“If we begin with certainties, we will end in doubt. But if we begin with doubts and bear them patiently, we may end in certainty.”

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Francis Bacon

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Whilst it is Harold MacMillan who is most usually credited with coining the phrase “you’ve never had it so good”, he was actually borrowing the phrase from the US Democratic Party who had used the expression as a slogan during the 1952 US Presidential election.

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Looking back over the last 30 odd years it is a phrase that can, and should, be used to describe the Utopian investment environment that global investors enjoyed over this period because, quite literally, none of us have “ever had it that good” before! The period between 1990 and 2021 will likely go down in economic history as an aberration…a period where all the stars aligned to create such an abundance of wealth that a repeat of these quite extraordinary conditions is very unlikely to ever occur again…or certainly not in our lifetimes.

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But what were the factors that allowed for this “economic nirvana”, and why might many of the favourable factors that delivered this stunningly benign environment now face a more challenging outlook?

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The (very) brief answer is that the “tinder” for this powerful economic “fire” was provided by the very fortuitous combination of i) globalisation, together with ii) exceptionally rapid technological advances which together delivered an incredibly powerful deflationary tailwind to the global economy. The “fuel” which was added to this “economic fire” was provided by global central banks who, not only cut rates progressively to help meet their “inflation mandate” but then, when the asset bubbles they had helped pump duly imploded, rushed to cut rates even further to support asset prices. A 25-year period by central banks of “pumping and printing” finally (we hope) came to an end just over one year ago, but the structural and systemic damage done over that period, which led to countless excesses and capital misallocations, still represents a clear and present danger to the global economy and markets.

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In order to try and understand where we might now be heading (in economic/investment terms), it makes sense to try and understand where we came from and what the main factors behind this impressive economic growth story were. We must understand why many of these factors might no longer apply, or if they do, how their impact might change.

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Whilst many, understandably, focus on the fall of the Berlin Wall as being a major catalyst for creating the conditions required for globalisation to truly flourish, it would be very wrong, and economically remiss, to ignore the exceptional contribution provided by Deng Xiaoping, the paramount Leader of China between 1978 to 1989. Deng understood that for China to have any chance of delivering on the core principles of Communist beliefs, namely: “from each according to his ability, to each according to his needs”, they would have to open up to the outside world and bring down what was termed “the bamboo curtain”. It was Deng who gave hope to millions of Chinese citizens when he coined the phrase “to get rich is glorious”. We forget that so soon after Mao Zedong’s death in 1976, it was very dangerous for, and therefore very brave of Deng to engage openly with the West, given the suspicion and resentment that had been entrenched in the popular psyche for over a century.

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If Deng had not taken these risks, China’s economy is very unlikely to have grown at around 9% annually for the next four decades and about 800 million Chinese people would not have been lifted out of poverty. If the fall of the Berlin Wall in 1989 was the final catalyst for the launch of a truly global economy, the reforms that Deng introduced 10 years earlier, epitomised by his phare “Socialism with Chinese characteristics”, laid the all-important foundations for the deflationary tailwinds and consequent extraordinary economic growth that we have all benefited from over that period. Absent Deng’s reforms China would not have been allowed access to the WTO in 2001 and if that had not happened the global economy, and indeed the political landscape, would look very different today. That said, Deng’s legacy will forever be tarnished by his response to the Tiananmen Square protests, but the fact remains that his vision did absolutely change the world.

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If we talk in terms of “economic periods” or “regimes” then, in broad terms, we can break the post-war period into two main timeframes, namely i) 1945 to 1989 characterised by the confirmation of “American exceptionalism” and the elevated political tensions resulting from the Cold War, and ii) 1990 to 2021 characterised by “Globalisation” and the confirmation of China’s rise as a global economic power, but with lessened political tensions.

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Following on from Covid and the Russian invasion of Ukraine, it is reasonable to ask whether we are now perhaps undergoing another “regime change”, where a return to a more Cold-War/De-Globalisation period is emerging. Certainly, political tensions are inevitably much higher, countries now better understand the need to ensure secure and stable supply lines so “re-shoring” is gathering pace. The deflationary tailwinds provided by free and open markets are giving way to inflationary tailwinds provided by increasingly protectionist policies and a very benign interest rate environment is being replaced by tighter monetary conditions, all of which unsurprisingly is leading to increased polarisation between the two major global economic & military superpowers, one led by the USA, the other led by China.

