Is it time to sell stocks? 2021 Macro Views (FINANCIAL HORSE)

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Recap of 2020

Starting in March 2020, we had:

· COVID lockdowns sparking a liquidity event in March 2020

· Feds managed to stop the liquidity crisis by slashing rates to zero and going to QE unlimited

· Big recovery heading into June as COVID started to die down

· Big falls heading into Oct as a second wave of COVID came back

· Massive recovery after the uncertainty of US elections and on highly positive vaccine news

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What will not change in the next 5 years?

· Interest Rates – The way the global economy is set up, it can no longer take higher interest rates – it will crash the entire system because incomes will not be able to service the debt burrden. So I don’t think we’re going to see interest rates leave the zero bound for a long time.

· Massive Government Deficits – Government deficits will only get worse post COVID – because of declining tax revenue, and increased spending requirements to drive fiscal stimulus.

· Demographics – The western world remains stuck with an ageing population. Demographics is really powerful because this massive group of baby boomers are retiring and are withdrawing assets from financial markets to fund their lifestyle. They do not actively contribute to society the way a 30 year old employee starting a family will.

Deflationary Impact of Technology – There’s a good book by Jeff Booth (The Price of Tomorrow) on why Technology is inherently deflationary. It’s worth your time if you’re interested in such topics. (Must-Read Investment Books)

· Inequality and polarization – Inequality was already an issue from 2008’s QE. It drove asset prices up, so the rich who owned assets got much richer than the working class . Inequality went up, and this was always accompanied by rising social unrest and political polarization – which we saw in the form of Trump, Brexit etc. 2020’s COVID will only make this worse, because the lower class has been hit very hard, while the rich who own stocks and assets have benefitted from the liquidity. This only gets worse going forward.

For the record, these 5 pillars were already in place pre-COVID. COVID was a catalyst, but it did not cause these structural issues.

What happens in the next 12 months?

It’s amazing that mankind discovered a new virus in early 2020, and by end of the year we’re ready to roll out vaccines to combat it. The logistics will be devilishly complex of course. But they will all be solved in due course.

2020 saw the imposing of COVID restrictions, 2021 will see the gradual reversing of COVID restrictions.

Base case – I would say around mid 2021, life may gradually start going back to normal for the more developed economies, and this would accelerate heading into late 2021. Global air-travel will probably take a while more to recover, because of distrust between nations (requirements for immunization and testing before you can enter another country).

Do we have another March 2020?

March 2020 was a liquidity style event – everyone was leveraged long heading into 2020, and COVID caught everyone by surprise, forcing a violent unwind. Feds had to step in with unlimited QE.

Now COVID is no longer an unknown factor, so it’s hard to see COVID itself causing a liquidity event (unless it’s something like a mutated strain). It has to be something truly unexpected, a big bank going under, Softbank going bankrupt etc.

Really tough to say if we see that this cycle. Governments globally are very keen to prop up their own companies. Capital markets have completely unfrozen (and partying like 2000), and there’s just a lot of liquidity around.

So it doesn’t look like we’ll see it, but by its very nature this is supposed to be an unexpected event, so we never know.

What happens in the next 5 years?

I actually think the next 5 years are going to be the golden years for macro investing – where all the 5 pillars at the start of this article will come into play.

The underlying structural problem, is that:

• Governments need to spend a lot more money to get out of this COVID recession

• That’s going to drive government deficits very high, which means interest rates cannot go up otherwise the debt burden will bankrupt the country

• The debt loan is unsustainable, so the only feasible way to repay it longer term is via inflation

• Effectively, the way to repay the debt will be to devalue the currency (inflation)

• The other way to solve it of course, is via deflation. Governments will cut spending and raise taxes, to balance their budgets. This was what was tried in the Great Depression, and we all know how that worked out. Anyway, modern understanding of economics has evolved significantly since then, and I think it’s unlikely we see governments going down such a foolish path.

As 2020 has shown, when faced with economic problems, central banks and governments are very quick to print, and that should remain the default stance going forward. Politics will gradually come into play going forward, so that may be potential problems to watch out for, especially for US and Europe.

Long story short, this happens all throughout history, and involves a big depreciation of the existing currency of the day.

There are 2 ways this can be done:

1. A shock and awe event – Think something like the Plaza Accord. This was in the 1980s when the G7 came together and agreed to devalue the USD, and the USD fell 50% over the next 12 months. This is a shock and awe kind event, with a violent reset of the financial system over a short period – and after that the economy returns to growth.

2. A slow grind – Think Europe and Japan, but for the whole world. Under this approach, we probably have about 5 – 10 years of negative (or low) interest rates for much of the world, accompanied by slow growth. It will be a slow and miserable grind, but the end result is the same, the devaluation of fiat currency.

I think it’s too early to call which of the above we will see.

Transfer of wealth from the creditor class to the debtor class

As happens all throughout history when such resets happen, they are accompanied by a transfer of wealth from the creditor class to the debtor class.

When you devalue fiat currency, the people who lend money will lose because their debt is now worth less, and the people who borrow money will win because their debt is worth less and more easily repaid.

There’s also not much point in trying to fight the forces in play. It makes more sense to ensure you’re positioned in the right way, for the coming changes.

My current framework

12 months wise it’s probably recovery phase, but I can’t rule out a big exogenous shock, hence I’m still maintaining elevated cash positions.

5 years out I expect a reset to the global financial system, and the renaissance of global macro investing (followed by a horrible death after the reset is complete). The reset can be either a one-off event, or a gradual one.

Either way, the mid term outcome to me will be inflationary in nature (depreciating fiat currency), so holding onto cash / fiat currency makes little sense – apart from the protection that is required in the short term.

So I will continue deploying my cash position into markets over 2021, because I don’t think cash will perform that well mid term. Interest rates are never going up in the foreseeable future, and asset prices are only going to go up.

We will want to be careful not to hold too much cash than what is required for working capital requirement, and to protect against negative one-off shocks.

Happy to hear your thoughts in the comments below!

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