Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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July 20, 2021

Freedom, Risk & Repression

Lockdown Security Blanket -

Freedom involves risk. This point occurred to me when recently listening to an interview with Yeomni Park, an escapee from North Korea. Her shocking story is a wake-up call for those of us who might be hankering after the security blanket of lockdown as we are allowed out to fend for ourselves in the post-pandemic world. UK Freedom Day this week highlights how the government now expects us to take on more responsibility for our healthcare risks. Meanwhile, in financial markets, the consequences of the government’s monetary policy are forcing us to take more significant risks with our money than we typically might choose. At the same time, ironically, its regulators warn us of the perils of excessive speculation.

Love of Risk -

Life in North Korea is unimaginable to us. Yeonmi described how people don’t know romantic love as it involves too much trust in other people. People are required to reserve all their affection for their leader, who is considered a god. The government deems any attachment shown to others as a dangerous sign. However, she highlighted that what most differentiated her life in the West was not the higher level of material well-being but the higher level of risk. She thought that our capacity to assume risk was a genuinely exhilarating differentiator from the dull, repetitive certainty of her homeland. Further, she felt we take this too much for granted and don’t appreciate and cherish the freedoms we enjoy nor embrace the risks it entails.

Unknown Unknowns -

Risk is the volatility of return in most financial textbooks. However, we do not think of the “risk” of winning the lottery. Instead, we believe risks are the damaging uncertainties against which we should consider insuring ourselves. John Kay and Mervyn King defined the terms resolvable and radical uncertainty. For them, uncertainty is the result of our incomplete knowledge of the world we inhabit. As they describe, a world where we had perfect foresight might be superficially appealing but would, on reflection, be a dull place to live. Resolvable uncertainty is what the recently deceased Donald Rumsfeld termed “known unknowns”. Radical uncertainty is not just that we do not know will happen, but those things that we cannot even consider happening, Rumsfeld’s “unknown unknowns”.

At Any Cost -

The most recent “unknown unknown” to induce radical uncertainty into our economy has been the COVID-19 pandemic. Since World War II, COVID was the most extreme exogenous shock to our economy, and similarly to that event, the government response has been to spend whatever it takes to deal with the threat. The cost involved is considered secondary to the outcome.

Stealing From Savers -

Like post World War Two, the most pragmatic way to deal with the large amounts of public debt we have incurred is via policies of financial repression. In short, this is a policy of allowing inflation to run higher than interest rates for a sustained period. If you are a borrower (and governments are the biggest of these), this is good news; if you are a saver, then not so much.

Safe Assets Become Risky -

Year-over-year average price inflation is currently 5.4% in the US*. And yet, the Fed’s central interest rate and T-bill rates are near zero, and the 10-year Treasury rate is 1.2%. As of the end of last year, over $20tn of bonds globally were yielding at or below zero %. You cannot make money by holding these assets to redemption. Historically, having cash in the bank or holding bonds was a way to preserve purchasing power until suitable investments made themselves available. Interest rates were generally equal to or higher than the prevailing inflation rate. You wouldn’t gain value while sitting in cash, but at least you wouldn’t lose purchasing power. Things are changing; today’s “safe assets” risk losing their purchasing power.

Use It Or Lose It -

The direct result of government policy is forcing people to assume greater risk with their money if they do not want to see the value of their savings eroded. Bonds and bank deposits, the traditional, “risk-off”, safe havens for our savings, are today bleeding purchasing power. It is little wonder that investors are allocating more of their savings into riskier assets to search for higher yield or better purchasing power protection. In the parlance of a rugby union referee, inflation means use it or lose it. The case for equities is not that they look attractive but that they are the least bad alternative. Little wonder in such circumstances we see the “irrational exuberance” of so-called “meme stocks” such as AMC and Gamestop.

When Japan Ruled the World -

US household equity holdings as a percentage of financial assets owned have risen from a low of 20% in 2010 to more than 40% today, exceeding the previous high of 38% seen in 2000. Over the last 70 years, periods of lower equity returns have followed extended periods of high household equity ownership. The most extreme example of this in living memory was the Japanese financial bubble of the 1980s. In 1985, it is hard to believe, but there were no US banks in the top 25 largest banks globally; 17 were Japanese. Japanese brokers, Nomura, Nikko and Daiwa, were the most significant global financial market intermediaries, channelling billions of Yen from household savings into the stock market. The much-hyped backdrop to the 1987 UK election was that if Magaret Thatcher got re-elected, a “wall of Japanese money” was about to arrive in the UK. What happened was the bubble burst, and the Japanese stock market today remains 20% below where it stood 30 years ago. (Ironically, Japan is today one of the biggest owners of US Treasuries as they gain a yield pick up on their negative-yielding domestic offerings).

Turning Japanese -

What happened in Japan in the 1980s is happening more widely in global markets today. Easy money that is bleeding value is everywhere, not just in Japanese banks. The spreads between risky and investment-grade bonds and corporate failures are both at historic low levels. Investors are behaving as if they cannot lose. The flow of capital from bonds and cash deposits and into equities continues at pace. Bank of America believes that if trends continue, the flow into global equities in 2021 will exceed the cumulative total of the last 20 years combined. It is little wonder that the rate of public IPOs is also running at supercharged levels, not seen since the dot-com boom, and we have more SPACs than appropriately listable private companies. When the music is playing, the bankers get up and dance.

Tops & Bottoms -

In 1997, the UK stock market was looking quite toppy; it went on to rise by over 30% in the following two years. Similarly, an old boss of mine said he thought Shell Transport & Trading looked quite attractive on a PE of 4 in 1973. It bottomed out on a PE below two the following year, a period that saw 72% wiped off the value of the UK benchmark FT30 index. The point is that picking the tops and bottoms in markets is impossible, but sensing a heightened level of risk is not.

Mind The Gap -

The irony is that the government and its agents at central banks and financial regulators are imploring us not to take undue risk while at the same time raising the risk of holding cash or bonds. They are stealing the purchasing power of our liquid assets while at the same time issuing dire warnings about the perils of speculative investments such as cryptocurrencies. (I think it is interesting that the lengths taken to restrict flows into Bitcoin, an asset deemed not to have a use case, but I digress).

The Climate Club -

Russell Napier has warned against investing in regulated assets during periods of financial repression as funds are increasingly vulnerable to regulators requiring them to allocate assets into approved investments. As “Green Bonds” and “ESG Approved Investments” become mandated, the most virtuous assets will undoubtedly be considered government bonds. Just as War Loans duped patriotic savers in the interwar years, so too will notions of ESG rectitude be used to mislead the environmentally concerned investors of the 2020s and 2030s. Indeed, who could not agree to such measures for such a worthy cause? (I know I shouldn’t, but when I hear Christine Lagarde and other central bankers talk of their duty to deliver on the green agenda, I cringe for them). If the steps taken to use Covid as a means of social control was unsettling, wait until you see what they have planned regarding climate change. Maybe the ends justify the means; perhaps we would be better off not being subjected to the mental torture of deciding for ourselves? But I would instead prefer to take the risk, all the same, thanks.

Born Free -

In trying to assess what to do, it is worth thinking about the issues raised by Yeonmi Park. Risk is a reminder that we still have the freedom to determine our future to a significant extent. The outcome is subject to uncertainty, sometimes radical uncertainty, which can be positive or negative. However, Yeonmi warns that we might be about to lose it. It is a vital part of being a free individual, and we should embrace it, enjoy it and allow it to exhilarate us, bon chance.



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