The past two weeks have been jam-packed with deep discussions into global affairs and the state of economic and financial markets. After drinking from the firehose, here’s what we took away.
Inflation - transitory or persistent?
Without question, inflation took center stage with compelling arguments made from both sides of the aisle.
From the transitory camp – Debt and aging demographic trends are deflationary by nature. Additionally, as the world collectively went into lockdown mode, initial shocks hit demand far greater than it did supply (recall negative oil prices). However, thanks to re-opening initiatives and unprecedented stimulus programs, demand is now outstripping supply. This short-term dislocation in the supply/demand equilibrium has been artificially created and will normalize.
From the persistence camp – Inflation is broken down into two categories: services and core goods. Looking at 20-year pre-COVID averages, services inflation has averaged ~2.8% per annum while core goods inflation has averaged 0.0%. Today, core goods are experiencing a sharp increase in prices for several reasons. For starters, raw material costs are up - energy, food, metals, lumber, etc. Next, tighter supply has led to record low housing inventories, record low auto inventories, and semiconductor shortages. Then there are shipping costs given that all core goods end up on planes, trains, ships, or trucks. Lastly, a soaring personal savings rate suggests that consumers have money to burn.
If you head over to any gas station, grocery, or home improvement store, you’ll undoubtedly notice an increase in prices. Needless to say, the cost of living is going up. For the past decade, inflation has been heavily concentrated on the asset side of the economy. With a myriad of factors at play – record stimulus spending, supply chain constraints, de-globalization – how long this trend lasts is anyone’s guess.
MMT – it’s raining money
Over the past year, central banks have delivered record amounts of stimulus, resulting in never-before-seen increases in government debt. Whether we like it or not, MMT (Modern Monetary Theory) is alive and well. To clarify, not all debt is bad. Debt can help fund productive investments – projects that provide a means to repay the debt down the road. However, since the beginning of the pandemic, this has not been the case. The increase in debt has been to fund consumption (which represents ~70% of US GDP). One way to disincentivize workers is to provide free government handouts. The opportunity to get paid while staying home – who could blame them? Coincidentally, job openings sit at record highs. But I digress. The big takeaway here is that individuals are becoming increasingly dependent on government assistance programs. Here are some interesting statistics to chew on:
- The US has printed ~40% of all the dollars EVER created in its history over the last 12 months;
- The percentage of personal income made up by Government Assistance payments is now ~34%;
- For the past decade, $19T in Central Banks balance sheet expansion (FED, ECB & BOJ) has only increased the market cap of global equities (MSCI World) by the same amount, with little to no multiplier effect;
- Since 2013, FANG stocks (Facebook, Amazon, Netflix, Google) have grown to represent less than 1% of Revenues, less than 5% of earnings but more than 12% of the S&P 500 market cap. During this time, these stocks have outperformed the index by 4x.
is a global reserve currency necessary?
Geopolitics poses a threat. The possibility of digital currencies poses a threat. Unlimited money printing poses a threat. It would appear that the US dollar is vulnerable in more than one way. But, perhaps the answer is not as cut-and-dried as one might like. Louis Gave presented a simple and effective analogy when thinking about global currencies - “… the US dollar is Microsoft, the renminbi is Apple, and you are going to have two parallel ecosystems. We are moving from a world with just one ecosystem to a world with two ecosystems.” To paraphrase, think of it this way: since most people grew up using Microsoft, it makes sense to keep using Microsoft – it just makes life easier. Today, most countries rely on US dollars because almost every other country uses US dollars. It makes little sense to replace such a globally complex framework unless there is an exceedingly superior solution. Apple knew they couldn’t challenge Microsoft’s corporate dominance. Instead, Apple shifted its focus onto niche consumer markets resulting in a successfully created parallel system. Enter China’s digital renminbi. Taking from Apple’s playbook, China’s focus is on the Asian consumer. Leverage the vastly existing digital payment trends in Asia and create a new, cost-effective, frictionless, and borderless payment system - one that does not require having to use US dollars or the Swift system.
BOTTOM LINE
Another year, another virtual conference in the books. It's hard not to miss meeting other conference attendees and the thoughtful discussions that arise.
Many of the long-term structural changes aforementioned should come as no surprise. They have been focal points at Sandstone OUTLOOKs in the past. No longer acting as a portfolio stabilizer, bonds offer an unattractive risk/reward scenario. Unfavorable yields continue to force investors further out the risk curve. We continue to believe that alternative assets, hard assets, inflation-protected securities, and dividend growers provide a hedge against the ever-increasing market instability.
10 years ago, China decided to be the best in the world at 5G and AI; the US decided to be the best at social media.“10 years ago, China decided to be the best in the world at 5G and AI; the US decided to be the best in the world at social media.”Mark Yusko
- Mark Yusko