As we move into the second half of 2020 uncertainty and volatility are unlikely to abate. We are still digesting the ongoing effects of COVID-19 as we get ready for the next set of hurdles which include the upcoming US Presidential elections and yet another looming Brexit deadline. Part of our success this year has stemmed from resisting the urge to pinpoint exactly what the market will do next. We have found it more effective to accept some of the inevitable dislocations and stick to a handful of basic, robust strategies. In a manor of speaking 2020 has not been the year to attempt hitting it out of the park. Many have tried, and many have struck out instead. This week Lansdowne Partners, one of Europe’s oldest and best-known hedge fund managers announced the closure of its flagship fund after a long period of poor performance, including a 23% loss in the first half of the year. Hedge funds as a whole lost an average of 7.9% in the first half of the year. They are the latest victims of a market that has been impossible to call.
Today we flip that on its head and discuss 5 longer-term themes that we DO have conviction on. In other words, in a market with unprecedented levels of uncertainty, what are the things we can still be sure about?
1. Technology
Tech has become ubiquitous. While its impact on our everyday lives has been apparent for years, tech has emerged during this pandemic as the undisputed king of the financial universe. The mega caps that were already gargantuan before this crisis have increased their market capitalizations significantly (Amazon, Microsoft, Google and Apple are now worth a combined 6 trillion USD). COVID-19 has been a stress test, and they have passed with flying colors. The Nasdaq is the only major index that is up this year. Some companies have undergone undeniable paradigm shifts as a direct result of the pandemic and have almost become household names, Shopify being one of them. Tesla, which is now arguably more of a tech company than an automotive company, is larger than Toyota which has been relegated to the 2nd largest car manufacturer on the planet, after having been in pole position for decades before Tesla even existed. Stay-at-home champions such as Netflix now barely register a dip on their YTD charts. Rock-solid Walmart (who famously weathered 2008 virtually unscathed, and have been criticized for years for their lack of online presence) have actually started to move into the online space aggressively over the last few months. It is unlikely that this unprecedented rise doesn’t experience some form of consolidation at some stage, but long-term it would be foolish to bet against tech and as a result tech continues to be an integral part of our investment strategy.
2. Stimulus
It would be equally foolish to fight the Fed. Stimulus is here to stay. We have entered an era of financial repression. The stimulus we are currently seeing from central banks across the globe has become a permanent fixture. This level of quantitative easing will not be tapered or unwound any time in the coming years. Interest rates globally are low, and will stay low for a long time. This can be said with more conviction than even in 2009, when it took the better part of a decade for rates to increase. While the Fed denies practicing yield curve control, the bond market is behaving like it does. The global repo market is being controlled. Frankly, there seems to be no pre-determined end point for the printing presses. This should influence how investors generate yield, and fuel the appetite for cheap debt in order to leverage higher yielding assets. The biggest investment risk in this context is the (for now still limited) risk of deflation. As demand starts to pick up after the pandemic the longer-term trend is likely to be a return to inflation.
3. Gold
Gold has been a complicated asset in 2020 so far, but gradually continues its steady incline and has just pushed through the 1800 mark for the first time since 2011. Gold actually sold off at times during the most volatile periods of the first half of the year. When there is a liquidity squeeze at some point investors will sell anything. Over the past few months however, as other markets have stayed range bound, gold has continued to slowly break out. Gold is one of the most effective inflation hedges (which ties nicely into the 2nd theme, i.e. constant money printing which is inherently an inflationary phenomenon). However, counterintuitive as it may seem, gold’s purchasing power has actually increased historically even during deflationary periods. It is hard to envisage a scenario where stimulus continues at this rate, and gold doesn’t perform.
4. Sustainability
Regardless of your stance on climate change, betting against ESG, Green Investing and Impact Finance is likely to be costly. During the pandemic BP announced their ambitions for net zero by 2050. Blackrock, the world’s largest asset manager, have announced that they will put sustainability at the heart of their investment decisions. Strategies associated with the sustainability theme will continue to attract more investment assets. In fact, according to the Forum for Sustainable and Responsible Investment, assets in this strategy have grown from 170bn in 2005 to 11 trillion in 2018. Only 6 months ago BP was worth close to 100bn, as of today it is worth 59bn. During that same period tech poster-child Shopify has increased its market cap from 40bn to 120bn. DocuSign (the app that enables electronic signing of contracts) is now worth 40bn, more than 4 times the size of former oil giant Halliburton. The world is changing and trying to buck the trend is futile.
