Notz Stucki Investment Conference

Notz Stucki Broadcasted Investment Conference – 29 June 2021

It has been clear since March 2020 when the pandemic struck that the world has been grappling with a completely different situation to anything anyone has experienced previously. The dramatic collapse in economic activity and equally unprecedented monetary and fiscal expansion was unparalleled in recent history. The experience of 2020 and 2021 has been opposite in the sense that last year the economy was in a state of collapse, while financial markets were booming, and this year the economy has been recovering fast, while since February financial markets response has been more muted. Now a year on from the initial panic investors are starting to look forward to what the consequences will be, particularly as regards inflation.

The consensus among market commentators is that the world will experience higher inflation from the middle of the current decade. There are strong reasons for this. Monetary policy is actively trying to generate inflation; fiscal policy is ultra-expansionary with governments and central banks globally united in pursuing growth rather than price stability; the reduction in globalisation as a result of the trade dispute with China; the emergence of technology monopolies leading to the threat that disinflationary pressures will be lessened; political trends favouring labour more; and demographics being less favourable. These are all compelling reasons and it is hard to believe that there won’t be some inflation. Certainly the relentless trend of disinflation that has prevailed for the last thirty years is being interrupted. However the concerns of many in the market that inflation is going to return to levels that did so much damage in the 1970’s may be misplaced. A more benign scenario is possible, and even likely.

Future inflation may be more like that seen in the 1950’s. What is important is how high inflation reaches and how quickly it gets there. A sudden jump to 5% plus inflation would be very challenging for markets. But if inflation creeps up gradually and remains in the 1 – 3% range the markets should be comfortable with this because it will be accompanied by strong growth. This is why the 1950’s comparison is relevant because in the 1945 – 1965 period macro policies targeted growth and employment in the same way as now. Encouragingly the markets at the moment are subscribing to this outcome. Despite the plethora of inflation fears from commentators both bonds and equities are behaving as though the economy and profits will continue to expand for the next five years. The reason that markets are sanguine about inflation is probably because the scale of the economic collapse was such that it will be difficult for inflation to get traction. There are temporary shortages and bottle necks in certain areas, but overall there is too much excess capacity. In particular unemployment remains high so it will be hard for workers to achieve structurally higher wages. Equally the exceptionally strong growth that we are witnessing now will not be sustained. The re-opening boom is by definition a one off. Over the next year the imbalances in the economy should adjust and the market be able to grow higher growth than we had over the last decade, and while inflation will also be higher it will not be high enough to derail equity markets.

This leads to the following investment conclusions. Bonds will slowly lose their purchasing power. Yields are so low that they are unattractive, but they are unlikely to move dramatically. The expectation is that the yield of the US 10-year will move in the range of 1 – 2% for the rest of this year. Given this equities remain reasonably priced, and those outside the US are cheap. On a five year view the rotation from growth to value should continue thanks to the better economy. However short term growth shares, driven by technology, may have a final surge. The Nasdaq chart looks very similar today to where it was in the summer of 1999 before the final blow off at the end of 1999 and early 2000. Many technology shares look very overvalued relative to their fundamentals, but that won’t stop them going much higher if the market becomes enthused by growth again as inflation fears dissipate. After that the value trend should reassert itself, and that is likely to benefit companies outside the US. In currency markets the dollar looks well supported for the rest of this year, but as flows move out of the US it will decline. Asian currencies are likely to be the principal beneficiary of this.

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Notz Stucki Broadcasted Investment Conference

Notz Stucki Broadcasted Investment Conference – 12 January 2021

Anatole Kaletsky during our NS Broadcasted Investment Conference

2020 was one of the most remarkable years for both the global economy and financial markets, witnessing perhaps the largest short term economic collapse ever, followed by governments and central banks unleashing the most enormous stimulus packages ever to offset the lockdowns that they had mandated. These stimulus packages far exceeded what would have been thought possible a year ago, and as the crisis evolved became ever greater. The conference considered what the effects may be over the medium and long term.

The sudden collapse in economic activity last year was unprecedented, though it was met with an equally unprecedented response in terms of fiscal policy. As such history is much less helpful as a guide to the future, simply because there are no previous examples to compare this situation to. Since March the world has been stuck in a Covid induced shut down, in which large parts of the economy have been prevented by law from operating normally. Since then the global economy has been in a state of collapse, but stock markets bottomed on 23. March just three weeks into the crisis, initially in response to the huge stimulus, but latterly as they have started to look to the medium and long term and detect a brighter future. Markets are being tugged in opposite directions by these two giant forces – the economic plunge and the tsunami of liquidity. As time passes the balance of these two forces will change and today we are at an important transition as we start to exit lockdowns with the arrivals of several vaccines that will allow a slow return to normality.

