletter subscriptions or believe gold is going to $10,000. Over time, equities tend to go up as growth wins and population and productivity increases. As the great Peter Lynch noted, “far more money has been lost by investors trying to anticipate corrections than has been lost in corrections themselves.”
With that in mind, the author would like to repeat this newsletter’s basic tenants from this year and then try to make some predictions:
Inflation was always going to be transitory. We were never, in anyone’s wildest dreams, going to have a wage spiral like we saw in the 1970s. Inflation was always going to drop at the fastest rate in history at some point. Isn’t it already?
The natural level for interest rates is MUCH lower. We have more savings than any time in history. That matters. For historical context of where we stand today, read Keynes’ Economic Possibilities for Our Grandchildren (1930). He wrote it in 1930 but it’s still relevant! Keynes was the greatest! Powell will have to cut dramatically at some point. (100 bps in January?). It was a huge mistake embracing the ghost of Volcker.
The world has a growth problem, not an inflation problem. We have been growing below trend since 2008. Milton Friedman won’t get us out of the actual deflationary funk we are in. A shock to the system like we saw in Japan is the only way out and that involves Keynes, not Hayek or Friedman. The good news is a Japan style Three Arrows policy is being planned in the US in the background at the moment (Yellen is the mastermind). Trump, unfortunately, is not part of the plan. (The author likes Trump in full disclosure)
Fear about the US bond market is overblown. There is no alternative and won’t be for years to come. The narrative about the US is just too negative. The US is unfathomably wealthy - infrastructure, IP, universities, corporations. Why do we always focus on debt? Won’t the US GDP be a lot bigger in 2040? The US is also fast becoming a closed economy (onshoring and energy independence) to the detriment of Europe. It’s not US sovereign debt we should be worried about. It’s European sovereign debt risk in 2024.
There has been nothing extraordinary about this year. The 60-40 portfolio allocation has made a comeback as happened the year after 1931, 1941, 1969 and 2018, when both bonds and equities were down. The volatility in September this year and the surge into year-end is perfectly normal in the third year of an election cycle.
Finally, we live in a Victorian Age of technology, one in which technology applications become an increasingly influential impact on our lives. In this environment, scale matters. The Magnificent 7 will go from strength to strength. And companies like Uber, which have run the VC funding gauntlet, will become category killers. This is important as it is a massive tailwind when rates do get cut just as the tech boom of the late 1990s was a tailwind for Greenspan, when he cut rates in 1993/1994.
This is a time for optimism.
There are also many signs emerging that things are improving out there. Most recently, we have seen the following:
Global air cargo demand was up 3.8% in October.
Both Pinterest and Snap raised their estimates for the ad spend market.
Plenty of evidence that construction is booming. There are even early signs that residential construction is picking up.
This is 2009!
Mark Twain has many great lines to see you through the darkest moments in life. Unfortunately, everyone in finance just knows his comment that “history rhymes.” Of course, it does.
The issue the author has had with the financial community is the historical moment it claims the last few years has rhymed with. It is intellectually lazy to think the economy today is anything like the economy of the 1970s. For the author, all we have seen since Powell started raising rates is a prolonged version of the market tantrum we saw in the autumn of 2018, when Powell first tightened too quickly. Nothing more!
And the market right now resembles Feb 2009, not 2007! Low interest rates matter. They should drive a recovery. The impact of a lower cost of capital will be profound for many areas of the economy. Let us explore some examples:
Housing
Ed Hyman famously said housing would be the Nasdaq of the 2000s. This newsletter has argued it will be non-tech bright spot in the 2020s. The US has a shortage of 3 million homes. And no affordable housing has been built in the US since the 1990s (this is why the author used to be in the mobile home park game).
People don’t buy house prices, they pay mortgage payments and lower rates should boost a long list of stocks such as Lennar, Cemex in Mexico and interestingly the Japanese homebuilders (they made some very clever strategic acquisitions of builders in the US before Covid). (Not financial advice).