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As countless empires, monarchies and nations have learnt over the last three millennia, military power grows from and relies on economic strength. For the last 80 years, if not longer, the US has been the undisputed global economic, and therefore military, powerhouse. That is indeed still the case and is not likely to change any time soon, but China’s rapid economic growth over the last 40 years means that they now increasingly have the economic wherewithal to challenge the US for economic & military supremacy. For sure this challenge will move at a slow pace, but the fact that the proverbial “gloves” are increasingly coming off means that the global investment outlook will inevitably be negatively impacted by this increased antagonism and polarisation.

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The charts below clearly show how China’s global trade reach has expanded over the last 15 years.

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Global markets and investors are now therefore facing a very different investment landscape than the one we all benefited from over the last 30 years. Many of the deflationary tailwinds which benefited investors, and which allowed central banks to lower rates dramatically, are now abating and in some cases turning into headwinds. Efforts to “re-shore” production, or at least move it to more politically friendly jurisdictions, are inherently inflationary, given that in most western economies weak demographics mean that labour is scarcer and therefore costs tend to be higher. Whilst it is true that automation/robotics can and will lower production costs, the benefits of these effects will take a long-time to play out.

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Even if, which is likely, headline inflation rates in the West do decline sharply, central banks have learnt, in a very painful way, that negative real interest rates and constant stimulus merely lead to greater capital misallocations. This in turn leads to greater market instability over the longer term, so investors need to reassess the prevailing view that central bank interventions during times of market stress are a certainty.

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In addition, further fiscal stimulus in the West is very unlikely given the very stretched finances facing most governments. A very clear and timely reminder of this can be seen with the current situation in the USA, where a stand-off between Republicans and Democrats over the debt ceiling, (which currently stands at US$31 Trillion), is beginning to concern global investors. The Republicans (reasonably if also very hypocritically) argue that the Democrats can’t just use the “Government Credit Card” to finance spending, and that spending cuts need to be agreed in order to ensure debt does not get out of control. It is more than likely that an agreement will be reached before the US actually defaults, but the point is that with debt levels (and interest payments thereon) set to rise sharply (as the graph below clearly shows), the room for any future fiscal stimulus to pump prime the economy becomes less and less likely.

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Source: Congressional Budget Office, The Budget and Economic Outlook: 2022 to 2023, May 2022

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The Germans (inevitably!) have a word to describe meaningful regime changes and/or the turning points in eras… Zeitenwende…

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We believe that word succinctly and accurately covers the events of the last 12 months.

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In our opinion, the economic, political and monetary conditions which prevailed for the last 25 years (which were truly extraordinary and unprecedented) either no longer apply, or if they do, their effect and impact are now severely reduced.

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How does the foregoing impact investors today and how, if at all, should investment strategies change to take into account what we believe to be the realities alluded to above?

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The first thing to point out is that the political, economic and monetary conditions referenced above were very conducive to passive investment strategies. It therefore follows that if investors accept the premise that the “investment landscape” has changed significantly, and not for the better, then continuing to allocate to passive investment strategies is unlikely to meet with the same success which they did until the end of 2021.

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Our base case is that central banks and governments, having learnt from their mistakes over the last 30 years, will resist the urge to bail out investors if/when markets do dislocate again, but that can certainly not be guaranteed. Given that the last 30 years saw economies becoming increasingly dependent on monetary and fiscal stimulus, it may be that politicians and central bankers, in extremis, feel obliged to step in, because to not step in might result in a systemic crisis.

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If this were to happen then it is likely that the currencies of the countries concerned would act as the  “pressure release valves” which allowed nominal valuations to be supported, but by engaging in this type of intervention, after such a prolonged period of monetary and fiscal excesses, it is very likely investors would recognise the highly inflationary nature of such intervention(s), and look to shelter in assets whose scarcity value stood in direct contrast to the liberal money printing being engaged in. In this scenario not just precious metals, but all commodities, would benefit from safe haven demand.

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Whilst at a nominal level, asset prices might well stabilise; the very real problem would be that this “stability” came at a very high long-term cost, namely currency devaluation. We believe that the number one priority of any investor or asset manager must be, at a minimum, to preserve real, long-term, purchasing power of your or your client’s assets. Effective management of currency allocations should therefore be central to all asset allocation decisions. Over the next 30 years, currency allocation will likely prove to be THE key decision guiding long-term portfolio performance.