5. AI
AI is guaranteed to be the next big disrupter in the financial world. Microsoft already spend billions on AI and started using AI in most of its products in 2017. Google’s search engine is powered by AI, Netflix use AI to predict what you want to watch next and Tesla has already put autopilot into consumers’ hands. Perhaps most notably IBM’s Watson, a cognitive AI and machine learning platform, is already in use for an endless stream of projects. It has had a profound impact on banking and finance. AI is guaranteed to continue being a major disrupter and catalyst for a huge paradigm shift in the job market. More than half of the 15 most common jobs in the USA can be performed by today’s existing technology. There are currently 3.5 million truck drivers in the USA, and some think tanks predict that as early as 2027 they may be fully replaced by driverless AI-vehicles. Similar trends exist in virtually every other sector. Out of the millions of jobs lost in the US over the past months many of them will simply not return at all. It is one thing delaying structural job market change in a controlled way, but once certain low level jobs are lost anyway, the incentive to replace them with technology and AI becomes much stronger. Just as this pandemic has been a catalyst for tech, it has also been a catalyst for the emergence of AI. This trend will continue into 2020 and beyond across multiple industries, disrupting how companies operate and having a huge impact on revenue.
12 thoughts on “Investment themes for 2020 and beyond”
Some great thoughts here, and hard to argue with. Given these thoughts though, how does one structure a portfolio around this? What needs to be owned in the medium term, and what needs to be avoided?
No quick easy answer to this, but if we’re talking about a balanced portfolio:
– majority of exposure to non-directional (ie very little outright equity exposure) option strategies offering a significant amount of downside protection. These strategies perform even if the market stays range bound or turns down a fair amount (large potential upside gains are sacrificed, but they are unlikely this year in our opinion). Essentially we’re selling vol when it spikes. 60%+ allocation
– very little fixed income exposure (some high grade credit is ok, we’re steering clear of HY currently as we anticipate further noise later this year)
– outright equity exposure limited to high quality names (there has certainly been a stay-home and tech flavour in the last few months). Pure index exposure limited to nasdaq and a some tech ETFs currently. We’ve avoided cyclical names and battered high beta stocks – 20-30%
– Diversified property funds (Europe and U.K.) we divested commercial real estate completely in early Feb – 10-20%
– Gold (mainly to protect the portfolio against shocks and hedge against all the money printing), most of the portfolios have GDX exposure as well (miners, essentially slightly more leveraged precious metal play) 5-10%
That’s a very crude high level summary – big disclaimer obviously as individual portfolios are constructed based on very specific client profiles.
I like point 4… how’s your climate change paper coming on? 😁 Joking aside, do you have exposure to any of these sustainable strategies in your portfolios?
Touché. I finished it and sent it to about 100 people at the start of the year. Out of those 100 people 3 have read it and think it’s brilliant 🙂
We don’t currently have much exposure to anything in this area. Impact Finance is about more than returns (in fact sometimes returns need to be secondary). My point was really that one can’t ignore the huge inflow of assets; the asset class has a natural bid. And, companies trying to dive the issue are going to get burned. If your ESG isn’t up to scratch the likes of Blackrock no longer want to own you, so it’s difficult to be bullish.
Thanks Greg, really helpful view on the world when nothing is certain apart from a few old truths. On Gold – traditionally a typical balanced portfolio has 5-10% in Gold but during the continued volatility likely to persist for some time 10% – 20% is probably more appropriate. Is synthetic exposure (e.g. ETFs) ok or do you prefer physical ownership / gold certificates?
Nice to see you on here Kai! I agree with your comments. We didn’t have any gold exposure in our portfolios for quite a few years before 2020. I personally divested the last gold I had in 2016 and didn’t buy again until early 2020. In those 4 years it didn’t do much and it wasn’t really an environment where one would have expected it to. In fact you could have held gold for nearly 4 years and have lost money. I think now 5-10%, or even 10-20% (if you’re less worried about predictability of returns and cash flow) is fine. This is a slow-burner trade, but chances are over 2-3 years it will do well.
We generally own SGLD (cheap ETC with very good liquidity) and GDX (Gold miners ETF, bit of an equity play and more leveraged), and not physical gold. Physical gold is harder to trade, reallocate and leverage in a portfolio esp when the emphasis is on liquidity. We can liquidate entire portfolios in 24 hours if we need to. Physical gold does have distinct advantages though. ETFs can go haywire when liquidity seizes up (oil was a good example a few months ago, plenty of ETFs were suspended). And during this pandemic we actually saw a physical gold squeeze which we haven’t seen for decades purely because refiners have never had to shut down. So there was a period for a few weeks where supply/demand was disrupted and futures skyrocketed to the highest premium versus spot prices we’ve seen in a very long time. Many investors flocked to physical gold as a haven asset when the virus first started disrupting the market in march. At one point the April contract traded $20 higher than the June contract (another sign of a squeeze), that was short lived though. This basically comes down to the fact that when investors were demanding physical delivery, one couldn’t logistically load it onto trucks (pretty unique problem).