IT Capex
In 2021, digitalization was the mot du jour. Gartner in 2021 released a very bullish report on the prospects of IT capex in response to new digital business initiatives. The consultancies looked forward to juicy contracts advising corporates how to spend the dough.
Unfortunately, everything got pulled back during 2022/2023 as the cost of capital went through the roof but that is bound to turn now. Lower rates should mean more cash flow is available for IT spend. Wait for the new Gartner report.
Fintech
The author argued in June 2022 that most fintech would prove to be ephemeral. Even though that’s more or less played out, it makes sense to look at some of the listed fintech names, which are trading at multi-year lows and still have a pulse.
The non-bank lending industry, for example, has been hurt by higher wholesale funding costs. What happens to those costs in 6-12 months? VCs will invest again into their fallen angels in the fintech space through follow on funds. Fintech remains a great way to allocate capital and earn fees.
Venture Capital Funding
The low point for the Venture Capital industry was in 2022, when Sequoia produced a macro report. Isn’t Venture all about secular growth? Thomas Perkins would be turning over in his grave at the state of the industry.
In a letter to Roosevelt in 1937, Keynes said the private sector roars like a lion when times are good, and it meows like a domesticated cat when times are bad. That is exactly what we saw with venture capital over the last couple of years. The good ones (the lions) continued to invest, picking up great deals at great prices. (Weren’t the deal terms available in the autumn of 2022 (Northern Hemisphere) just amazing?) The bad ones sat there like dears in a headlamp, meowing like cats! (Meowing dears - does that work?)
If venture capital is an inverse beta play on interest rates, the VC community should receive a dose of joie-de-vivre again when Powell cuts. The author believes Q1 and Q2 of 2024 could see record funding months. We will soon appreciate just how bi-polar the industry is. Marc Andreesen will release a report soon no doubt saying now it the best time to invest in software….EVER! The thing is he might have a point.
Tech Compounders
Large cap technology companies with high ROIC win in an environment of lower interest rates. The big tech names led the index during the 2010s for a reason. It is not surprising that the Magnificent 7 are doing it now. We live in an era where scale is everything. Everything should grind towards the large cap tech compounders over the next 10 years. For instance, Apple should own health and fintech. If Apple maintains its ROIC, why couldn’t it be a USD$10 trillion company this cycle?
Japan
EM tends to be a winner if the US Dollar falls, but the author has little interest until we see more evidence of growth. China, the engine of growth and arguably the savior of the world in 2009, is not the beast it was. India might pick up the slack but it’s not clear there is much going on with the other BRIC nations, really. It’s all a bit disappointing if you look close enough.
Arguably, the most interesting equity market in the world, even more than the US, is the Topix index in Japan. We have discussed this at length in previous newsletters, but, as a longtime observer of Japan, this is the most exciting it has looked for a long time. Shinzo Abe is the greatest leader the world has seen this century, and his bravery is resulting in Japan regaining its energy back!
Volatility in January?
Of course, someone said (not Mark Twain) that volatility doesn’t travel alone. The upside and downside usually travel together. And when an index like the Russel 2000 goes from a 52-week low to a 52-week high in 6 weeks, you know at some point, things will get choppy. The author guesses the volatility will spike sometime towards the end of January. None of it will be easy next year. It never is.
As always, thanks for reading. I appreciate all the support shown for this publication over the last year and wish you all the very best for 2024. I am taking two weeks off to chill with the family before getting back into it next year. I think 2024 will be a huge year for capital markets.
Btw, always do your own research! None of this is financial advice - it’s just the random thoughts of an ex-finance guy who doesn’t have enough hobbies.
Merry Christmas to you and your families!
Best regards
Mateen
DISCLAIMER: None of this is financial advice. The opinions expressed are purely my own opinions and it is imperative for you to do your own research. They do not represent the views of any company I am associated with