As we enter the next stage there is a high probability that the tremendous stimulus will start to overcome the economic collapse. The public health situation is on the brink of improving because of the vaccines. Further there is always a time lag between the announcements of a stimulus and its impact on the economy. Usually this lag is about six to nine months, but this time it is likely to be one to two years because of the delay that has occurred before business is allowed to return to normal. So the various stimulus packages will arrive with full force this summer and it is highly likely that 2021 will see a strong return to growth, and this boom should last for the next two to three years. The market has anticipated this, rallying with extraordinary speed in reaction to the size of the packages and the explicit statements by Central Banks that they would keep monetary policy loose for several years. Indeed the conditions are extremely conducive for the bull market to continue. On top of current fiscal and monetary policies two other supports to growth were achieved last year. First the EU has finally managed to agree a unified fiscal policy which goes a long way to removing the risk of another European crisis. Second the Asian bloc has handled the crisis far better than the West both in terms of protecting its economy and its public health. It looks as though this area can grow strongly even if the US and Europe remain subdued. These more vibrant economies may decouple from the West, but in any event they are providing a strong support to global growth. All these conditions are ideal for creating bubbles in equities and there is little doubt that in some areas these already exist, with some areas of US tech being the most obvious example. Bubbles always burst eventually but timing this is impossible and they have a tendency to go far further than what is believed to be possible. Investors need to be aware of this but there are plenty of other areas of the market which can do well.

Looking further ahead there are consequences that investors need to start to consider. The first is inflation. The likelihood is that the massive money printing and spending by governments will lead to inflation. It is almost certain that over the next decade inflation will be higher than the rate that has pertained over the last forty years. There were anyway a number of structural forces pushing inflation higher namely: the weakening of globalisation; expansionary fiscal and monetary policy; the shift in technology from being a disruptive force to the establishment of monopolies; politics shifting to a position that is more supportive of labour leading to the rise of wages; and demographics. The debt piles that have been built up over the last few years also make inflation a temptation for governments, as historically that has always been the way that they have repaid them. So the question becomes how rapidly does inflation return? If it bounces back to a 4-5% rate in the next couple of years then that will be very negative for financial asset classes and social stability. However if it only creeps up gradually over the next few years then we could see a repeat of the Keynesian Golden Age that dominated the period from the late 1940’s to mid-1960’s which enjoyed strong growth and employment. This scenario is plausible because output gaps are so large coming out of Covid it is hard to see where inflation will come from. There is a strong possibility that we get strong growth accompanied by controlled inflation. This period could last a decade or even more. What is strange at the moment is that many commentators are expressing a lot of concern about inflation, but making almost no comment on this possibility that we may be entering a long term expansion, while financial markets appear completely unconcerned by inflation but are starting to price in the longer term growth.

The next nine to twelve months will be a crucial period. If we see growth returning and inflation does not take off in an alarming way then sentiment in financial markets will harden towards the view that we can get a low inflation boom. There are plenty of themes for markets to get excited about such as the energy and transportation revolutions that are taking place. Globally markets may start to focus more on the East as those countries return to normal more quickly than the West. With liquidity and stimulus so abundant valuations may rise to much higher levels than those witnessed in the past as PE ratings rise. The main danger to this outlook is inflation. If there are signs that it is starting to move significantly higher, then that would end an era that has prevailed since the early 1980’s. For several decades bond and equity values have been set on the basis that prices would be relatively stable. If they start to jump higher that changes everything, but for the next few months markets should enjoy the combination of lots of liquidity and a recovering economy.

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Notz Stucki Investment Meeting – Anatole Kaletsky

“Bull Market Will Continue – despite all the risks”

2018 has been a difficult year in financial markets with almost every equity and bond market suffering, with the notable exception of the US stock market. A further complication for investors has been that this has not been caused by a serious deterioration in economic fundamentals. Instead markets have been driven by political risks and uncertainties. Ultimately the question for investors is whether this is just a painful correction, and therefore a buying opportunity, or is this the start of a reversal in markets, signalling the end of the US bull market. The presentation considered three causes of the setback in markets since April/May, and then how far these issues might develop or revert. Anatole made a case that the bull market would resume, but cautioned that others in Gavekal were more cautious.

