Complicated charts, simple story
It took me while to fathom this chart. The blue line is the estimated annual return, over the next 12 years, for a standard portfolio mix of 60% S&P 500, 30% Treasury Bonds and 10% Treasury bills. The red line is the actual result. So, the chart compares a 12 year prediction to an actual outcome, therefore we only have a result up to 2007, 12 years ago.
It suggests that expected returns from traditional assets are expected to be low and falling from here. It’s not hard to rationalise why this might be correct. Bonds are very expensive, they must be, since in many cases interest rates are negative and it now costs money to be a lender in those cases. Equities continue to rise and although most commentators seem to think they are “not historically that expensive”, I think they are. We are in the 90th percentile of historic valuations and in the last 80 years PE ratios have only been higher than now for about 5 of those years. The green dots are the bottom of bear markets, with ratios hitting around 8x, currently we are at 23x.
So maybe the graph isn’t complicated. Classic portfolios look expensive and because of that, the likelihood of replicating recent returns is low.
What to do?
If you believe the scenario above, you could go short. Short equities, short bonds and depending on your degree of confidence you could use leverage to do it. Sit back and wait for the gazillions to roll in and then laugh and laugh as the world falls apart.
Unfortunately, if you choose that route, you will likely go bust first before your first gazillion down payment arrives. Back on the first chart look at the period 1984-1987, exactly the opposite of the prediction is happening. 2003-2006, same thing. Three years is a long time to be short against the tide, too long.
I think that it is highly likely we might see divergence from the model again. We have seen multiple times the Federal Reserve step in and buy assets at times of crisis. If there is a full blown collapse in bonds or equity prices, they will simply print money and buy them. There are just too many voting constituents now relying on these asset prices to retire that they cannot be allowed to significantly decline. So I can easily see the predictive power of the chart, if it has any at all, being destroyed by central bank interventions. Particularly because it is tested only to 2007, just before the QE era begins.
That is why we run a Bitcoin fund. It allows you to effectively be short the monetary madness in an asymmetric way. You can still have your equities and bonds and ride the money wave but you have some protection on the downside without the pressure of time expiry and margin calls of short positions.
While it is not certain that bitcoin will behave as the hedge we think it might, most people could agree that governments are in a tight spot. The ageing population is retiring, they will divest assets, there are fewer people to buy them. I predict there will be a buyer of last resort and that buyer will just print the money because there really is no other option. What’s more, the investing public will demand it and they will cheer from the stands when it happens.
Of course, governments print money all the time and they have done across history. It is really a question of the rate of increase in printing, rather than the printing itself.
For example during the last century, the erosion of value has been severe, with the $100 of 1913 in the chart now worth $3.87. That’s against the backdrop of a strongly growing US working population and a strongly growing economy, neither of which exist any longer.
Fundamentally, the risk is that the rate of increase in money printing rises. Driven by demographics, fewer people will be paying tax and more and more old people will be consuming a disproportionately large amount of government resources. It would be reasonable then to expect, that on the balance of probabilities, the rate of money printing will rise.
So now the ‘average target is 2%’, not the actual target. It’s a work of semantic genius. The number in peoples heads remains at 2% but is actually higher.
I find it instructive to watch the way these messages are delivered too. Everything is drip fed as news, first a junior official, next a more senior member of the team will speak about it then perhaps the Chairman/Governor. Anyone heard of Lael Brainard? Nope, so they are just testing the water. If there is a huge backlash then Lael will presumably be running the Bank of Greenland before the end of the year. So far there hasn’t been any backlash, so I expect Jerome Powell to be parroting the same tune some time next year.
$95 billion sounds like a lot. That’s the amount of money the Federal Reserve pumped into it overnight repo operations on Tuesday. The repo mechanism is foreign to me, I don’t understand it at all but it does make me worry a bit when the largest central bank in the world decides it needs to provide credit lines of this magnitude to its major banking participants.
For context, the Fed is pumping the entire GDP of Kenya into the system in it’s Tuesday operations. It’s as if money has lost its meaning, giant sums of cash are simply thrown around with little or no discussion. Maybe it’s just me and that I’ve never been to Kenya, but I much prefer the type of money where I know how much of it there actually is and how much of it there will be in the future.