This month I�ve discussed some possible pathways for 2019. But beyond that, for the past year or so, I have been talking about what I think may unfold over the next decade. The term I often use is The Great Reset, but in my mind it�s more than just resetting global debt.
I think a number of equally important trends, all extraordinarily eventful, some amazingly positive and some frustratingly negative, when taken all together (which we�ll have to, like it or not) will produce an era unlike anything previously seen in human history. I call it the Age of Transformation.
We can point back in history to events similar to each of the individual trends. We can even argue some of them happened relatively simultaneously� key word �relatively.� The pace of this transformation will be breathtaking. For all of these changes to happen in roughly a decade will be unprecedented.
This is going to be an extraordinarily (and I use that word precisely) difficult period for those relying on historical precedent in their investment planning. You often see the phrase, �Past Performance Is Not Indicative of Future Results,� and we need to re-examine what that means. Normally, we use it to say that the past returns of a particular investment may not resemble future returns. It�s become part of the legal jargon, usually ignored.
I have been pounding the drums for some time to say those circumstances are not only not going to be repeated in the next decade, they�re going to be profoundly and deeply different. Which means we are going to get different results than most people expect.
I want to be very clear here. I�m not being doom-and-gloom. When I say we will get different returns than history suggests, I mean we will need to look at the world differently to get the results we want. Investment �business as usual� is not going to cut it. Good and maybe even solid returns will be possible, but not with the old paradigms.
In any case, it makes little difference to our portfolios whether recession strikes in 2019 or 2020. The benchmarks will drop between 40 and 50%�some more, some less. To the extent that you are exposed to stocks and other financial markets, your portfolio is going to take a hit.
For a long time, politics have had a short-term significance to the market, but the long-term driving factor was a growing semi-free, semi-capitalistic economy. Further, for almost 40 years the Federal Reserve, beginning with Volcker, provided an era of extraordinarily low rates and easy money. It let governments and businesses worldwide grow their debts alarmingly fast. As I�ve demonstrated in other letters, global debt could easily reach $500 trillion in a few years. Investors and businesses act like that is normal and can continue.
This corporate debt will precipitate a liquidity crisis and create havoc in all sorts of �unrelated� markets. Investors will learn, once again, that all asset classes are globally correlated in a crisis. There will be few places to hide.
Recessions always bring higher unemployment, on top of technology-driven job losses. This will exacerbate the current political tensions. Humans want scapegoats. Many will blame markets and capitalism, when we have neither free markets or true capitalism. The progressive left�s siren song�guaranteed basic income, free college, free everything, etc.�will begin to play everywhere.
If you haven�t already heard of the economically illiterate insanity called Modern Monetary Theory or MMT, you will. It says we don�t need to worry about government debt; we should simply monetize it. Create and spend whatever we need for the common good. They produce fancy equations and rationales, but monetization is the bottom line. It essentially what Alexandria Ocasio-Cortez and others in her world espouse. They talk about raising taxes on the rich, but there�s simply not enough money to do what they propose, even if you take everything the rich have. The arithmetic doesn�t add up. So they will have to increase the debt and eventually monetize it. Which is exactly what Japan has done, and seemingly succeeded.
It is that experiment that we in the US are eventually going to try. Past performance is not indicative of future results. With a vengeance. Except that we know exactly what happened in other countries that tried this. Our experiment will yield a new witches brew of problems and opportunities, which we can�t yet predict. Buy and hold investing will be perilous. Active management is once again going to be paramount.
This will all happen while technology �eats� jobs faster than it creates them. It was all well and good when we went from 80% of the workforce on farms to 1% today, but that happened over several generations and centuries. We are going to see that kind of upheaval in many industries in half a generation. Can you say frustrated workers? People wishing that they can have their jobs protected? Wanting the government to do something?
I think the political arena will become more important to markets in the coming decade than it has ever been. That is not to say we can�t figure it out. But if you are looking at past historical performance to guide your portfolio, you are unlikely to be happy with the outcome.
It is said that a Chinese curse is, �May you live in interesting times.� For better or worse, we live in interesting times. For most of us it won�t be violent, which is what usually accompanied historical interesting times, so for that we can be grateful. But it will be emotionally wrenching.
I am going to finish with some selected quotes from Klarman�s letter, leaving out some of the more incendiary remarks, even though they are no less true. I�ve posted the full 21-page letter for Over My Shoulder members (you can join here if you aren�t one). You need to read it. Here�s Seth.
