HyperNormalTimes

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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June 18, 2023

The Battle Against Entropy

Father,And,Son,Holding,Hands,Walking,Together,On,The,Beach

You should always bear in mind that entropy is not on your side. Elon Musk.

Every man tries to live up to his father’s expectations or make up for their father’s mistakes. Barack Obama

Passings

Last week I was reminded that we survive in a world of relentless entropic forces that eventually do for us all. Populist politicians Berlusconi, Trump, Johnson and Sturgeon all suffered significant setbacks. Silvio’s setback was permanent, and they were career-changing for the others. A well-known London hedge fund manager also succumbed to a sharp reversal in his career. And I had what is now a weekly discussion with my 92-year-old dad about the prospect of death in the hope that he could enjoy the time he has left. Our talk’s recurring theme is how his anxiety about dying might prevent him from living. His is simply a more pressing example of our entropic reality.

Experience Dividends

A few years ago, successful energy trader and hedge fund manager Bill Perkins wrote a book called, Die With Zero: Getting All You Can from Your Money and Your Life. His life philosophy contrasts with the well-understood Buffet and Munger mantra eulogising the benefits of deferred gratification, thus enabling our wealth to compound. Perkins believes we should optimise our life’s fulfilment between the parameters of wealth, health and time. It’s a simple idea with some profound implications, such as the concept of the experience dividend. [I have never heli-skied, and maybe I never will. However, as every year passes, my ability to go heli-skiing and the value of the experience I might get from it, should my ageing joints allow, diminishes the experience dividend I would receive].

Does It Make You Happy?

Investment books hold Nebraska’s nonagenarians as the gold standard of success. Yet through Perkins’ lens, Buffet and Munger’s $120bn combined wealth represents a suboptimal outcome in the extreme. The pair would be indistinguishable from any well-off country club regulars if they had more conventionally retired 30 years ago to play golf. But Warren and Charlie don’t play golf; they like to invest, and due to their sustained consistency and the mathematics of compound growth, they have amassed personal wealth they will never be able to enjoy.

Rates Diverge

The diverging paths of global monetary policy also emerged last week. As the Fed decided on a “hawkish pause” or skip in its previous 14 straight months of policy rate increases, China manoeuvred to cut rates, and the ECB joined Australia and Canada in continuing to hike. The price of time is moving in different directions among the major currency blocs with unsurprising FX consequences. The Dollar weakened, and Sterling reached a 15-month high in expectation of a further BoE hike this week. A strongly recovering Pound is, prima facie, at odds with the popular narrative of exceptional British decline. But the latest move is a by-product of the fear of more embedded inflation in the UK than in other developed markets. The real fear of sustained UK inflation is apparent but not unique.

Not Unique

Market wisdom holds that the cure for higher prices is higher prices, and we know that tighter monetary policy works with variable lags. But additionally, price transmission mechanisms vary by sector. For internationally traded goods such as energy, materials and commodities, prices adjust more quickly than services’ prices such as accommodation and labour. The UK, a service-led economy, has an unexceptionally slow adjustment mechanism similar to several other European economies.

More Breakages

However, with UK interest rates heading back to levels last seen in the panic-stricken days of the Truss inter-regnum, there is a greater chance that something unexpectedly breaks. Last time it was our derivative fuelled defined benefit pension funds. This time, it increasingly looks like the residential mortgage market. With headlines screaming out for the government to do something to help homeowners as their fixed-rate loan deals expire, the idea of fiscal bailouts for mortgage holders holds certain irony. The very purpose of monetary policy is to impact consumer behaviour negatively. As the Bank of England’s Chief Economist lamented, we must accept that we are now poorer.

Something Strange

The increase in the price of time over the last 15 months initially gave rise to the performance of tangible value. Share prices of old economy stocks in energy, financials, and industrial materials eclipsed those of technology and consumer staples during most of 2022. Investors devalued duration in favour of near-term tangible value. NASDAQ plummeted, and Exxon soared. However, in the first half of 2023, rate rises have been accompanied by a flight back to duration. Approximately 100% of the S&P 500’s performance year to date has come from just eight stocks. And of this impact, 50% of that has come from just Apple and Nvidia. The best-performing companies in Europe have been the luxury goods and consumer staples suppliers, and by far, the best-performing equity market is Japan.

The Safety of AI

The Chinese authorities, the oil price, inverted yield curves and Jay Powell all see something for which the equity market is now preparing. The move to Nvidia, everything AI, Big tech, consumer staples and luxury, represents a flight to safety. And as Tom Stevenson of Fidelity pointed out in the Telegraph, this trend will widen into a broader market recovery in soft or no-landing scenarios. However, China’s recovery is delayed or not happening; Jay Powell conceded risks remain within the US regional banks, while oil prices and other industrial commodities suggest deflationary and recessionary threats are real. In this scenario, risk assets could test new lows, particularly as the Treasury funds its newly raised debt ceiling. But year to date, investor desire for safety has overcome the mechanical force devaluing the future and has started to discount a much less inflationary outlook. To this end, they have sought low-risk Japanese equities, AI plays and reliable consumer compounders.

Future Still Happening

As London Tech Week illustrated last week, the future is still taking shape in the form of entrepreneurial energy applied towards areas such as AI, quantum computing, personalised medicine, nuclear fusion, and space exploration. As Martha Lane-Fox reported: 30,000 technology leaders, entrepreneurs, globally renowned thinkers and politicians flocked here from the US, Europe and Asia. They are not just here to network. In just the past week, a16z, the Andreessen Horowitz investment firm, committed to a UK HQ. Sequoia Capital, Coatue and Thoma Brava have done the same in the past few years. All of which brings me, reluctantly, to unicorns… In 2014 there were only 5. Now, there are 160 across the country. This matters. It is these new global businesses that will mean we stay relevant. This applied energy is valuable for our future. In whatever form they might evolve, the UK can participate in Web 3.0, AGI, quantum networks, personalised drug delivery, nuclear fusion, blockchain payments and other hopefuls.

Balanced Life

Fundamentally life is the application of energy to overcome the universe’s natural entropic state. Silvio Berlusconi applied his powers to overcome opposing forces in business and politics, forging a populist path for Trump to follow. Silvio, now fully overcome, has not Died With Zero but a multi-billion dollar estate. The Donald is now fully incentivised to run in 2024 as his only way of avoiding a lengthy prison sentence. We all have a finite amount of time left. While the good old boys of Omaha are remarkable investors, they are not role models to people for whom investing is a means to an end, not an end in itself. Staying in the game with good health and cashing in on life’s experience dividends in a timely manner are also essential elements of a fully balanced portfolio.

Jeremy

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