In other words if the sh*t hits the fan properly, real physical gold is what you want. For anything less severe (and I don’t expect anything quite as crazy as March again anytime soon) synthetic does the job.
The other issue with gold (which I eluded to above) is that its textbook characteristics do break down sometimes, usually just temporarily. Gold was super correlated with risk assets many times this year. So equity markets puke, and you expect gold to hedge you and it did the opposite, it puked just as hard (that was indicative of serious liquidity issues in the market as a whole). But if you take a step back (zoom out the longer term graph so to speak) eventually the theoretical relationship with risk assets and inflation holds up. Similarly to property, you can’t really take a view on it for short periods of time.
Needless to say any scenario where the monetary system breaks down completely, real assets are what you want. Physical gold, physical property, land, etc etc so it’s never a bad idea to have some real assets as part of your overall portfolio.
What about property, surprised that’s not a theme?
Yes thought about that, property isn’t really so much a theme as it is a permanent fixture for us. All of our portfolios have property exposure in some way (even if only through funds). Most have physical property exposure which has distinct advantages (access to cheap leverage which ties into point 2, and the fact that it is a real asset and a good inflation hedge). There is a feature a few posts down about property specifically. It’s definitely still a core part of the strategy. We have slightly diverging views when it comes to commercial (negative) versus residential (neutral to positive) and that article goes into detail why.
One thematic point on residential property in the UK right now is the fact that we have this 500k stamp duty holiday. Its being introduced because it is needed (so that tells you something about the governments outlook on the market), but it is a good opportunity to bring transaction costs down. I still believe property prices everywhere, including resi, will be slightly softer this year. There is just no way you have this sort of economic disruption and job losses without property being affected. But long-term, buying the right type of property with strong yields, and financing it cheaply, is still a good move.
Do you think the system’s capacity for stimulus is truly limitless? Or are we approaching territory where we potentially start to see negative effects emerging, be they deflationary, inflationary, or even sovereign credit concerns?
It’s surprising that not more people are asking this question generally. It’s clearly the elephant in the room. One needs to differentiate between the Fed and others. I think the Fed’s capacity is virtually limitless currently. They have already gone so far that it seems unlikely that they stop if they feel another trillion is needed. Part of the strategy is clearly to make the market believe that there is no limit. A change of administration can obviously impact things as well (Biden seems to want a more progressive approach to stimulus legislation for example). The US in general has this massive advantage that they can print without seemingly affecting the currency too much in the short-term (as USD is still somewhat of a haven and has continued to rally with risk-off). Pretty unfair advantage versus the rest of the world (in particular EM).
Then you go to the BOE… probably second most proactive in terms of stimulus, but they’ve expressed a clear need to stop, they have a limit. At some stage the furlough schemes and interest payment holidays will stop, and they’ve been fairly open about the fact that there’s nothing they can do about it. They can’t print money forever and at some point they’ll need to let the economic fallout sink in – but HOPEFULLY only when there’s an end in sight to the pandemic.
Then Europe in general is another step behind – they struggle to coordinate stimulus to begin with, but their capacity is clearly limited (both economically and in terms of what is politically viable).
EM’s… they’re in the worst position. Some countries that have never done QE before have started it, but they just don’t have the same fire power as the US, and their currencies get effected a lot more immediately. The EM’s are also quite clearly first in line in terms of sovereign defaults. Multiple EM’s will default at some point (in my opinion). There is no IMF bailout big enough to save them. There will be years of complex debt restructurings. There’s an article on LinkedIn which talks about it, I’ll forward it to you.
So overall globally there is a limit.
As for approaching territory where we see negative effects as a result… I think we’re way inside that territory already. I think even if we found a vaccine tomorrow and the stimulus stopped almost immediately we would require years and years of austerity, tax changes, restructures etc to get out of the mess. And obviously its a political minefield – what politician anywhere is going to run on having to increase taxes and retirement ages? It’s impossible to say whether the whole system can crumble at some point as a result of all of this. Central banks are clearly aware of how dangerous the strategy is, but there just doesn’t seem to be any other viable alternative. So the hope is they only have to do this for a few months, and then they manage to correct the damage over the next 10 years…
Great response, thanks
Very interesting article and hard to argue with any of the points made. The difficulty is expressing these views in a portfolio. Finding appropriate products and matching them with liquidity requirements and volatility tolerance is the challenge. Fighting the Fed has never been a good idea and the size and scope of stimulus is eyewatering, however it is a confidence game (Investors aren’t sufficiently confident in EMs) and if the confidence is rocked the consequences would be very dire. I am not a fan of gold ordinarily but the tail risks probably warrant exposure.
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