A year to remember

Time moves at strange rates during a crisis. Hemingway’s Mike Campbell in The Sun Also Rises famously went bankrupt “Gradually and then suddenly”. But once the alea is definitively iacta, the worst sort of fate is the one that pursues you slowly – but relentlessly, and unavoidably. Yul Brynner’s malfunctioning robot gunslinger in the original Westworld is scary not despite his casual swagger but precisely because of it. The same holds for Arnold Schwarzenegger’s murderous cyborg in the first Terminator. He can afford to take his time the same way a cat toys with a mouse – because he knows he’s going to win.

Which is precisely why the story of RMS Titanic is so compelling, both literally and metaphorically. Once its five compartments are flooded, the die is cast; it becomes somewhat academic whether the ship will sink quickly or slowly, it’s only a matter of rearranging its deckchairs. Probably many of its victims went to their watery graves gradually and then suddenly.

Roy Ward Baker’s A Night to Remember will always be the definitive account of the disaster. In the more than 60 years since its 1958 release, it has lost none of its raw emotional power. (The James Cameron version, by comparison, is just a pompous, inflated mess.) There are a number of sequences in the former version that depict a lounge in one of the upper class quarters of the ship as it slowly sinks beneath the waves. Notwithstanding the vessel listing alarmingly, a motley band of toff revellers are determined to go out in the finest Hooray Henry style. Some continue to play at cards with a fatalistic resolve while behind them, a group of braying nobs determinedly quaff spirits direct from the bottle. One may be doomed, but one can still party on. As the millionaire Benjamin Guggenheim remarks to the shipbuilder Andrews as the story reaches its grim climax,

We have dressed now in our best, and are prepared to go down like gentlemen.

There was indeed once a type of businessperson who behaved with moral elegance under duress, as opposed to trampling over men, women and children in search of a bailout.

A few years ago, Jeremy Grantham’s wrote a market letter that is particularly good on the professional asset manager’s need to navigate not just irrational markets but to cater to clients hungry for performance and intolerant of the bad kind:

Over the years, our estimate of “standard client patience time,” to coin a phrase, has been 3.0 years in normal conditions. Patience can be up to a year shorter than that in extreme cases where relationships and the timing of their

With good luck on starting time, good personal relationships, and decent relative performance, a client’s patience can be a year longer than 3.0 years, or even 2 years longer in exceptional cases. I like to say that good client management is about earning your firm an incremental year of patience. The extra year is very important with any investment product, but in asset allocation, where mistakes are obvious, it is absolutely huge and usually enough.

We make just one cavil with Grantham’s observations in this piece. Like most of the financial services industry, he restricts his asset universe to the two conventionally dominant classes of listed equities and (investment grade) debt. The problem with this perspective is that the asset management industry tends to view those asset classes as both uncorrelated and representative of the entirety of investor choices available.

But the reality is a) that investors can pursue other distinct types of assets (we would single out real assets as an obvious and relevant alternative), and b) that there can and will be times when both debt and equity markets together underperform, in both relative and absolute terms (the relative benchmark being cash since developed government debt can in no way now be considered a risk-free asset class).

We may be fast approaching a macro environment that threatens conventional portfolios with exactly that outcome – a bear market in both stocks and bonds simultaneously. In other words, the authorities and central banks could attempt to throw a bull market party for both bonds and common stocks, but nobody would show up.

Having long since exhausted the armoury of conventional policies to keep the unsustainably indebted and now almost randomly releveraging and deleveraging show on the road, increasingly desperate politicians are doing increasingly desperate things – courtesy not so much of the spread of Covid-19 as of the mass governmental insanity that attended it. The madness that is Modern Monetary Theory is now with us, de facto if not quite yet de jure.

Project ‘End Up Like Japan’ continues to advance well throughout the western economies. The Eurozone continues to perform like a group of drowning men lashed together for buoyancy. Here in the UK the Bank of England has the dubious privilege of being able to print money with abandon, and it is taking every opportunity to duly abuse the purchasing power of Britons with savings. We continue to hear Mr. Takashi Ito’s sad refrain, published as a letter to the FT back in August 2010:

“..after a huge housing bubble bursts, there is nothing to do except suffer many years of economic indignity.”

Politicians, of course, are not in the business of sitting idly by while the country collectively suffers that economic indignity (the savers, at least). They must be seen to be doing something. The ironic triumph of the Keynesians means that in trying to save the economy, our central bank may end up losing control of the printing press. Having put much of the world and its economy under virtual house arrest for several months in the guise of avoiding risk, politicians are now about to get a powerful lesson in what risk really means.

We all now get to experience some of the full-on horror of the Japanese malaise, c. 1990-2010. As the debt burden and currency debauchery satire rise together toward some form of climactic end-game, the sense of politicians simply not getting the point is almost palpable. Just when it were most needed, evidence of social urgency and economic priority from government is almost invisible. Instead, we get the likes of an almost comical U-turn on indefinite free school meals facilitated by a premiership footballer.

So, in a portfolio sense, we close all water-tight doors. Debt holdings, having previously been restricted to those of only the most objectively creditworthy borrowers, are now almost entirely eliminated. Equity exposure is kept modest and restricted to only the most defensive.

We diversify further into the one actively managed strategy that doesn’t attempt to predict future market performance, namely systematic trend-following. And we diversify further still into the highest quality currency available, namely the monetary metals, both gold and silver – together with cash-flow rich bullion miners, trading on modest multiples, with little or no outstanding debt.

With Grantham’s sensible caveats about investor patience still ringing in our ears, we repeat our increasingly urgent suggestion that investors in debt and equity products (especially debt) enjoy the party but dance near the door. And if you intend to panic, please have the good grace to panic early. Developed market debt investors have enjoyed a 40-year bull trend in interest rates (and credit creation) but the fat lady in the next room has started tuning up. Unlike ‘Molly’ Brown, this particular fat lady may not be unsinkable.

In both asset allocation and instrument selection, having diversified well beyond defensive equities into uncorrelated funds and real assets, we have already left the party in all but name. Our portfolios are not particularly dependent on the continuation of any kind of bull market environment – for either conventional debt or equities. We are already essentially sipping non-alcoholic drinks at the after-party (waiting impatiently for the pubs and restaurants to re-open, admittedly). We look with keen interest at our watches to see how many other revellers will end up joining us.

To put it another way, the ship is listing badly but has not yet sunk. So what colour is your life-jacket ?

Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: info@pricevaluepartners.com.

Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and specialist managed funds.