This post was originally set to go out on Friday, but we thought it worth digesting the narrative being created over the weekend after the ‘storming’ of the Capitol by Trump supporters. What is clear from the hyperbolic – and to our view orchestrated – (over) reaction to the crowds breaking into the Capitol building is that the establishment has finally defeated Donald Trump and that after this ‘outrage’ he is now also finished as a future political threat to them. The prospect of Trump 2024 looks to have vanished and big Tech has moved quickly to circle the wagons to cut off his access to ‘the people’ – demonstrating, if it was ever needed, who actually controls the narrative.
Our key takeaway is that Political Unrest in the US is likely to remain elevated for a considerable period and this furthers the case for some diversification out of US equities.
It was once again ironic to see that the same people who celebrated Hong Kong protestors storming the government offices as freedom fighters now condemning similar scenes in their own country as ‘domestic terrorism’, just as they did with the earlier riots and their comments this week offered both the Chinese and the Russians the opportunity for some major New Year trolling, which has doubtless fueled the Democrat Brahmin class’ desire for revenge on Trump and the ‘deplorables’. A ‘Crackdown’ on dissent looks guaranteed, even as the increasingly authoritarian Medical Industrial Complex demands further crackdown on the people said to be defying the lockdown orthodoxy. Meanwhile, the Republican Party is now split – as indeed are the Democrats, while the Crony Capitalists consolidate their power.
The mask has slipped, Crony Capitalism is firmly back in control in the US.
However, while populism may have been stymied by the defenestration of Trump and more generally suppressed by Covid restrictions, it is not going away and as commentator Pepe Escobar puts it, the risk now is of “The Deplorables becoming the Ungovernables”. Certainly we believe that, should the Democrats use their new found majority to try and impose a more radical agenda, especially with challenges to the first and second amendments, then this discontent will rise. The question remains that now that ‘The Empire has struck back’, will a Jedi Return?
At the moment, the markets seem surprisingly unfazed at the ability of a mob to enter what was previously regarded as probably the most secure public building in the United States outside of the White House (where is Gerard Butler when you need him?) and, while undoubtedly scared in the moment, a large number of US politicians must also have been relieved that this incident managed to shut down any official discussions of voting irregularities, likely forever. Meanwhile, the announcement of a Democrat majority in the Senate was greeted initially by a sell-off in markets, but a big jump in US Bank Shares, perhaps because the markets believe that the man formerly known as “The Senator for (giant Credit card company) MBNA” will look after his friends and donors when he becomes President. In many ways this reflects the agnosticism of markets; Covid restrictions may be hitting the small businesses in the private sector, but they aren’t featured in the investment universe.
Main Street marches on the Capitol, Wall Street shrugs. For now.
Against this background we see a widely circulated piece last week from Jeremy Grantham of GMO about an Equity (and other Asset) Bubble in the US and while we do not always agree with Mr Grantham, there are elements within his argument we would highlight.
First, his point that the bubble is in the US domestic markets, this is key, since in our view the best diversification is to move some money out of the US equity market, which is now as dominant in benchmarked portfolios as Japan was in 1989. Second, he mentions earlier major market breaks of 2008, 2000 and 1989 Japan, much as we ourselves did in the January Market Thinking. His point is that they were sufficiently distant that many market participants are unable to relate to them and we would agree, but rather in the sense that they marked some major turning points from an asset allocation point of view and that we may be seeing one now.
We should listen to what markets are telling us, rather than expect markets to listen to what we are telling them
To be fair, Mr Grantham concedes how GMO have been ‘too early’ on multiple occasions, which is certainly our understanding of his track record, but then harks back to his models such as the CAPE asset price indicator favoured by Robert Shiller as currently flashing red, when it is exactly those models that led to the ‘too early’ calls in the past! He rightly points out the froth in markets and the fact that greed has replaced fear, especially among small, leveraged, retail investors and notes, as we have, situations such as Tesla. We would throw in Bitcoin into the equation here as well; since we mentioned our Five Cs approach to looking into 2021 and the prospect of Government Balance sheet expansion at the end of November, all of the assets mentioned – China, (+11.9%) Commodities, (Wood +17%, Pick +32%) Convertibles (+13%) and Cash flow (Quality +6.7%) have done well and most well ahead of the MSCI World (+8.3%) while equities have continued to outperform bonds (+6.8%). Crypto Currencies meanwhile have been spectacular; the Grayscale Bitcoin Trust we highlighted has effectively doubled in a month!
He also points out, as again we would, that institutional brokers and investors are always incentivised to be bullish, but while we would agree that there is undoubtedly a lot of froth at the moment, we are also aware that being out of a market that rises 60% in order to avoid a drop of 30% still leaves clients behind where they would otherwise be, which is why we use our risk based system and scale in or out of assets on a semi systematic basis reflecting what the markets are telling us, rather than expecting the markets to listen to what we are telling them.
If US Politics has become like an Emerging Market, why not buy into some actual Emerging Markets?
His final points, on Emerging markets and value stocks, are ultimately things we would broadly agree on. Of course, nowadays Emerging markets really means China and South Korea, which together make up 50% of the benchmark, with Taiwan a further 13% and we would rather look at Cash Flow and cyclicals rather than the group simply known as ‘Value’, but the recommendation of a broad diversification away from US Growth looks sensible.
To this end we would look at the big Asset Allocation Call of Emerging Markets. Rather like the calls on Japan from 1989, or US Energy and Banks from 2001, or US Tech from 2005 and again from 2010, the call to exit Emerging Markets in 2010 made a lot of sense and was heavily correlated with a stronger US dollar, as shown in the chart.
The White line shows the relative performance of the Emerging Markets ETF EEM US relative to the S&P500, while the red line (inverted) shows the US $ Trade Weighted index. The chart goes to 2003 (when EEM was created) and broadly speaking shows an 8 year bull market in EEM coinciding with a 25% drop in the value of the US$ followed by a near decade long bear market as the US $ strengthened.
Notwithstanding a small rally over the last few days, we have been saying for some months now that the US$ is weakening and risks a return to a bear phase – indeed this was the essence of our 5Cs argument – and, should this relationship hold then we would expect the relative performance of EEM to accelerate from here. Note, this is not to recommend this ETF per se, but rather to emphasise that it offers an indication of what the market is telling us should happen – and indeed may very well already be under way.
