1/26/20

None of the following is investment advice.

There’s a massive depression today. All the symptoms are there, except that markets are rising with every passing day. Why? Monetary and Fiscal innovations – lowering taxes/interest rates, and providing infinite liquidity. The question now becomes, is this a good thing? The brain capitulates; nobody can answer such rhetoric.

More rhetoric – if these monetary and fiscal innovations were introduced in the 1930’s, we wouldn’t have had a Great Depression. People wouldn’t have lost everything. The greatest generation wouldn’t have watched their parents eating cat food to survive. A million things would and would not have happened. But if those innovations were introduced, what would today’s world look like? Would the world be better or worse off? Nobody can answer that, either.

Long story short, these financial innovations are unnatural and will have unbelievable ramifications on every part of the world forever. Pandora’s box has been opened, and a couple things stand out.

Irrationalities abound – it is no longer possible to successfully short sell any market (with the exception of currencies). To do so would mean that not only do you profit, but you outperform longs. This is no longer possible. It does not pay to do anything but buy productive assets. For about 6 months, I have been telling anyone I can this new-age axiom – only buy productive assets. Do nothing else with your money. No cash. No speculation. No negative-yielding bonds. This is not advice, but just what I’m doing with my own money. I also must say that shorting debt to give yourself leverage should yield good results, given that rates are paltry.

Is what I’m describing irrational behavior? YES. But that’s okay, because that irrationality pales in comparison to the irrationality behind monetary and fiscal policies today. The irrationalities of today – Gamestop, Hertz, AMC, Bitcoin, SPACs, leveraged loans, these irrationalities are foreign, but they are NECESSARY. Governments around the world have decided for us that they prefer for assets to rise in value, rather than drop like they did during the 1930s.

It is what it is.

Because things can only rise in value in the midst of these policies, we will continue to see things that are unnatural and irrational, but that is by design. Let me reiterate – this is the path our governments chose. So stick with a strategy and don’t worry about these unusual things going on. Because the policies themselves are most unusual.

The biggest losers will be those that either avoid participating or cannot participate. If you think we are in a bubble, you are right, but that’s exactly the point. Governments can create whatever bubbles they want using currencies. Get with it or lose out.

So many people think the government mistakenly grew a deficit and that they intend to fix it. I have never heard or read any government reports to acquiesce this intent. In fact, the government seems to be purposely growing the deficit, because it spurs more innovation and growth at any cost. And it’s working. As long as we keep growing, the deficit will too, and I’m hip to it. Meanwhile, any new USD prints will be absorbed by the rest of the world, as USD is the reserve currency and constitutes 75% of all global transactions. All of this is good news, but know that the deficit is not going away; it will likely expand as long as people still use USD.

It’s the best time in history to be rich. These deficits both fund innovation and inflate all assets as a byproduct. It works and I won’t be the one to fight funding innovation.

This means that shorting the dollar is probably reasonable, but interestingly dollar-denominated debt cannot be a catalyst for a downturn. There, I said it. For the reason, look no further than pages 142-145 in George Soros’ seminal playbook, “The Alchemy of Finance” While Soros (c. August 1985) predicted exactly what most doomsayers predict today, he and they were and are… Wrong. Soros did give a wonderful description of the savings and loan crisis that is timeless – debt doesn’t matter if banks’ bad loans can be papered over with both time and new loans. In that sense, Soros described banking as a Ponzi scheme, and he’s not wrong in that.

The conclusion is that darwinism will have more of a place from here, since the standard of living under innovative policies has risen instead of dropped. This is the depression – people without assets are being left behind no matter what they do from here.

During the 1930’s maelstrom, there seemed to be the sense that the world was together in fighting for a brighter day, but today, the brighter day is already shining on the rich.

It is what it is.

For years, I have considered innovations in my industry.

I believe that the Hedge Fund dynamic has the most appeal and puts everyone on the same side of the table. I believe that RIA’s are mostly dead, because the incentives are totally irrational. Having owned and operated an RIA for more than 3 years, I don’t understand the future of RIA’s outside of being a sales company. The dynamic does not incentivize the client or the advisor.

