Tuesday, January 19, 2021

Absolute Return Partners: "V for Vaccine?" (maybe not)

 From ARP's Absolute Return Letter, January 5:

"Don’t worry about the world coming to an end today. It’s already tomorrow in Australia."
—Charles Schulz

From time to time, readers of the Absolute Return Letter ask for my opinion on this or that and, every now and then, I decide to turn my response into a letter. The last few weeks have been no exception. In early December, the extraordinary rise in the price of Bitcoin drove one of our readers to ask what I think of that investment opportunity, and the trade agreement between the UK and the EU, which was entered into just before Christmas, inspired another reader to ask me if I could provide some more colour on that deal.

Whilst I love those sorts of challenges, in this particular case, I am facing a timing problem. As you may or may not be aware, the January Absolute Return Letter is always about the issues that I worry most about, as we enter the New Year. In other words, the earliest I can cover anything else is in the February letter, and we’ll be into March before both of those issues have been covered.

As you can see in Exhibit 1 below, I am not sure my thoughts on Bitcoin should be mothballed that long, and neither should the paper on the Brexit trade agreement, considering how important it is to all of Europe. Therefore, I have made the executive decision to prepare a research paper on Bitcoin, which will be published on ARP+ later this month. You can subscribe to ARP+ here. My thoughts on the trade agreement will then form the base of the February Absolute Return Letter.....


.....My not-so-outrageous predictions

I am occasionally asked why pandemics don’t feature prominently on our list of risks to worry about, and my answer is always the same. The last pandemic which caused millions of deaths was the Spanish flu in 1918-20, i.e. almost exactly a century ago. If you take all once-in-a-lifetime risks into account, you cannot invest in equities at all. You can’t even buy government bonds. It is so far out on the left-hand side of the risk curve that it is impossible to plan for.

As we enter 2021, there are certainly risks which shouldn’t be ignored. I am not going to mention them all (what about an asteroid hitting Earth?) but, as I see it, three plausible risks stand out:

  1. The V-shaped economic recovery in 2021, which equity markets are taking for granted, fails to materialise. Either the COVID-19 vaccine doesn’t work as expected or rolling out the vaccination programme takes much longer than expected, turning 2021 into another year which can be largely written off.
  2. The massive increase in global money supply, which has been part of governments’ response to the health crisis, begins to have a rather unpleasant impact on inflation which financial markets react negatively to.
  3. For whatever reason (could be as a result of either (1) or (2) above), the runaway bull market in Big Tech finally punctures and retail investors who have dominated the buying of Big Tech for most of the past year panic, leading to a collapse of the (overvalued) US stock market. I think of this risk as a re-run of the collapse of Tokyo Stock Exchange, anno 1990.

As you may have noticed, COVID-19 dominates my ‘ensemble’ of 2021 risks to worry about. Am I suggesting that the pandemic is all we need to worry about as we enter 2021? Not at all, but those three risks stand out as I see things. More on that later.

Before I go there, allow me to briefly mention one or two other risks that I urge you not to ignore. As a colleague of mine often says, “you should always worry when there is nothing to worry about”. He is referring to complacency and how it often finds its way into the human mindset in benign times. We often see it – most recently last spring when, from one day to the next, COVID-19 was suddenly on everybody’s radar screen.

Another risk I am worried about is the state of the American Union – the sad reality that tens of millions of Americans remain convinced that the November elections were rigged despite there being no evidence whatsoever of any improprieties. However, I decided not to add it to my list above, as political incidents rarely have a lasting impact on financial markets. Unless you expect this one to end in civil unrest, perhaps even civil war (the risk of which is tiny in my opinion), it is not likely to have more than a passing effect on financial markets.

One final point before I drop the ball on this topic. The polarisation of American society is not really about Biden vs. Trump. In essence, it is about the fact that the gap between rich and poor is getting bigger and bigger, and the poorest 90%, who have suffered so much in recent years, are now saying that enough is enough. They see the mega-rich getting away with murder (not literally!) and think it is grossly unfair.

In the context of COVID-19, the very expansive monetary policy programme conducted by the Fed in 2020 has only made the difference in wealth bigger. That is due to the very positive impact Fed’s actions have had on financial asset prices – equities in particular. If you never read the September Absolute Return Letter about my old friend TINA, I recommend you do so. You can find it here. The wealthiest, who are always loaded with financial assets, have earned another gazillion in 2020, whereas many of the not-so-wealthy lost their job....


And of course the HT for the earlier Saxo post.