Transforming personal finance since 2011

#62 — What Now?


April 15th, 2020

By Andrew Craig

Reading time: ~ 18 minutes

I wanted to take a moment today to pen some of my thoughts about what is going on - as it relates to finance and investment specifically.

To be clear - the fact that what follows is only concerned about the economy, financial markets and investment is not meant in any way to trivialise or belittle the far more human suffering that many people are having to endure as a result of this coronavirus crisis - it is just that this is not the place for that subject matter.

My articles are about economics and finance and so that is where I will continue to place my focus. I will leave a broader discussion of the situation to journalists, politicians and scientists. Although I will say that I hope very much that the last of those three groups get the most attention in the weeks and months ahead!

Many people are incredibly stressed about the current situation and about what may or may not happen to their jobs, to the economy, financial markets and to their financial future as a result. This is entirely understandable given what is going on.

Those stress levels are being further compounded by a predictably noisy crowd of "I told you so" doomsday commentators, nearly all of whom have been saying there would be a "massive crash" for years and can barely conceal their glee that they're finally "right".

This puts me in mind of the excellent line that city traders use about how...

"…even a stopped clock tells the time correctly twice a day..."

Or, as Paul Samuelson, the first American to win the Nobel Prize for Economics, used to joke about stock market commentators:

"They have correctly predicted nine of the past five recessions..."

I find these people particularly distasteful and moronic - mainly because of how much damage they do to people's actual ability to build wealth. It is so depressing how these perennially bearish folks get so much airtime the one year in ten that they're "right", given the untold damage they do to their audience's ability to get rich for the other nine years when they are so comprehensively wrong!

They are the most awful examples of "you only sing when you're winning" but they get a tonne of airtime because the mainstream press has no interest in "boring" stories about how relatively easy it is to build wealth slowly and surely by investing in financial markets most of the time. Sadly, the press are far more interested in "gurus" shrieking about how dreadful everything is. More's the pity. This is quite literally tragic for millions of people who pay attention to this nonsense...

It is very easy to find people at the moment who will tell you that this is "the big one". The sky is going to fall down. The whole system is going to change. Everyone is going to get screwed. Fire. Brimstone. The four horsemen of the apocalypse etc... etc...

...and what I want to do is tell you that I firmly believe that they are fundamentally wrong. The thing that informs my belief is actually relatively easy to understand:

Humanity has a multi-century track record of making incredible progress…

Back in February, I wrote a piece about the biotech industry in which I highlighted the existence of a thing called "Moore's Law" - and the fact that it has been described as:

"...the most important graph in human history."

This point is so important that I will repeat what I said in that article: Moore’s law is the basic idea that processing power per dollar or pound spent doubles every 18 months. Amazingly, this has been happening more than 120 years (this really is utterly astonishing when you think about it).

Moore's law is the underlying driver for literally all of our technological progress and a large chunk of our societal progress as a result. It has been with us for more than a century as I say and most tech’ experts believe that it is highly likely to continue and possibly even accelerate given the advent of things like quantum computing.

Those of us who are invested in this progress will more than likely be far better off than those who are not – as has been the case, more or less, for roughly two centuries since financial markets were invented.

The “end of money” and coming hyperinflation?

One of the main things that the doomsday brigade is shrieking about at the moment is the fact that governments all over the world have just decided to invent vast quantities of money out of thin air (again).

This is true and this is happening. Most readers will be fully aware that governments all over the world have announced trillions worth of support for the hundreds of millions of their citizens at real economic threat from the coronavirus situation.

…but I would argue that anyone who thinks this is bearish (negative) for stock-markets quite clearly doesn’t understand what they’re talking about (in nominal terms at least). The reason for this can be explained in two words:

Relative scarcity…

Governments the world over are inventing trillions of new “currency units” and taking on vastly more debt – whether this be in dollars, pounds, euros, yen or lots else besides.

The supply of fiat currency has been exploding upwards for many years, for sure. This was one of the key themes in my book. The current situation means that this is now going to accelerate even further – and in a big way. Lots of talking heads are screaming “sell” because of this news. I’d say that the correct reaction is very likely to be precisely the opposite – in the medium to long term at least.

