The new English Premier League soccer season has started, with my TV viewing rising correspondingly. In the half-time break in a recent match, I was struck by a commercial that basically consisted of a handful of well-known technology-related stocks shuffling round a version of a games board, which on closer inspection turned out to be an advert for an investment trading platform, the implicit subtext (or maybe even explicit!) being you only have to put money in these names to make a quick buck. Suddenly I was transported back 20 years to the height of the Tech Bubble, where I vividly remember the same zeitgeist being captured best by a commercial whose strapline and sole content was “If you want to be rich, you could wait for your grandma to die… or there’s Ameritrade?!”
On discussing this with our Chief Investment Officer, George Patterson, he expressed little surprise. Indeed, he talked about the growing number of enquiries he is receiving from younger cousins etc. on how could they trade options (although for the avoidance of doubt, he is unrelated to Masayoshi Son of Softbank fame). Is this simply the manifestation of the last leg of a bubble as it was 20 years ago?
Maybe it is. But, on reflection, I do worry that there is something a little bit deeper going on as well, which is an erosion of the appetite and progress towards long-termism that had been such a strong feature of industry debate in the last few years preceding COVID-19. The accusation that the investment industry is too short-term, and the need for everyone involved to make decisions for the longer-term has been very pronounced in the last few years. Aside from the general rise of sustainability as an issue, I think of instances like the launches of the Focusing Capital on the Long Term (FCLT) organization backed by McKinsey, CPP and BlackRock or the World Economic Forum’s New Paradigm. Yet, increasingly, I see short-termism strengthening across the industry and its decision chain. If we were right to try and focus on the long-term before, then we will surely regret losing sight of it now.
I’ll turn shortly to some examples of where I see this short-termism, and to how we may regret it. However, before that, I do think it’s worth considering what’s driving it. To do that, we have to accept certain facts about COVID and markets:
- Although there is no doubt in my mind that we will get there eventually, no one on the planet actually knows when we will “beat” COVID, how quickly life will return to normal, what facets of life will change, and what the implications of all these unknowns will be for stocks, bonds and other investments.
- Moreover, there is no real precedent that we can use to guide us with any confidence. If we want to make judgments about these things, more than usual we are guessing.
- We are desperately short of real information from companies and the economies that will help us.
A useful analogy is that we are trying to gauge what landscape we will find on the far side of a thick cloud as we travel through it, but the cloud itself is almost impenetrable and useful information cannot break though. However, what we have in abundance is short-term information e.g., we are traveling more quickly or slowly than we thought – analogous to medical progress in fighting COVID, the view behind us as we move forward – analogous to how companies are performing month to month. Therefore, in the absence of that useful long-term information, rather than acknowledging what we can’t know, we start putting too much emphasis on the short-term data that is available, even though we know in our hearts that its long-term value is limited. So, the rate of change of short-term data gets hugely extrapolated, or interpreted far beyond its relevance when we do escape from the cloud. Suddenly we find ourselves back (over)reacting to the short-term rather than adopting the long-term behavior that we all know we should.
So what things do we know that can guide us as we try and find our way back to long-term decision-making? Here are a few that strike me as most relevant:
- When the dust settles, governments around the world will have taken on a huge amount of incremental debt. The only precedents for this expansion are arguably wars.
- Monetary policy is ultra-loose around the world. There is very little ammunition left.
- Current prices are a certainty, in that they are not subjective in any way, although of course the value that they represent is completely subjective!
- The same is true of historic prices and price patterns.
- However, current earnings information is surely of very little use. It describes how well businesses are navigating the cloud, but offers very little insight of any to what will happen once we exit.
How do these elements combine to elevate the short-term over the long-term and what are the risks of so doing? Let me offer a couple of quick examples starting with the debt mountains that governments have built up. Simplistically there are only three ways that the debt story can unfold over the medium to long term:
- Maybe the Modern Monetary Theorists (MMT) are right, and governments can just print money at will to meet whatever spending commitments they want to make. However, given the reception that MMT as a proposition received from economists of all stripes before the COVID crisis, that surely seems a highly-risky assumption as a central proposition.
- So, therefore, we have to assume that the real value of debt to Gross Domestic Product (GDP) has to be brought down. One route for doing so is to run primary surpluses, which effectively means taxes need to rise, and likely rise substantially. The political appetite for large and broad tax rises across the political spectrum seems very muted to me.
- Hence, inescapably we are led to conclude that governments are likely to have to inflate away some of this debt over the long term.
Naturally, if you look through a short-term lens, with global demand depressed and the hangover from the COVID cloud to work though, that inflation seems a long way away. However, I would argue strongly that a long-term investor should be thinking about addressing it now – it’s always better to be early rather than to have to join the herd when it’s obvious!
My next example is around diversification and the “Fed put.” Given levels of valuation at the start of the year, if you’d specified that we would have a global economic shock of the scale that we have experienced, any strategist would have predicted severe disappointment for both equities and credit spreads, highlighting the importance of having diversification in your portfolio. Of course, that was also the initial reaction and yet, as we sit here today, equities are at or close to all-time highs and spreads have recovered strongly as well. Why is that? The answer is the giant stimulus governments have provided (for equities), and secondly, the actions of the Fed in backstopping the credit markets, including extraordinarily the high yield market at the height of the crisis. Indeed, when we have discussions with clients on these subjects now, the dominant perspective seems to be that the Fed has shown it will be there when needed.
Again, this feels to me to be all about the short-term versus the long-term. The Fed acted; it’s fresh in our minds. However, in the long-term, the monetary ammunition to provide support is all but exhausted, and the Fed surely wants to extricate itself from the moral hazard that comes with its actions over time. Moreover, once we” beat” COVID, the imperative to act will be very different. So, if we put on our long-term glasses, it cannot be sound to rely on the Fed or monetary policy more broadly to bail out risk markets. In addition, as explained about, the long-term prognosis for fixed income seems at the very least mixed given the debt environment. Given the very rich starting valuations, a long-term investor will surely see the importance of diversification now, rather than waiting until it’s too late.
Finally, in terms of what’s going on within equity markets, this has been a truly unique period. Whether on the upside or the downside, no long-term investor would extrapolate the markets of the last few months into the future. Maybe we are in a bubble as I said at the start, maybe not – many valuations point to the former. But it’s surely true that what has worked in the last six months won’t be of use when we leave the cloud, and I sincerely hope that George’s cousins heed his sage advice to be careful at this time!
The embrace of long-termism was one of the more positive discussions of the last few years across the industry. I do very much hope that we can prevent it becoming another casualty of 2020.
The comments, opinions and estimates contained herein are based on and/or derived from publicly available information from sources that QMA believes to be reliable. We do not guarantee the accuracy of such sources of information and have no obligation to provide updates or changes to these materials. This material is for informational purposes and sets forth our views as of the date of this letter. The underlying assumptions and our views are subject to change.
References to specific securities and their issuers are for illustrative purposes only, are not intended, and should not be interpreted as recommendations to purchase or sell such securities.