— Oct 7, 2021


For the second quarter running we have seen most equity and debt markets seemingly acting as grown ups – plodding along – while almost everything else seems a little broken and teenage.

Inflation has been sharply affecting commodity prices – most industrial metals have surged, as has oil and gas. There has been wage pressures, HGV driver shortages and even A level grades have got in on the act. It must be an awkward topic in the school staff room that the one year in which there was much less teaching resulted in record smashing grades. The consequences of this will linger and will cause repercussions. What will happen to next year’s grades? What will Universities do to separate out students from a cohort of almost universally high grades? What will future employers do? Pity the student that got normal grades but took a gap year, what chance do they have to secure a desirable University against this steroid-fueled cohort?

What teachers have done, of course, with ample support from the government, is to diminish the value of the only thing they are selling. If academic rigour has been jettisoned then employers will increasingly self-evaluate rather than taking the grades awarded by A level or Universities as being representative of academic or intellectual ability.

The A level student today may feel a surge of pride in their results but in truth their prospects have been considerably diminished over the last decade. The surging asset prices, caused by interest rates below zero (in real terms), has pushed back when they can buy a house and when they can get married and have children. Denied the prospects of being able to “settle down” is it any surprise that they have given up and spend their money on entertainment and living. What is the point in saving? Paying back student loans from a lower earnings threshold (which has been proposed) and higher National Insurance contributions are yet more transfers of wealth from the young to the old.

Further teeth grinding came when pensions expert John Ralfe worked out that the average cost of public sector defined benefit pension schemes is 63% of salaries, of which the average employee contribution is 8%. When you next consider the wages of a nurse or fireman or council official please make sure to add more than 50% to the figure to get a real understanding of what the taxpayer is paying. Defined benefits schemes are dead in the private sector. In the public sector more than 6m are enrolled in these gold-plated taxpayer guaranteed funds. All of them remain open to new members.

And as we approach the denouement to a miserable year we enter the final quarter facing empty petrol stations because of panicking drivers and irresponsible media.

Behind many of these problems is a simple observation: demand is exceeding supply right now. The lockdowns concussed supply chains. As we emerge rapidly into the current slightly diminished normality the increase in spending has met supply bottlenecks and logistical holdups. This has driven inflation and an exotic and rapidly expanding list of shortages. Much as the deep recession of last year was unusual (caused by an imposed lockdown) so is the recovery. The twisting of the economy to accommodate the lockdown has not unbent itself back to its original position. The economy before the lockdown had also been twisted by a decade of zero interest rates and by the firehose of fiscal and monetary spending by governments. The economic signals have never been less reliable or more opaque.

Our response to this is increasingly one of caution.

We can see evidence of bubbles in multiple locations: extreme technology stock valuations, cryptocurrencies and meme stock speculation by an ill informed American public, bored during lockdown and often using government stimulus money to fund this new found hobby.

We have been reducing our clients exposure to equities and risk assets and this trend will persist. The underlying causes for the high asset prices we see around us are shaky. Should even a few small pillars of support creak then we could see a very rapid readjustment from stock markets. This is euphemistic and we should be direct and clear in our language: we believe there are fertile grounds for a market crash. We are increasing the amount of cash and defensive assets we have in order that we can take advantage of it, like we did in 2020; starting the year with substantial cash and then investing it at the height of the lockdown panic.

This may not happen in 2021 and if markets continue to rise then we will not keep pace. We are content to underperform under these scenarios because in many ways the job of an investor is to work out when it is the right time to be taking risk (when the potential rewards justify it) and when it is not. In our judgement, now is not the right time.

We have made decisive steps in this direction and we will continue to reduce risk and bulk up on cash, high quality debt assets, absolute return funds and gold. Should a market setback occur or inflation risks increase these assets are far less exposed and should protect our clients wealth until such time as the buying of risk assets is justified by the potential rewards.