Long time readers know that I love movies. I am very happy that, in process of normalization of our lives post Covid, we can all go back to cinemas and enjoy new shows. However, for this monthly commentary, my memories go back to and old movie by Christopher Nolan of the year 2000: “Memento”. It is a must see. I do not want to spoil it too much but it the story of Leonard Shelby (actor Guy Pearce) that suffers of “short-memory” loss. His brain damage was due to a physical aggression that changed the course of his life. He cannot remember anything for more than 15 minutes. Then, he goes back to the very moment of the incident and starts all over again, and again, and again. He is in search of revenge, but it is difficult to recollect evidence in his state. In an illusion of control, in a messy sequence of events, he uses polaroids and even body tattoos. Like in other movies by Nolan such as “Inception” or “The prestige”, the story unfolds in a crazy un-chronological order with blurred lines between causes and effects. A thin line divides truth from lies and vice versa. I am using this movie as an introduction for this document because I feel that, in this particular market context, me and value minded investors like me should not fall into “mind traps”. Substitute 15 minutes memory loss of the movie Memento with 5-10% correction in the S&P and you could understand my point. Trying to be clearer. September was a bad month for risky assets. Stocks were down except for Japan. Credit spreads generally a little bid wider during a widening move in government yields (hence bonds down). Not a good set up for the average long-only portfolio. When this happens, it is natural for contrarian investors to reload energies and point out that debt is too high, valuations are toppish, and investors are better served reducing positions for good. This could be the “beginning of the end”. Well maybe, not too fast. Let’s start with the evidence. Economic data is showing signs of weakening all over the world. The best YoY comparisons post Covid are behind us. Having said that, right now, a recession is not a likely outcome anywhere in the world. We can simply say that economic growth has moderated on positive low single digit figures. On the inflationary front, until the end of the summer the market was happy with the “temporary” narrative of the central banks. This is not the case anymore. So, higher yields are warranted. However, this is not a structural issue for valuations until inflation and rates are much higher for a longer period. There is a lot of talk of stagflation but, in economic history, rising inflation in a negative growth environment has been a real exception and not the rule. In addition, the upcoming reporting season presents more uncertainties than the ones in Q1 and Q2. Base effects are mitigating while earnings expectations are still very high. On top of that, bottlenecks in several global value chains and rising raw materials pose a risk for the short-term outlook for earnings. We all know that, so it will be crucial to see how the market responds to CEOs commentaries in the following days. Following this reasoning, there are many motives to be more cautious than the recent past. A tactical reduction could be welcomed. Having said that, I invite you to have longer memory. Since 2009 we are in an environment of ever rising monetary base. It has influenced the price of everything. Now we are stuck in a policy situation where there are only two possible outcomes. One is a complete disaster. It will be a market clearing and the vindication of liberal thinkers that hate price controls and the trend towards socialism of western societies. Anyway, we must always be “careful of what we wish for”. We should consider this scenario as a possible one, but we must attach a low probability weight. This probability weighting would rise should we face a “policy mistake” and a market rebellion of some sort. Does anyone remember the bond vigilantes anymore? I expect the currency market and/or the price of gold to signal that beforehand. At the moment, I do not see this change in landscape. If you have a different view or something that keeps you thinking that a policy mistake is actually in the making please shoot me a message. The second plausible scenario is a “never ending” procrastination of financial repression with negative real rates while economic growth and inflation keep registering low but positive numbers. So far, this is the most likely solution. The one central bankers and governments have invested a lot of money and reputation on. What is the marginal cost of changing idea on tapering for the Fed? In the medium term: zero. What is the marginal cost of introducing curve control to allow governments to invest in a greener and more sustainable future and in a redistribution of income? In the medium term: zero. These expansionary policies are here to stay. So, tactically we can get some chips off the table but, in the medium term, we must be exposed to real assets. Some of these real assets are mispriced, some are not. From the top down, gold and gold miners, industrial commodities, Asian equities are still offering opportunities and tools for diversification. On a sector and company level there are always opportunities to find reasonably priced stocks among the over 90k listed globally. Bonds offer low value overall, but even there it is possible to scratch the surface and look for hidden gems (though you might have to dig a lot). In a nutshell, general market levels sound unattractive and they might get more difficult in the coming quarters but, strategically, this could be a potentially good environment for active managers of real assets with a medium to long term horizon. Invest outside the comfort zone of popular indices and ETF be ready to accept some tracking error while being vigilant on the underlying liquidity of the target investment. Ok, if my guesstimate is roughly right, reading this short letter should have taken you around 10-12 minutes. You have another 3-5 minutes to relax on your desk, get a coffee or chat with a colleague and then… like in a sudden memory loss, you can forget about it and start it all over again, and again, and again….
Peppe Ganci, CFA