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Notz Stucki Investment Conference – Notes 27 06 2017

So far this year the optimists have been proven right, as stock markets have advanced steadily. This is supported by evidence that the world economy is in better shape, and is in a more predictable and sustainable condition than it has been for ten years. While this has been increasingly evident in economic statistics over the past year it has been overshadowed by political turmoil, particularly Brexit and Trump’s election, which could have had a serious impact on world growth if it had been followed by similar results in Europe’s elections this year. The Dutch and French elections conclusively rejected the populist surge, and now financial markets have a reassuring combination of stable economic growth and political calm. Where are the best opportunities to take advantage of this?

It is clear that the US has discounted this brighter outlook the most, largely because their recovery was well ahead of the rest of the world. From 2010 to 2014 the US economic expansion was driven by QE. However, since that ended interest rates have been rising slowly, yet the economy has still maintained modest growth. Employment has grown at a rate of two hundred thousand jobs a month with the odd soft patch, and US private sector GDP has been growing 3% p.a. since 2010. There was a danger that Trump’s election would bring a Reaganomics style economic boom which with employment already full could have caused inflation to take off. However, the Trump Administration has become paralysed through some self-inflicted actions, and as it collided with the Congressional process. As a result it seems that it will get little of its agenda through. This is disappointing for cyclical assets, but to the extent that it puts less pressure to raise interest rates and a higher dollar it is helpful for most other assets. From here the US economy should follow a slow self-sustaining expansion. Nonetheless the stock market has largely discounted this story, and as interest rates rise and monetary support is gradually withdrawn the headwinds will build making further advances of the index more difficult. Moreover the US stock market has become very narrow with just a few stocks pushing the index up, which is a sign that the market is not healthy. These market leaders are all technology companies and their profitability is based on monopolistic practices. History has shown at some point these monopolies get broken, or at least reined in. The US bull market is looking mature, and it is worth highlighting that the last four years global stock market performance has been carried almost entirely by the US. Since 2013 the US has surged ahead while the rest of the world’s markets have been almost flat when measured in US dollars (they have done better in local currencies). It looks to be a good time to start to rotate assets elsewhere.

Europe appears the most attractive alternative. The threat of the break-up of the Eurozone has gone, and Europe is reporting much better data, with even Italy improving and Greek debt recently upgraded. The shift in politics from six months ago has been dramatic and this takes away the risk premium that, quite rationally, had been there before. The genuine concern about a political nightmare that Draghi would not have been able to solve has disappeared. Furthermore the ECB continues to pump gargantuan quantities of liquidity into the system; €85bn a month or the equivalent of 200% of net sovereign issuance.

The other concern of investors last year, which was the collapse of China’s growth, is also receding. It is clear that China is slowing but if the rate of slowdown is held at 0.5% that still represents considerable economic growth given the large base effect. The concern on China is rather the lack of reform that has taken place, the build-up of debt levels, the signs of increased central planning and poor corporate governance. By virtue of its size these concerns mean that China has become a potential source of instability. When China sneezes the world will catch pneumonia, but that day is a year or two away.

The tremendous positive factor in the world today is the oil price. The fall of the oil price from over $100 to under $50 represents a transfer of two trillion dollars from producers to consumers. This is underwriting the recovery around the world as it releases consumers spending power and allows for more debt repayment. It has the effect of a giant tax cut.

As the global picture becomes one of steady growth everywhere bonds look more and more overvalued, particularly in the US. Policy has been unprecedentedly stimulative, for example in the US real rates have been negative for ten years. The expectation must be that US bond yields will drift higher. However, in Europe and Japan bond yields will probably stay low despite the recovery of their economies because their Central Banks are determined to keep monetary policy loose. The same does not apply to their currencies. The dollar looks extremely overvalued, arguably as overvalued as it has been in the last fifty years, with the exception of the brief peak in the mid 1980’s driven by Reaganomics. The euro looks correspondingly undervalued and but for the expectation of interest rates rising the euro would probably be climbing against the dollar now. But Fed tightening will not be enough to hold the dollar at its current levels. As Europe recovers the euro should recover with it over the next few years.

World growth is solid, and is supported now with a much more constructive political environment. The US has largely discounted this situation but the road map for the rest of the world is one that should follow the US with a lag. Japan is probably about three years behind the US and Europe maybe five years behind. This gives plenty of opportunity for equities in these countries to catch up over the next several years as growth comes through. Care needs to be taken as there are areas of the market that exhibit a high element of speculation; a number of companies are selling on high multiples while their growth is nothing special, and overall equities are not cheap except when compared to very expensive bond markets. However, the better environment in Europe should bolster returns there, though it should be noted that the returns are likely to derive as much from currency gains as stock appreciation.