The Last Decade and Coming Revolutions.....

“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”

- William Arthur Ward

“To wait. All human wisdom is in this single word. The greatest, the strongest, the most skillful is he who knows how to wait.”

- Alexandre Dumas

“History never repeats itself. Man always does.”

– Voltaire

A. The Last Decade: 2010-2020

Sometimes to look forward you have to look backwards.

Ten years ago, we emerged from the financial crisis of 2008-2009. Few investors liked the idea of investing in stocks and everything seemed like a good reason to stay away from the stock market.

Here are some of the geopolitical and macroeconomic events that took place during the last decade:

• The anti-stock-market movement of “Occupy Wall Street” (2011)

• The downgrade of American bonds (2011)

• Financial crisis in Europe, particularly in Greece (2011)

• The debt ceiling crisis with the US government (2012)

• The “fiscal cliff” in the US (2012)

• The start of the conflict between Russia and Ukraine (2013)

• Lawsuits by the US government against large banks (2013)

• Oil price collapse (2014)

• Economic slowdown in China (2015)

• Brexit (2016)

• The trade conflict with China (2018)

• The Impeachment of Trump (2019)

• The COVID-19 Pandemic (2020)

If we had known in advance everything that had happened in the past 10 years, many investors would have waited on the sidelines before investing in the stock market... and many did.

What I take away from this is that humans are not well suited to understand complex adaptive systems like the stock market. It’s easier in hindsight to ascribe rationale to what actually happened - The FED.

Having said that, my old boss from Goldman Sachs, Alan Brazil, did great work outlining why the recovery will be a “U” not “V”, summarizing his reasons:

1. The Virus itself

2. Concerned public stays indoors longer

3. Damage already done leading to lower consumption and capital expenditure

4. Negative impact of fiscal stimulus - for ex. being paid to stay home

Maybe we can’t predict the markets, but maybe we can try to see how human behavior could change in the next few years.

Will COVID-19 be like 9/11 and the GFC in how it will reshape our world ?

Some ideas that came to mind (thank you Elliot Turner).

1. A greater societal focus on hygiene and cleanliness: with those most vulnerable dealt the harshest COVID-19 outcomes, people will do more to be less “vulnerable” in the health sense.

2. A move from cities to suburbs: dense, highly urban cities like New York are especially tough to be in right now. The per capita infection rate is higher than in non-city environments and the challenges of locking down in a small apartment, accessible only by elevator, with limited outdoors space are especially daunting.

3. Everyone who can afford to will want to own a car: remember just a few months ago when popular Silicon Valley lore believed everyone would ditch their car for Uber?

4. Buy online, pick up in store - The experience is great for consumers and simple. This will require new kinds of employment and a rethinking of some parking lot space, but once behaviors are shaped, there is no going back.

5. Contactless payments - Cash itself is a means through which the virus can spread, as is the handoff of a credit card for a swipe. The infrastructure for contactless has been in place for a little time, though a catalyst for change had been lacking.

What do you think will change and what will stay the same ?

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B. The Coming Revolutions…..

I worry about a few things.

Firstly, today, it seems increasingly likely that Swedish and Japanese policymakers may have chosen the best course of action, both in the short term, by avoiding economic devastation, and in long term, by allowing the early development of herd immunity.

This also recalls the old market adage that “if you are going to panic, then panic early.” Panicking late is usually counter-productive.

In bear markets, the guys who panic early do well. And the guys who ride out the bear market often end up fine in the longer run. The ones who get crushed are the guys who panic late.

In COVID-19, Taiwan is the guy who panicked early, while Sweden and Japan are the guys riding it out. Italy, France, the UK and the US are the guys who very visibly sold at the bottom.

Worse yet, the Western leaders who panicked late are now moving the goal posts to try to justify their panics. A few weeks ago, the argument was that lockdowns were needed to prevent health systems from being overwhelmed.

Fast forward to today, and almost everywhere you look—outside Wuhan and Northern Italy—health care systems have not been overrun (Eastern France was touch and go for a while, as was New York City). Yet here we are, still in lockdown. And today the argument to justify the lockdown is not “we need to protect the health system from being overwhelmed,” but “we need to prevent needless deaths.” This is a worthy goal. But it is much harder to quantify.

Meanwhile, populations grow restless and the economic pain compounds.

Some people I speak to call this the greatest financial transfer in our generation. Asset values are being driven upwards, while incomes fall.

The pressure will be on policymakers to be seen to be “doing something”.

This something will likely involve a ban on share buybacks (buybacks were forbidden in the US until 1982). That’s a fairly low hanging fruit. Or perhaps it will be the nationalization of the health care system? It is hard to claim there is no money for public health care, when you’ve just signed off on a budget deficit of US$4trn. Or maybe it will mean a large increase in minimum wages. Again, it’s hard to argue against a minimum wage once you’ve paid people US$15 an hour not to work.

Secondly, after the 2008-09 global financial crisis, banks took a hit to their returns as they responded to regulatory demands to strengthen their capital bases.

In 2021, it is possible governments may impose stricter capital requirements on other businesses following this crisis. More immediately, insurers and lenders – feeling the impact of bad loans and rising business continuity claims on their balance sheets – are likely to shore up their own finances by imposing higher premiums and credit costs on riskier clients.

There will be a push to on-shore production and supply chains. Increased complexity will lead to higher costs, including in terms of supply chains and tariffs. However, just as governments will be expected to build in resilience in socially critical areas of the economy, companies will be expected to build in spare capacity to withstand “black swan” events such as this in future.

This will be inflationary because (a) we will have to re-build new infrastructure (b) that infrastructure will cost more to build and run than the prior infrastructure. After all China gave the world 1st world logistics at 3rd world prices....

Source: GaveKal

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C. A Few Things Worth Checking Out:

1. Mike Milken & the Milken Institute has been on the forefront of bringing clarity and transparency to global response to COVID-19. They have done great work on their Power of Ideas site and then Mike sits with leaders on his podcast Conversations with Mike Milken series.

2. Frontier Markets Investing - Invest Like the Best had Manny Stotz (founder of Kingsway Capital) to discuss the nuances of investing in frontier markets.

3. Bringing hedge fund investing mindset to Venture Capital. Jihan Bowes-Little (founder of Bracket Capital) was on the Pomp podcast discussing how they are in my view creating a new asset class while helping startups and early venture investors.

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I’ll leave you with some humor