Ever since we started in 1994, we have written an investment review, garnished with a cartoon, and filleted by compliance for political incorrectness. In normal times, it appears shortly after the quarter end. Amid the fireworks of COVID-19, it is appearing now, in early June, rather than waiting for early July.
We sent clients regular indications of how their portfolios were moving in the days when the markets had lost control – those days, are, for the moment, behind us. But there is more weather to come. This review touches briefly on what has gone before, then sets out what we expect for the coming months and years.
Ruffer portfolios stood firm during the market death spiral at the beginning of March and our performance, at its worst, slipped marginally into negative territory for the year – this was the subject matter of the last review. Since then, markets have recovered, and, at the time of writing, portfolio performance is around +5% year to date1. When we look back, my guess is that this period will be the one we are most gratified by – since we were positioned for a mighty fall, broadly based across asset classes, and we had a portfolio construction that only made sense if these were the very conditions which occurred. Capital preservation may sound boring in advance of a shock, but it enables us to make good money in its aftermath, and April turned out to be one of the best months in our history.
Coronavirus was the catalyst for the market turmoil, but it was the pathology of the financial world, and its interaction with the markets – not a prediction of a pandemic – which gave us our dispositions. The sharp falls, and the buoyancy of the recovery, follow a sequence with which we have become familiar. Thus far, it has been accompanied by satisfactory short-term performance. But in the battle to protect portfolios, the next phase, and beyond, also need to play out according to plan. Our philosophy is never to aim to be precisely right, but, rather, always to be ‘not wrong’. Ruffer portfolios therefore hold a multitude of investments, a good number of which should do well even if the views expressed in this review turn out to be wonky.
First, why have the markets recovered? The classically correct answer is that interest rates have come down, both at short and long duration – future profits in the stockmarket are discounted at a lower rate than before; they are therefore worth more than they were. This, of course, seems to assume that the profits will reappear, and much chalk on banana skin has been expended to predict what those future profits will look like. But Pavlov and his dogs have as much, and probably more, to say than the chalk bearers. As an ichthyosauric investor I’m partial to repetition, and the repetition here – of a point from my previous review in April – concerns the game changer of the late 1980s.
Alan Greenspan, chair of the US Federal Reserve, began the policy of supplying the market with funds whenever it had a headache. It is a policy executed over three decades without even a pause for a coffee break. The first iteration was after the 1987 stockmarket crash – it took two years for the markets to throw off the fear that it had been a 1929 moment. Since then, investors have come to see that bad news is the precursor of Fed-gifted good news – and only the patsies sell the bad news. The hardwiring of almost all investors active today was forged by events subsequent to October 1987. You probably need to have been running money from before the start of the long bull market in 1982 to know how markets operate without medication. For a longish while now, the prevailing wind has been one where everyone knows you don’t sell on bad news. Yet one day the wind will change, and bad news in the real world will be bad news for asset values once more.
Before we address that change of wind, there is one strategy in Ruffer portfolios in 2020 which is a repeat of how we handled things in 1999/2000. That was a period of the TMT (technology, media, telecoms) boom – it was only labelled a bubble after the boom bombed. In retrospect, the bubble seemed a bit bonkers, but the key to its power was that the new-economy businesses were so much better in prospect than the cheesemakers and the manufacturers of industrial cables. It wasn’t enough to point out that what you pay for a stock can be even more important than the quality of the business you’re buying into. Amazon is valued at $1.2 trillion2 – why not 2.4, or 3.6? The answer is that the checks and balances which are an inherent part of life are a great leveller. All we business folk have got used to Zoom (up threefold), shopping online, and an acceleration of new technology’s inroads into the old ways of doing things. Stocks with good market momentum are often full of intrinsic growth qualities that make them attractive to investors for reasons other than herd instinct. Nevertheless, the relationship between growth stocks and their opposite (known as value, although try telling that to shareholders in the cruise shipping companies) is at an extreme – even beyond the levels of 1999. Ruffer held no TMT in 1999, no financials ahead of the 2008 crash, and today, we hold as little momentum as we can in the current market. Investors are crowded together, peering over one side of the boat, unbalancing it as they gaze at the graceful growth fish below; a slowing in the momentum of the stockmarket’s favourites will see investors gradually, and then suddenly, move to the other side of the boat to see what the value fish are up to. Certainly, this will cause a fall in the growth stocks; it should also see the least-favourites rise, quite possibly sharply – even if that rise is not, in all cases, justified by the fundamentals.
