The Long and the Short and the Tall of trying to figure out investment strategies.

Blain’s Morning Porridge – May 19^th, 2023; The Long and the Short and the Tall of trying to figure out investment strategies.

“The world is full of omens, and we pick the ones we like..”

Markets are focused on the immediate debt-ceiling crisis, and the short-term game of guessing rates vs inflation. Down the line are the bigger challenges of the medium and long-term: issues we need to be investing in now to garner long-run returns or just to survive!

Markets have spent the week apparently unconvinced about anything very much. Stocks and bonds have moved up and down on whatever noise, bluster, smoke and not a few mirrors have caught traders’ attention. Basically, the concerns we’ve held for months remain in place about interest rates, inflation and growth remain unanswered and uncertain, while the short-term growling feedback-loop of the potential US debt ceiling FUBAR is spicing up the mix.

Since markets are acting in a news reactive manner, this morning I’d thought I’d try to think about markets in a different way – what are the immediate, short, medium and long-term investment themes, threats and opportunities to be thinking about, and how to invest into them. That’s when it struck me: “Events, events my dear boy” to cite a UK premier when asked what concerned him. Events, as they say, seem to be becoming more frequent and increasingly volatile and unpredictable.

Let me explain….

My thinking this Poets day has been triggered by the Italian floods across the Emilia-Romagna. It’s shocking – up to 50 cm of rain in 36 hours has scoured the Cities of the valley, killed dozens, and chaotic weather is set to continue. Last year the region was in drought. The land dried up and hardened. The River Po, Italy’s great river, was reduced to a trickle. When the drought switched to incessant rain, dry land funnelled water faster into the equally hard rivers, which were unable to cope with the increased flow.

It’s what caused the switch from drought last year the waterbomb rain this year that’s scary – an unstable jet-steam bringing up loops of hot Saharan air to collide with loops of cold maritime air that’s been sitting over the Alps. Massive precipitation is the result. Normally the Jet Stream is strong and stable, but when it’s not – as has become increasingly frequent in recent years – it triggers extreme climate events with serious economic consequences.

What’s happening to the Jet-Stream is part of the interconnected climate-change phenomenon.  There is nothing we can do to shift the high-altitude wind, but we can mitigate it effects though hydro-engineering, flood prevention and better prediction, defences and warnings, but these cost money and take time to invest in. If the Jet Stream loops north, bringing warmer air and more precipitation over the Alps, storms into the Med, or loops bring down polar air over Britain in the middle of the summer – again massive consequences.

As I wrote earlier this week, record sea temperatures, which affect the Jet-Stream, raise the risk of more hurricanes, droughts across Asia, may trigger an strong El-Nino, and the possibility of melting polar ice shutting down the North Atlantic Drift (The Gulf Stream) – potentially plunging the North West of Europe into a colder, damper fimblewinter of bad harvests and higher energy requirements are very real threats. (Curiously, such a cooling event in the 1400s triggered a colder Baltic, brought in the herring, which enabled wealth creation and prosperity around the Hanseatic ports, leading to the Protestant Reformation and Northern Europe becoming the nexus of growth for the next 400 years! More herring is unlikely to rescue Europe if it happens again.)

Investors need to be thinking about the consequences of extreme climate change events and how to position into them. Increased volatile weather events with hit insurance (weather catastrophe bonds are off my buy-list), will cripple agriculture and push up prices, and will have effects on migration and the stability of political systems. That’s a pretty broad list of potential crisis points. And the environment is just one aspect of global change and evolution.

So, this morning I thought I’d try to think more systematically about the big issues and how to consider them – when I say something is long-term that means it will need investment today for problems that will be with us for decades):

Immediate Market Threats and Opportunities (TAO)

US Debt Ceiling – kind of obvious this one, but it’s going to be a near-earth potentially Chelyabinsk Meteor event – frightening, scary but not fatal. If it strikes, Gold and Treasuries for choice. It will be resolved, but add questions about the US’s Virtuous Sovereign Trinity of stable currency, sustainable bond market and political competency.

Short Term Market TAOs

Inflation, Interest Rates and Growth – What’s the outlook for central banks getting it right or wrong? Do we face: i) a deflationary bust, ii) stagflation, iii) reflationary expansion that feels like recession. I am veering towards the latter, a period of economic resilience driven by a more common sense global economy, but sticky inflation as diminished incomes make it feel like recession. That has important society consequences down the line if income inequalities are not addressed.

