Monthly Market Commentary - October 2020

Rapa Nui Finance


Warning, this monthly commentary is of no practical use for investment decisions. You might say: “what’s the difference compared to the ones you published until now?” Well, good point, but this time is done on purpose. So, I will just write down some of my reflections. At the time of writing, we know that Joe Biden of the Democratic party is going to be the next US president (although with a split Congress) and that a vaccine for Covid-19 is close enough to look beyond this very sad and unfortunate 2020 with hope of a better future. Both news are certainly positive for the market outlook and risk assets responded with an outstanding rally in a matter of days. The prevailing narrative is that we can now move towards 2021 with the conviction that the current global recovery will continue, boosted by a never ending QE and a sufficient fiscal stimulus. Do not take me wrong, nowadays the word “sufficient” means “in the order of trillions”. Everyone will have its fair share. At the same time, the gridlock in Washington reduces the risk of sudden changes in regulation or taxation. These elements, combined, keep inflation in check. The bond market would not revolt asking for higher real and nominal rates. By this time of the year in 2021 Covid-19 should be a bad memory of the past. There might be some violent rotation towards the value and reopening themes but, in the absence of new evidence and a different yield structure, those should be short lived; trading rallies. Investors would soon go back to the loved winners of this investment cycle: the structural beneficiaries of “free money”. This “goldilock” view is very plausible. Accordingly, we generally run portfolios with higher risk levels compared to our history. You probably do too. As I said, I do not want to get back to my old habit of raising red flags etc etc. Looking around, my best assessment is that you probably do not care. Fine with me. In spite of this, I would like to write of the greatest paradox I see right now in the market: sustainability. If you have been involved in finance at any level in the last 3 years, I am sure you have been proposed a “sustainable investment”. The investment case is catchy. We got to stop polluting our planet. General sentiment and government action focus their attention on investments that do not harm the environment. We aim achieving a circular economy: a steady state where limited resources get re-used an unlimited amount of time. The time to act is now and generous budgets are available at favorable financial conditions. More will come down the road. We must do this for the future generations. Nothing wrong with that. However, we can believe in a sustainable economy but should not talk about sustainable finance. By definition, finance is sustainable when risks and rewards are balanced. The price at which those are in check is called “the cost of capital”. If you invest resources at or above the cost of capital, you are creating wealth. If not, you are destroying wealth. Wealth creation and destruction foster a positive cycle that rewards innovative and competitive firms (and individuals). Today, we are in what a would define “unsustainable finance”. In order to keep things as they stand, central banks must print an enormous amount of fiat money, governments must send checks to citizens or incentivise investments while keeping zombie companies alive. Is this sustainable? Ok, it can go on for quite some time but I bet no one would define this model that needs continuous stimulus as “sustainable”. Are we doing this for future generations? Nope. Today, we are spending money we do not have increasing debt levels that the youngsters are supposed to repay in the future. It sounds pretty selfish, isn’t it? I do not see “circularity” in that. I know what you are thinking. How come that everybody is happy with this and you complain? How is it possible that millions of people believe in these new economic dogma and you do not? These are legitimate questions and I do not pretend I got the right answers. I have my personal views. I know that one of the things that characterize humans is the ability to share a “fiction”. It can be religion, faith in the king, the nation, politics, a law system, a football team. Over the millennia, those things pushed humans to extreme actions, even killing their same species. This is typically human. In his wonderful book, Sapiens – A brief history of humankind, Yuval Noah Harari rightly said that “You could never convince a monkey to give you a banana by promising him limitless bananas after death in monkey heaven”. With humans you can. The rationalist in you would imagine that humans do believe in certain fictions up to the point that benefits out-weight negative side effects. Well, history has plenty of examples we are not so good at stopping on time. The best example is the island of Rapa Nui (Easter Island), in the Pacific Ocean, out of the coast of Chile. Civilized by brave Polynesians around 1200 (they canoed for 2600 Km), it flourished thanks to excellent climate and fertile ecosystem. Unfortunately, the inhabitants developed a “fiction” that brought the civilization down to extinction by the nineteenth century. They believed in the worship of the dead ones. To honor them, they created almost 1000 Moais: giant hieratic stone faces. To move the statues from the quarry to the coast, they had to let them roll over trees. Lots of statues required lots of trees. De-forestation caused an imbalance in the island’s ecology bringing the society to collapse in a short period of time. Were they stupid? I do not think so. They believed in their fiction. Here at my desk I can let my thoughts wander and imagine a day around 1700 in Rapa Nui. Faithful islanders finished cutting all the trees near their village and asked the highest priestess for enlightenment. A new Maoi was ready to be transported. Every day lost could anger the dead. She must have looked at the sea… paused a little and said that their cutting needed “recalibration”. With no hesitation, the priestess sent the strongest men to cut the forest over the hill. I know I have a sense for drama… but please be careful of the “fiction” you choose to believe.

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