This momentum versus value decision in portfolios is tactical – it is a view on the markets, not a view on the real world. But it is held at a time when the outlook is, in its most important elements, becoming clearer. Events following the 2008 crash have benefitted the few, not the many, as the marchers might put it. Wages have stagnated, but house prices haven’t, and the price of nice things has gone up to boot. This divide has been something that many have had time to dwell on during lockdown – their colleagues, whose only skill was being born 20 years earlier, have had a much better time of it in their large gardens and duplex offices carved out of the fourth bedroom. There is a reckoning coming. One political price will be François Hollande-style taxation – except that he called it a day at 75%, whereas in the UK it rose above 90% in the second half of the twentieth century. Taxation at higher levels will help reduce the monumental debt pile a little, but that may be almost beside the point – for many, it will be a visceral pleasure to observe. This, one might add, will be a worldwide trend, not a local one.
The other horse of the apocalypse on its way is inflation. A goodly percentage of our readership will think ‘gramophone record’, and ‘cracked’ at that. In nervous self-defence, I would point out that it’s only ten years, and that clients have made plenty of money in our oft-misunderstood holdings of inflation-linked bonds. We have owned these bonds because we believed primarily in financial repression – suppressing the cost of borrowing to you and me – repression that would, eventually, lead to inflation. This has been our reasoning since 2009. If we’d been sure that inflation was imminent, we would have used swaptions much more systematically than we have done, to get exposure to break-even inflation in a pure form. Financial repression is why we have made money on inflation-linked bonds so far; inflation remains the horse to come, and she is ready to gallop.
Why is inflation worth considering now? The answer is that the monetarists (who, bless them, have been wrong for 20 years) are soon to be right, too. One of the few economic theories which has stood the test of time is that money value will be determined by multiplying two things: the amount of money in the system, and its velocity (how often money changes hands).
After 2008, quantitative easing meant there was a lot of money around, but it went to those with no propensity to spend – much went into financial engineering, especially in the United States, where the market has, unsurprisingly, outperformed for a decade. ‘Financial engineering’ sounds like something on a crime sheet in the Stalin purges – and it is easily used for mischief. One of its manifestations – again largely in America – has been the share buyback: companies, whose profits may not be growing, buy back their shares from profits. Typically, they borrow cheaply to do so, while eschewing traditional investment in new plant and equipment, and often leaving themselves little or no buffer for hard times. ‘Same profit, fewer shares’ mimics a growth company at the level of earnings-per-share. It allows management to issue itself new shares, confident that more shares will be cancelled next year.
Senior managers have share options, shareholders a rising share price – but, the whey-faced trade union leaders might ask, what about the workers? That is exactly the right question for today. Falling profits, a re-energised workforce calling for its rights, a shortage of prosperity to start paying down debts – it all adds up, in our view, to a re-run of Britain and much of Europe in the 1970s. Here, the money isn’t enough to go round. As the old joke put it – ‘My weekly pay is ok, it’s just the week is too long to make it last’. When there’s not enough money, it’s either austerity, or more money is created. Last time round it was austerity, and up went asset values – this time, the authorities will strive to keep prosperity alive, and will, in so doing, create a great deal of money.
This is a world where it’s difficult to preserve the value of savings. The economic climate and the politics combine towards redistribution. A combination of gold and inflation-linked bonds are, in theory at least, exactly the right place to be. Yet these assets may grow to become tall poppies, prone to be cut down.
The challenge before us at Ruffer remains unchanged – to keep clients safe. Vigilance will be the watchword for this naughty world.
Notes: 1 Ruffer LLP, 31 May 2020, ruffer.co.uk/performance. 2 Bloomberg, 21 May 2020
The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment. The information is fact based and does not constitute investment research, investment advice or a personal recommendation, and should not be used as the basis for any investment decision. Ruffer LLP is authorised and regulated by the Financial Conduct Authority.