"Infinite" money chasing "finite" goods, services and companies

Let us look at the supply and demand dynamics here. As I said in my book – imagine there is a fixed supply of actual, tangible “stuff” in the world (crops, metals, oil & gas, concrete) today and “x” amount of currency units (i.e. dollars, pounds, euros etc…). Now imagine if the money-printing actions of governments lead to there being twice as many “currency units”.

All that this does is double the price of the stuff. If there is twice as much money chasing the same quantity of goods (and services), those goods and services will double in price, all other things being equal. It isn’t quite as simple as that, not least given that such things take time (which is why inflation lags money-printing) – but, broadly, this is what happens. We have centuries of evidence for this real-world outcome.

Now let us think about “stuff” in terms of “quality companies”, rather than crops or concrete. It should perhaps be obvious that the companies that produce all this “stuff” and do lots else besides, will experience the same doubling in their price as the stuff does – again, all other things being equal.

One of the biggest themes of the last ten years has been that the world’s most important stock-market – the S&P 500, went from 666 to just shy of 3,400 – before the recent pull back that was catalysed by the coronavirus situation. Even now – it is trading not far off 2,800 – i.e. still up by more than 300% in the last decade (in dollar terms of course. So an even better outcome for British investors in terms of pounds by the way).

There are plenty of reasons for this – but I would argue that one of the main drivers has been, quite simply that there are vastly more “currency units” in the world today than there were before. That is what I mean by “relative scarcity”. There are trillions more dollars in the world. There are still only 500 companies in the S&P 500 and a few more than 1,600 in the MSCI World. That is to say that companies are “relatively scarce” things as against dollars (or any other major currency for that matter).

I think this theme is going to run and run. In fact, I think that there are plenty of other related structural reasons for the continued relative performance of stock markets in REAL terms (i.e. after accounting for REAL inflation).

I have written about this a fair bit in the past, but money printing and the creation of vast quantities of debt is what gives us artificially low interest rates. When this is the case – i.e. interest rates (bond yields) are extremely low, the vast majority of retired people are essentially forced to own a higher percentage of “higher return” equities. I wrote the article I linked to above in June 2017. In it I said:

“In 1987 – if you had managed to build a pension pot of, say, £500,000 by the time you retired, with interest rates at around 10% - you could just sit on that pension pot earning about £50,000 a year – i.e. more than likely enough income to live on for the rest of your life. Today – with annuity rates at more like 3% - that £500,000 pot will only pay you about £15,000 a year of income – nowhere near enough to live on.

Millions of baby-boomers now at or near retirement just don’t have enough to live on if they are only able to make returns of 3% (or even less). For many of these people – and for the financial advisers and investment funds they use – the answer has been to chase higher returns by investing in the stock market – that is to say shares rather than bonds.”

Of course – interest rates are now more like 1% than the 3% I mentioned in that article – so this phenomenon is now even more pronounced and that retiree could only hope for £5,000 a year of income in today's environment!

Citing the Wilson Towers Watson Global Pension Assets Study, a splendid ex-colleague and mentor of mine, Mark Clubb (managing director of the investment company Team Asset Management), has estimated that pension systems in developed countries alone probably need to buy more than $2 trillion of equities in the relatively near future – broadly as a result of the point I’m making here about interest rates. As Mark has written:

“…the “baby boomers” are retiring and that demographic is weighty for the next decade or so. That means more buyers than sellers (Ed. Of equities). This could be building the next bull market… Forget what is happening right now. It is about what will happen over the next five to ten years.”

I would argue that he, and others, probably made those estimates before the coronavirus-inspired “emergency” interest rate cuts of the last few weeks. In reality, demand will likely need to be significantly more than that $2 trillion. The Wall Street Journal had a recent headline about how $47.4 billion was pulled out of global equity funds the first three weeks of March. A few weeks before that, the FT ran the headline: "Global equity outflows hit $23bn on coronavirus fears". Those both seem like big, scary numbers until you consider that, if the longer term estimate of $2 trillion of inflows is correct - that is around 40 - 80x bigger than the numbers quoted in those headlines.

But the market is going to “tank” from here! Some “guru” told me!

“The market” (S&P500 / FTSE 100 etc…) could well go down a lot more from here in the short to medium term, but there are any number of reasons why you should consider this possibility fundamentally irrelevant to how you invest and ignore it altogether!