Debt – Everyone is apparently in fight or flight panic mode about the debt load upon governments, companies and individuals. There is now a whole industry of doomsters predicting end of the world economic consequences because of debt. Yawn. Get over it. There will be defaults. Some folk will struggle. There will be solutions. When there isn’t a global debt mega-crisis, we shall move on and worry about other stuff.. and then worry about debt again in a few years time. (2009, 2012, 2023.. peak debt worry years..)

Geopolitical Change – Surprisingly I think this is a short-term concern. The world will get sensible again. I wrote yesterday about how the War in Ukraine looked likely to herald a massive geopolitical shift from US hegemony towards the Chinese century. That’s looks increasingly less likely to happen as the Russian threat recedes. The markets realise there is no alternative to dollar and US treasury liquidity. Increasingly they will see it’s in China’s interest to re-engage as previously in global trade and supply chains, rather than risk the economy on a single throw of the dice on Taiwan.

Medium Term Market TAOs

ESG – ESG is going to mature. In the medium term (it’s happening already) investment strategies are likely to shift from today’s strident, bragging ESG towards practical ESG, where the requirement to improve the environment is balanced against social equality and improvement, and the absolute need to create sustainable growth to raise living standards. It’s an optimisation that will create mitigation opportunities. On top of that is a growing realisation companies with Strong Corporate Governance tend to have a strong moral compass and will do the right things to achieve a better environment, strong Social Cohesion and a better planet. I see a shift from Green Finance to Good Finance… and investors will favour firms and deals that demonstrate “doing the right thing”.

Pollution Growth and the Environment – Not withstanding my comments on ESG above, there is a crying need to clean up the planet, while promoting growth. That may trigger a rethink on obvious hypocrisies like burning coal to power electric cars (doh), or the unsustainable inefficiency of windfarms (not all), leading to more considered long-term clean energies. Some of this will be addressed by government subsidy programmes, (in the US and Europe) and some by invention and progress. Who knows, someone may stumble on practical Nuclear Fusion!

Technical Change – AI, the next industrial revolution is the obvious one here. The world is divided on whether it’s the ultimate boon or existential threat to our existence. Let’s go with its an opportunity to enhance productivity, raise wealth and change the world. It will be a case of “not as bad as fear, but not as good as we hope.”  Its worth remembering that corporate evolution is a swift thing – few companies rise to the top of the corporate pile and remain there for more than a couple of decades. That’s less true of the global commodity firms like the oil majors, or even the largest banks, but in anything Tech, they burn like ultra-hot stars…. Burning bright but for shorter periods. In periods of swift technically evolution and innovation today’s winners may swiftly become tomorrow’s who?

Long Term TAOs

Politics – I am deliberately putting politics as a rising long-term threat. The quality of politicians is falling – a commonly heard complaint. Why is that? The calls of service are now seen as opportunity by many politicians who see it as a career rather than a calling. It leaves them in conflict with the bureaucracies that oil the machines of state. The result is increasing voter dissatisfaction with the swamp, the blob or whatever. Equally venal political opportunists seize the moment to launch populist campaigns that inflate vote concerns, but offer absolutely no solutions – like Brexit, the Alt-right or Trump. The result is steady weakening of the political process, fuelling social unrest and division. Over the last 20-years income inequality has risen to record levels, yet few market or political commentators ever factor it into their thinking. Unstable politics will lead to unstable markets.

Climate Change – Chaotic weather and extreme climate events are going to become increasingly common. We can deny the reality or we can invest to mitigate the consequences. Warmer oceans will trigger more storms and change standard weather patterns with all kinds of consequences for agriculture, migration and politics. I expect these effects will become increasingly pronounced in coming years. I hope that decarbonisation, renewable power and agricultural improvement will enable us to cope and reduce the chaos, but I suspect they will prove far greater challenges for markets, governments and economies than the normal up and down of interest rates..

Conclusions

I’ve just skipped around the many and multiple threats and opportunities likely to dominate markets – whether they know it or not. Successful investment is always about buying into the trends. Successful trading is understanding how the markets are playing them. I’ve got some ideas, and as always we’ll be happy to talk about them.

Five things to read over the weekend:

Project Syndicate          Will Europe Be the World’s Biggest Loser?

FT                                 Carl Icahn admits mistake with bearish bet that cost $9 bln

Businessweek               The True Cost of an Extended US Debt-Ceiling Standoff

WSJ                              Alibaba Shares Are a Bet on Spinoffs Not Growth

Economist                    Businesses are in for a mighty debt hangover

Have a great weekend… back to the day job..

Bill Blain

Strategist – Shard Capital