Authored by Bill Blain via Morning,

Meanwhile.. back in the Real World..

At some point in 2021 the builders might have finished our home renovation, and mankind will have beaten the Coronavirus. (More chance of the latter I think.) 

Today, there is good and bad news. More vaccines that show enormous promise, but  infections are rising. It feels like a race. I note JP Morgan predicting a Q1 GDP contraction is possible next year. 

But the finish line is in sight. By Easter businesses will be reopen, we’ll be back in our offices, we’ll be flying again, cruise ships will be cruising, and there will be a massive rebound in consumer spending as populations work their way through their excess savings built up during lockdowns. The hedge funds have been anticipating this; buying into distressed assets ahead of recovery has been a massive theme in recent months, everything from aviation, shipping to pubs and clubs. 

The markets are taking the view the multiple vaccine announcements and recovery prospects means it’s time to Buy, Buy, and Buy some more. Take you pick of positive investment theses: the great rotation trade, the small cap bounty, emerging market rebound. You will trip over market analysts explaining this is the start of a new positive cycle, or a long-term valuation play. There is nothing to fear. (Really?) 

Having got the remarkable age I am – 35 years in markets and spending every penny I earned on fast cars, fast boats and … well you know the rest, I now read through the investment pap with increasing interest every morning, wondering how I shall afford retirement when yields are effectively zero in real terms? There are plenty of good economists out there arguing the massive increase in government spending and support, plus increasing M3 money in circulation, is the genie that will create real inflation next year. All this talk about rising markets, recovery and inflation means I am a tad concerned that 20% of my PA portfolio still defensively in cash.

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I am, by nature, a pessimistic optimist. That’s very different from an optimistic pessimist. 

An optimistic pessimist reckons things are bad, but we will likely get to where we want to go. A pessimistic optimist knows things are improving, but that someone is likely to f*** it up by making a massive mistake and things will end up much worse than they need to be. 

My expectation is for Pandemic recovery – but will that lead to a bright new industrial age to justify the current stratospheric markets? Not so sure that’s the way this plays out. I reckon the risk of policy mistakes as conventional politicians try to rein back spending too early, raise austerity taxation and generate wage inflation are substantial. Yes, Mr Sunak.. I mean you! 

Inflationary threats are another reason to be concerned on my cash position – it’s one reason we’re investing in building work now. 

Many businesses will remain crippled for years as a result of lockdown losses and repaying emergency lending. 18% of firms were effectively debt-locked zombies before the crisis. Yet, many other businesses have thrived despite the pandemic – the reality is a reopening economy of winners and losers. 

Human nature being what it is, I’m predicting some pretty fraxious times ahead here in the UK as our government tries to row back on pay hikes for front-line workers and civil servants. Their demands will likely fuel demands for higher wages across the private sector. There will be winners and losers – which just increase the “Not Fair!” aspects of a crisis we are supposedly sharing together. 

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I’m not quite predicting a Black Death scenario where losing ½ the workforce caused wages to balloon and killed feudal systems, but I do expect a lot of noise. The pandemic could well have shattered wage stability, and since the government is about as popular as boil on the bottom, the only hope for avoiding industrial strife is probably the sheer amateurishness of the unions and the left. 

And we haven’t even got to post virus stage! The government says Easter so there are still five months before vaccines are widely available and in circulation. That’s five more months of potential slowdown and pain to come. Will I be able to go skiing? It ain’t over till it’s over!

Moreover, I am even more concerned about the health of markets. Bonds and Equities are pretty much fully pricing a full recovery already. Corporate bonds have never been so tight. Equity valuation metrics are pretty much at record levels. Yields have never been so low – and risks, uncertainty and threats have never been so high.

The problem is a growing mismatch between risks and returns. Markets are way, way ahead of the reality and priced pretty much for a perfection we are unlikely to acheive. Yet the global economy has never been so stressed in terms of rising trade and geopolitical uncertainty. When US junk bonds yield close to negative real yields. When zombie debt-addled companies are trading close to negative actual yields. When equities are at record valuations.. Etc..

The reason markets are so strong when the economic reality is so weak is nothing to do with expectations of a bright rose growth future, but entirely due to distortions in market pricing that flow from ultra-low interest rates and QE infinity. If you have been looking for inflation these last few years, then look no further than financial assets – that’s where its been. Now it threatens to break into the real economy.  If confidence in the ability of Central Banks to keep fuelling the positivity was to wobble….. then its game-over. 

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How will Central Banks react if wage inflation, real inflation and government reinback strikes next year? Now that is a real and rising risk. 

The result is investors will do anything to find diversified and greater returns – which favours equities despite the obvious overvaluations, and fuels belief in the extraordinary. In that latter bracket I would put the impossible valuations being put on “story” stocks. Tesla is the obvious one, but there are just a many other tech and health marvels that are hopelessly overvalued on hype and insane optimism. Then there is Bitcoin – which I wrote about last week, and received a barrage of hate-mail about. 

In extraordinary times.. extraordinary belief trumps common sense everytime. If you want to demonstrate leadership and success in these markets – be critical and pragmatic. Learn to tell hype from fact. 

So where does that leave my portfolio? A balance of risk vs defensive stocks, upping equites and cutting bonds, diversification from Occidental economies into the Orient and a lot of concern about inflation hedging. Maintaining a position in Gold, and thinking about how to invest in recovery commodities as the global economy emerges next year. And looking to put my cash to work. 

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