“A Hare was making fun of the Tortoise one day for being so slow.
“Do you ever get anywhere?” he asked with a mocking laugh.
“Yes,” replied the Tortoise, “and I get there sooner than you think. I’ll run you a race and prove it.”
The Hare was much amused at the idea of running a race with the Tortoise, but for the fun of the thing he agreed. So the Fox, who had consented to act as judge, marked the distance and started the runners off.
The Hare was soon far out of sight, and to make the Tortoise feel very deeply how ridiculous it was for him to try a race with a Hare, he lay down beside the course to take a nap until the Tortoise should catch up.
The Tortoise meanwhile kept going slowly but steadily, and, after a time, passed the place where the Hare was sleeping. But the Hare slept on very peacefully; and when at last he did wake up, the Tortoise was near the goal. The Hare now ran his swiftest, but he could not overtake the Tortoise in time.”
This, and other stories, teach investors the virtue of patience, which will be crucial in the final phase of The End Game.
So far this week, inspired by the Grant Williams podcast series, we’ve been discussing ‘The End Game’.
It’s been a battle, trying to achieve two things.
Firstly, that we are somewhere. And secondly, that we must get to somewhere else.
We are overburdened with debt, over-reliant on central banks, and that financial asset prices are too high, causing social divisions which are getting worse. Good luck, Joe Biden…
But why must this end?
Markets are cyclical, swinging around points of equilibrium, never settling in balanced positions but never straying too far (or too long) either.
I also want to describe how we as investors should approach the coming transition from one phase to the next – as the saying goes there is no such thing as bad weather, just the wrong clothes.
There are two main relationships which must always come back into balance.
They are the size of the stock market (market capitalisation) compared to GDP, and the size of the debt pile relative to GDP. The debt can be government debt, corporate, or household, or a combination of all three, depending on the situation.
Corporate debt to GDP is currently at all-time highs, and so is market cap to GDP:
The variation of market cap around the line of GDP is created by the combination of financial engineering and human emotion that we investigated on Monday.
Market cap cannot stray too far from GDP though. It must eventually return to the point of equilibrium. Either market cap must fall back in line with GDP, or GDP must catch up.
It’s important to remember that there are two ways in which balance can be restored.
Firstly, through a deflationary crash – essentially, stock prices fall far enough that market cap is cut down into proportion with GDP.
This is what happened in the tech bust between 2000-2002, as you can see below:
Alternatively, GDP growth can outpace the stock market, while stock market prices stay flat.
This is more like what happened between 1968-82, when inflation took hold.
A fourteen-year bear market took place, but it was in valuations more than prices – which ended up roughly where they started.
In our current situation with market cap to GDP nearly at 175%, the highest recorded level ever, those are the two methods of escape.
Price deflation, or GDP inflation.
In the former, standard portfolios lose money in a very obvious way, as prices decline fairly rapidly.
In the latter, the loss is more subtle. 1968-82 so a 0% share price return on the S&P 500 over a fourteen-year period.
If you are within thirty years of retirement, such a period with no positive returns would be truly devastating, forcing you to work longer or live more frugally.
There is a similar story with debt to GDP levels, and two pretty similar routes from where we are today, to where we end up once The End Game has played out.
Let’s look at a few different debt metrics.
Globally, corporate debt to GDP (not including banks), is at all-time highs:
And global government and corporate debt both just jumped in the wake of Covid-19, with the onset of massive fiscal and monetary stimulus.
Just look at America’s government debt as a % of GDP – it’s back at WW2 levels (over 100%) and forecast to rise plenty more in the years to come:
Again, this is a relationship which must come back into balance eventually.
Debt moves in grand cycles – something Ray Dalio is pretty famous for if you’d like to read more. You can see the first one building up to World War II, but incredibly we have now surpassed the debt levels, relative to GDP, that were reached back then.
Debt also moves in cycles.
Too little, and growth suffers because people can’t afford to invest in new machines, employees, advertising and other things for growing their businesses.
Too much, and growth suffers, because the interest burden grows too much, overpowering a business’ profits.
Sadly, after a crisis, as debt helps to rebuild growth and confidence, people take it too far. Convinced by recent history that the economy is healthy, people take on more debt and more risk. As businesses do so, competitors are forced to do the same. And on it goes.
When a country, or in this case most of the world, is overburdened with debt, two choices are once again available.
One is default, which is akin to the deflationary crash in asset prices we described earlier.
It is a sudden stop, a shock, a crash.
Corporates and governments simply say they cannot repay their debts, and start again (but with lower trust and higher future borrowing costs).
Throughout history, a second option has more often been chosen – inflation. The EU may struggle here, as nation states no longer control their own currency, so cannot print money.
If you can generate inflation, your debt burden will slowly fall in real terms.