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It has been said that there are two types of investment managers:

1. those that don’t know what’s going to happen, and
2. those that don’t know, that they don’t know, what’s going to happen.

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We have always tried to keep ourselves firmly in the former category. It is for this reason that we run unconstrained investment mandates because, by definition, if we don’t know what’s going to happen, why would we adopt a prescriptive mandate?

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We start from the premise that protecting capital comes first. Part of this process therefore means we only invest when we think that the odds of any given investment are in our favour. That may often require a subjective input but, to paraphrase Warren Buffet, it also means we don’t have to “swing at every pitch”. An unconstrained mandate provides that flexibility, a passive one does not. On the contrary, a passive investment means having to always invest “irrespective the odds”.

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In the type of (rare) regime which we have just come out of, where all the stars are uniquely aligned and central banks “have always got your back” then, maybe, a passive approach can be justified.

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If we are indeed in the early phases of a new global “regime” (and our best estimate is that we are), with all the attendant uncertainties that inevitably accompany these turning points, then we believe that an unconstrained mandate, predicated on preserving capital and growing wealth (in real terms), offers the greatest flexibility and potential to meet the challenges and exploit the opportunities which lie ahead.

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In our opinion, in this ‘Brave New World’ of significantly less fiscal and monetary stimulus allied to higher geo-political tensions & risks, the entities best structured to manage these risks and consequently profit from the opportunities which will present themselves are Family Offices.

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Whilst we may not be a Family Office, our investment ethos, philosophy and asset allocation decisions aligns very closely with that of a Family Office.

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The last 30 years were exceptionally kind to investors. We don’t expect the next 30 years to be anywhere near as obliging.

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As the man said: “When the facts change, we change our mind. What do you do?”

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CONTACT US

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For further information on any of our services, or if you would like to arrange a meeting with an investment manager to see how we can work with you, please get in touch.

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Disclaimer:

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We try to ensure that the information provided is correct, but we do not give any express or implied warranty as to its accuracy. We do not accept any liability for errors or omissions. The content of this brochure is for guidance purposes only and does not constitute financial or professional advice.

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Important information

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Shard Capital Partners LLP is a limited liability partnership, registered in England with registration number OC360394. Shard Capital Partners LLP Registered office: Floor 3, 36-38 Cornhill, London, EC3V 3NG. Shard Capital Partners LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom, reference number 538762.

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This document is provided for information purposes only and is intend for confidential and sole use by the recipient. It is not to be reproduced, copied or made available to others. The information set out in this document does not constitute investment advice or a personal recommendation. The views expressed in this document are not intended as an offer or a solicitation, to purchase or sell any security or other financial instrument, credit or lending product or to engage in any investment activity.

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Past performance is not a guide to future performance. It is important that you understand that with investments, your capital is at risk. The value of investments, as well as the income derived from them, can go down as well as up and investors may get back less than the original amount invested. It is your responsibility to ensure that you make an informed decision about whether to invest with us, based on your particular objectives. If you are still unsure if investing is right for you, please seek independent advice.

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The information and opinions expressed within this document are the views of (the company) and are based on information we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. Any information provided is given in good faith but is subject to change without notice.

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No liability is accepted whatsoever by (the company) or its employees and associated companies for any direct or consequential loss arising from this document.

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Disclaimer:

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This document is provided for information purposes only and is intend for confidential and sole use by the recipient. It is not to be reproduced, copied or made available to others. The information set out in this document does not constitute investment advice or a personal recommendation. The views expressed in this document are not intended as an offer or a solicitation, to purchase or sell any security or other financial instrument, credit or lending product or to engage in any investment activity.

‍

Past performance is not a guide to future performance. It is important that you understand that with investments, your capital is at risk. The value of investments, as well as the income derived from them, can go down as well as up and investors may get back less than the original amount invested. It is your responsibility to ensure that you make an informed decision about whether to invest with us, based on your particular objectives. If you are still unsure if investing is right for you, please seek independent advice.

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The information and opinions expressed within this document are the views of (the company) and are based on information we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. Any information provided is given in good faith but is subject to change without notice.

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No liability is accepted whatsoever by (the company) or its employees and associated companies for any direct or consequential loss arising from this document.

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