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The global economy was like a car hurtling forward at 200 miles per hour at the beginning of the year, driven by the U.S. and China. In our previous investment outlook, we asked the question, “What are the risks to Goldilocks1?” We considered whether the car could slow to 70 miles per hour without putting too much pressure on interest rates, driven by inflation, which would upset the financial markets.
Is the car still speeding or is China, a major driver of global growth, hitting the brakes too hard? We think Chinese policy makers have all the tools, including liquidity moves, to avoid a crash.
Inflation was the big question. The financial markets are still debating whether we have an inflation problem or whether global growth may slow too much. We won’t get a good read on this until next summer, but I would say the inflation side of the argument is winning so far. Whether it’s supply chain issues or labor market issues, we’re still talking about these longer than I think the transitory camp would like. Also, let’s be more specific about inflation. Although commodity price inflation matters, our concern with respect to inflation and financial markets is wage inflation, which tends to be longer-lasting and may affect long-term interest rates.
Another surprise that has affected commodity prices is that, as the economy grows and demand for commodity grows, increasing supply has become harder. This is in part due to ESG policies in place, causing “greenflation” and a multi-year trend of price pressure. Finding supply sources like new copper, lithium or gold mines is harder because of, to a certain extent, the environmental impact of these activities. I think this supply issue will continue to underpin commodity prices, and is why I believe that commodity equities are an interesting investment that people should have in their portfolios.
I think higher interest rates is a potential risk we need to keep an eye on, as it would impact both stock and bond markets. When it comes to rates, it feels like the Fed has inflated this balloon. Bank of America recently released a research note2 that said over half of the S&P 500’s returns in the past decade can be attributed to the Fed’s balance sheet expansion, rather than earnings. The risk is of some bad shock, as seen in March and April of last year, but the Fed keeps pushing more air into the balloon. That’s why I think the markets are so overvalued these days, on a price-to-sales and price-to-earnings basis. It’s really a bet on the Fed. I personally think it’s not a bad idea to keep some money on the sidelines and wait until prices come down a bit.
The 0% interest rates from the Fed has led to overvaluation in the private markets as well as the public markets. While it’s great to see IPOs happening again, companies are coming to market at very rich price-to-sales. For example, Uber is a great business, but the stocks are like zombie stocks—they’re disconnected from the profitability and revenue growth of the underlying company. So after an IPO, the stocks don’t go up although the company’s sales are growing. I think investors have to be aware that it may take several years for the business to catch up with the zombie stock.
Two themes that we’re currently focusing on are the energy transition and blockchain or crypto. The energy transition is the move away from fossil fuels, which is being driven by a lot of innovation in the private sector. In our resources portfolios, we’re looking for disruptive companies in the sectors that need to be more energy efficient. One is agriculture, which emits about as much CO2 as the energy sector. AgTech businesses are embracing technology to modernize agriculture, leading to higher crop yields, safer crop chemicals and other innovations in food production to provide healthy diets for the world’s growing population.
Cryptocurrencies and the underlying open-source database technology can provide many financial solutions at much lower cost. The fintech revolution that goes hand in hand with crypto is something we find really exciting. There are some over-valued companies, but we think it’s another interesting multi-year trend that investors should consider.
1 A Goldilocks economy is an economy that is not so hot that it causes inflation and not so cold that it causes a recession.
2 Source: Bloomberg, https://www.bloomberg.com/news/articles/2021-09-08/bofa-s-subramanian-dumps-dire-stock-call-to-catch-up-with-rally
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