The divide between Americans has been exacerbated by the echo chambers of modern-day media and the internet. Many have written of how, in only about four decades, an America of three broadcast networks has become an America of hundreds of cable channels. A few decades ago, we had less connectivity but more connection. David Brooks and others write regularly about the challenges of increased loneliness and isolation. A person today can have a thousand Facebook friends�and few, if any, actual friends."
These days, Americans do not seem to agree on much of anything. Some of it is today's politics: "Deep state" or dedicated civil servants? �Witch hunt" or legitimate investigation into crimes? "Fake news" or free press? "Alternative facts" or facts? Accomplished adversary or "lock her up?" And some of it goes beyond politics into the realms of scientific inquiry and American values. Climate change or "climate hoax?" Refugees seeking sanctuary or "caravan of foreign invaders?"
�We would argue vehemently that democracy, and the liberties and protections it provides, is not just of importance to individual citizens, but also to businesses and markets. In a democracy, businesses have the benefit of equal treatment under the law, including unbiased regulation.
Potential rule change: US national security may be more important than risk asset performance for the 1st time in 35+ years (but risk assets don�t seem to realize this yet).
If we are moving back to a �Cold War� world where US policy is driven more by the national security establishment than the Wall Street/Treasury establishment (as has been the case for the past 30+ years), then it would seem the odds are good that the chart on the front page of the attached pdf would mean revert, implying as much as a 30�60% drop in corporate profits as a % of GDP just to return to the levels that prevailed during the last Cold War, before cheap Chinese labor & (at least temporarily disappearing) Fed largesse elevated US corporate profitability to all-time high %s of GDP.
If a new Cold War is indeed breaking out, it would in turn seem to have severe implications for the global & US corporate debt & equity markets�it is HIGHLY unlikely that any of this money was borrowed assuming a 30�60% drop in US corporate profits as a % of GDP was even remotely possible, & on many metrics (IG, HY, leveraged loans, US equities v. ROW), valuations are quite stretched already. There are record levels of leverage in the US corporate debt market, & the rules appear to be changing for national security reasons in a manner quite unfriendly to corporate margins!
I asked about some of the China analysis I�ve seen. These experts confirmed everything that I had read and then doubled down. The geopolitical risks are serious. We in the West simply don�t understand the Chinese mindset or their intentions, even though they write strategic papers every other year detailing exactly what they are thinking and doing. There should be no surprises. But we ignore these writings as political noise and then try to exploit the vast (and real) potential of Chinese markets, yet it may not work out the way we hope. I will have to write on this in a later letter.
But the point is that we do indeed live in interesting times. We simply can�t expect the old investment paradigms to meet the challenges of the future. Past performance is indeed not indicative of future results.
I can�t close this letter without pointing out we will cover all these topics at the upcoming Strategic Investment Conference in Dallas May 13�16. We will be dealing with China, global debt, geopolitics, the upcoming elections, markets, new technologies, social upheaval, and much more. We will be talking about specific investment opportunities and how to structure your affairs.
Conferences have become my personal art form. I design them in building blocks to develop themes that help you plan your own personal future. �Protect and Participate� is the model I think we need to embrace: Protect what we have, participate in the future�s potential.
As I write this, I�m on my way to Baltimore to see 300-year-old mice�or ones that have aged the equivalent of 300 human years. Oh, dear gods, how the world is going to change. We will look back in the late 2030s and wonder why we all worried so much. And this is just one of a dozen different experiments that I personally know about. There must be hundreds of others. What might humanity achieve if we could only get governments out of the way? I only say that semi-humorously.
Then I am off to New York where I have meetings Sunday night and Monday, before I fly on Tuesday to finally see Shane again in Boca Raton. There I will be speaking at a conference and meeting with my friends Doug Kass and Michael Lewitt, who live in the area. I will be on stage with Grant Williams and Martin Barnes, old friends and comrades, where we will be expected to espouse wisdom and knowledge, but frankly, we will just be having the usual intellectually stimulating and aggressive in-your-face fun, and conference attendees will get to listen to us. That�s the best kind of panel.
It seems strange to say I�m going back home to Puerto Rico. But in less than two months, and at age 69 for me and a number that I will not mention for Shane, it has become home. Home is where the heart is? Texas will always be my home, then. But for now, Puerto Rico is where I want to have my closet.