So again we have two options – one which is very sudden and very painful, and another which is slower and much subtler.
This is the End Game.
Two problems, two solutions.
Overvalued stock markets, and overburdened governments and corporate sectors.
A stock market crash, with a wave of defaults, or inflation slowly reducing the real value of the debt, and quietly stealing away your real returns.
The hare, or the tortoise.
We cannot know which way things will go.
So what can investors do?
Turning once more to popular stories, here is the tale of the three brothers, from Harry Potter and the Deathly Hallows. Feel free to skip if this isn’t your thing…
Three brothers, travelling along a lonely, winding road at twilight reached a deep treacherous river where anyone who attempted to swim or wade would drown. Learned in the magical arts, the brothers conjured a bridge with their wands and proceed to cross.
Halfway through the bridge, a hooded figure stood before them. The figure was the enraged spirit of Death, cheated of his due. Death cunningly pretended to congratulate them and proceeds to award them with gifts of their own choosing.
The eldest brother, a combative man, asked for a wand more powerful than any in existence.
Death granted his wish by fashioning the Elder Wand. The second brother, an arrogant man, chose to further humiliate death, and asked for the power to recall the deceased from the grave. Death granted his wish by crafting the Resurrection Stone. The third and youngest brother, who was the most humble and wise, did not trust Death and asked for something to enable him to go forth without Death being able to follow. A reluctant Death, most unwillingly, handed over a part his own Invisibility cloak.
The three brothers took their prizes and soon went on their separate ways.
The eldest brother walked to an inn not far from the site and spent the night there. Taken by his conscience and lust of the Elder Wand’s power, the eldest brother boasted of this wand gifted by Death and his own invincibility.
That very night, a murderous wizard crept to the inn as the eldest brother slept, drunk from wine. The wizard slit the oldest brother’s throat for good measure and stole the wand. That was when Death took the first brother.
The second brother returned to his home. Turning the stone thrice in his hand the figure of the girl he had once hoped to marry, before her untimely death, appeared at once before him, much to his delight. Yet she was sad and cold, separated from him as by a veil. Though she had returned to the mortal world, she did not truly belong there and suffered.
Finally, the second brother, driven mad with hopeless longing, committed suicide by hanging from his house’ balcony so as truly to join her. That was when Death took the second brother for his own.
Death searched for the youngest brother as years passed but never succeeded. It was only when the third brother reached a great age, he took off the Cloak of Invisibility and gave it to his son. Greeting Death as an old friend, they departed this life as equals.
The moral of the story is that survival is the only form of victory. You cannot beat death, nor cheat it.
We have seen it time and again.
From Warren Buffett to Howard Marks, longevity is the ultimate weapon in the game of compounding.
Chasing glory, chasing returns, they won’t lead to long run success.
Like the fable of the Hare and the Tortoise, slow and steady wins the race.
Survival is key, and in all scenarios, in all paths through the end game, there are assets which can perform well.
However, I do believe that the standard, basic strategies are not up to the task.
Whether by steady inflation or rapid deflation, the returns from traditional investment portfolios like index and 60/40 funds will not be able to withstand the oncoming storm.
True diversification requires a greater variety of assets, strategies and investments.
Here at Southbank, we have a wide array of offerings, from energy transition stocks to gold to trend following strategies, all of which have great merit in my book.
But one man brings it all together.
With decades of experience, having managed billions of pounds for HSBC, and the contrarian, multi-asset mindset required to do well in the years to come, Charlie Morris really is the man for the job.
Using his unique method of looking at markets (his Money Map), he has been guiding investors through the recent turmoil with skill and flexibility.
I have read every word Charlie has written since I joined Southbank almost two years ago, and consider it one of the most valuable resources we offer.
If you’d like to join me, and find out how he can guide you through not just the end game that I have described, but all possible market developments…
I truly cannot recommend it highly enough, now more than ever.
To finish though, I’d like to strike a slightly more positive note to end the week.
The thing is, for all the doom and gloom this week, I’m not actually that pessimistic. For those who are well prepared and set up to capitalise on the opportunities that will arise, it could be an incredibly fruitful period.
And so, I’d like to end with this quote from Lord of the Rings, with the armies of Sauron approaching looming, this conversation takes place:
“PIPPIN: I didn’t think it would end this way…
GANDALF THE WHITE: End? No… The journey doesn’t end here. Death is just another path, one that we all must take. The grey rain-curtain of this world rolls back, and all turns to silver glass, and then you see it.
P: What? Gandalf? See what?
G: White shores, and beyond, a far green country under a swift sunrise.
P: Well, that isn’t so bad.
G: No… No, it isn’t.”
All the best,
Editor, UK Uncensored
Cash, stocks, bonds, gold, cryptos, ETFs, mutual funds… Want to make sense of it all, and turn it into a portfolio built for the current investing environment?