Namely, RIA’s:

1. Do not remove emotional bias – I can’t tell you how often I get calls from clients nervous about portfolios. Many readers of this will think that they should be allowed to, but why shouldn’t we try to solve that? Why should clients go through that pain?
2. Do not have flexibility. In the future, if you find a great investment, but it’s against the mandate for certain clients, isn’t it a conflict of interest to buy that investment for some clients if it has a high likelihood of making them money? I already find situations like these – where some clients can have half the gains of other clients and wonder why.
3. Do not allow for Concentrated positions due to visibility. Concentration allows for much higher risk-adjusted returns. This is how the vast majority of all wealth is created – concentration. I find myself handcuffed on almost a daily basis by the thought that if I buy a large investment for someone, he or she will become emotionally difficult and obsessive about it. Of course that’s true of concentrated positions – so I believe in order to have them, there needs to be trust in the advisor and a removal of all emotion from the investment.
4. Do not support a proper fee structure. Today’s RIAs are built for index investing. 1% AUM fee makes some prospective clients scoff, since Vanguard and Blackrock charge virtually 0%. The client isn’t incentivized to go with that index-advisor. So in order to make it up, index-advisors do a dog and pony show* that I’m not comfortable with. But if you are outperforming by 10% per year, a 1% fee is nothing. But then if the advisor isn’t a salesman, maybe he never gets enough AUM to make the day-to-day stress of outperforming worth it. Buffett began his empire with only $100,000 and never solicited business thereafter – people came to him. But then again, Buffett took 30% of all profits.
5. Do not encourage mental growth of the advisor. For all the above reasons, RIA’s are a hustle where the salesman is better off than the investor. To me, salesmen are commodities, but investors are rare. Investing well is an honest art form. There is so much truth in it. To give up and become a salesman is the death of one’s soul.

*By dog and pony show, I mean that they advise on taxes, insurance, estate planning, cash flow planning and all these other things. Those things are important, but there is an enormous conflict if you are a financial advisor doing these things that index invests, charging 1% behind the scenes. The conflict is that you appear to want to save clients money by paying less taxes and fees elsewhere, but if that were true, you would suggest the client just buy index funds from Vanguard and Blackstone. If you advise on estates and taxes, you should charge a fee for those things. Plenty of people do, but that isn’t my game, and it will never be.

Maybe I’m naïve..

Hedge funds don’t attempt to do anything but invest professionally. I think more clients need that transparency. I couldn’t live with myself if I was paid to index invest and run a bunch of meetings all day, but many people love doing that. Many people love providing non-investment advice and do so for billions of clients, but I don’t understand how that is a sustainable business model.

3 years ago, coming out of Merrill Lynch, I thought it was. Since then, I have been trying to find a path to get clients the best service possible. It hasn’t been easy, and it’s required me to experience significant pain and ultimately no social life.

I envy the advisors that aren’t compelled to run like I do.

A quick anecdote – since July, I have had an outsize position in Intel. After many ups and downs, a beleaguered client with about 5000 shares called me when Intel hit $52 in the first week of 2021. Although I believed (and still do) that Intel has great upside, he instructed me to sell. Not because I overreached an investment mandate, but because he was losing sleep over it. Perhaps I should have done a better job explaining the position, but is that my job? To continually explain to clients each investment I make? If that’s true, that’s an even bigger conflict of interest, because I will never want to invest in things that are beaten down.

How often will this happen in the future? It kills me when I have sold for illogical emotional reasons, especially if the emotions aren’t my own.

Okay, you get it.

Let’s wrap up with a few more market ideas.

Emerging markets? Too hard pile. I’m mostly steering clear because EM is out of my circle of competence at this time.

As it relates to China, Soros had this to say in his aforementioned playbook: “In the 1970s, Japan followed a policy of keeping the value of the yen high, creating a high hurdle that exporters had to pass in order to export profitably. The policy was very successful in favoring the industries in which Japan had the greatest competitive advantage and in discouraging the older, less profitable exports.”

I’ll let you form your own conclusions….

My thesis on SPACs and Mergers has come around 180 degrees after capitulation. These are simply new innovations. Mergermania is probably a good thing for a recovering economy. With the emphasis on gains and returns of capital to the would-be buyers, productivity should improve, all else equal. Good news is that the layoffs and unemployment we have seen and will continue to see means that upticks in such productivity and market capacity (TAM) should go straight to the bottom line.

These can be overdone, but, like most other things today, I think they are simply two other irrationalities revolving around the irrational government policies.

I will begin studying for the last iteration of the CFA in late February. This may distract from my focus, but I don’t anticipate that it will.