Anyone who has followed my output for any length of time will understand by now that if you invest regularly each month in the right mix of assets, crashes really need not matter. Even big ones.

Thinking like this is the difference between INVESTING and TRADING. For most people, this is a really key point of differentiation and really important for your ability to become wealthy and, perhaps even more important, stay happy, dare I say even relatively relaxed, at times like these.

Anyone who reacts to what is going on at the moment and to times like this more generally, and who then decides to take all of their money out of the market, for example, is no longer investing. They are trading. Investing is something you do every month, without fail, for your whole life. It is best done on auto-pilot and entirely dispassionately. If you use the right approach and the right mix of assets, then you really can and should just completely ignore the news. The better you are at doing this (ignoring the news), the more likely you are to enjoy real success with your investments and build significant wealth over time.

The more you listen to the bleating of self-proclaimed financial gurus and trading “experts”, the more likely you are to make mistakes that will significantly reduce the likelihood you get wealthy.

The reason for this is actually pretty simple: It is all about human psychology. Imagine you panic and go to cash right now. In that scenario, I would ask you two questions:

  1. What will you do if you end up being wrong? What if you sell now and then the market bounces heavily and goes away from you (something that has happened to many, many people in the last month for example)? Now that the market is, say, 20% above where you cashed out, will you ever have the mental fortitude to get back in, or will human nature and your innate psychological biases mean that you continue to wait for the market to “come back to you”? When this never happens, you will just have to lick your wounds as you get decimated by inflation in the years ahead and miss out on decades of potential upside.
  2. Even if you ARE right and the market “tanks” from here - at what level will you get back in? How and why? Will you just end up in cash forever as never sure if the market is going to fall further or bounce from here with the same, extremely sub-optimal, result?

This is precisely why I describe this sort of activity as TRADING, not as INVESTING – because the minute you do it, you better have a keenly developed methodology and set of rules for what happens next. You need a properly detailed answer to both of the questions above if you're going to try to time the market in any way. The vast majority of people who do this do not have such rules, which invariably leads to disastrous results.
It is for this reason that any attempt to time the market like this is absolutely a mug's game for nearly everyone.

So, what now then?

I would suggest that in an environment of massive monetary stimulus, you will be well served by owning and investing in things that are going to become increasingly relatively scarce as money becomes increasingly relatively abundant.

To me, these would include some of the best companies in the world – of which there are only a few thousand listed on stock markets that you can buy, and gold – of which there has only been the equivalent of two Olympic swimming pools ever mined in history.

To be honest, this isn’t much different to anything I’ve been saying for not far off ten years now. What I would say is that it has quite possibly never been more important to do this. The key thing about massive monetary stimulus is that it devalues the currencies that it comes in, relative to everything else. This is why it is so dangerous to sit on the side-lines and to be uninvested.

Nominal vs. Real

The S&P 500 may well end up powering through 5,000 and beyond at some point in the next decade - a great result in "nominal" terms. The problem is that by then a pint will likely cost a tenner, the average British house will be “worth” more than a million pounds and £100,000 will be a pretty mediocre salary. If you think that this sounds insane, then you should have a look at what pints, houses and salaries were in 1995, 1985 and 1975 perhaps. You will quickly see that I’m perhaps not quite as mad as I may first appear.

The point here is that one of the only ways you will be able to preserve and grow your wealth in real (i.e. properly inflation adjusted) terms, given what is going on, is by owning those scarce assets. Everyone else will get absolutely taken to the cleaners.

To a great extent, this is what has already been happening for the last fifty years or so. It was one of the key issues I addressed in my book. One of the crazy ironies of politics and economics that "not one man in a million" understands (to quote JM Keynes) is that the more governments hand out, actually the more relative wealth goes to elites - due to how those hand-outs impact the bond market, interest rates and equity valuations. This is one of the great tragedies of our time if you ask me - but if you "can't beat them", you really better join them.

But what if the whole system “collapses”?

There are plenty of voices out there at the moment suggesting that the whole “system” is going to “collapse”. These opinions are particularly prevalent in the crypto community, where believers in bitcoin are convinced that it simply must replace the US dollar and other fiat currencies given what is happening.

A collapse or systemic change may or may not happen. There is actually quite a lot of evidence from history that monetary systems tend not to last for much more than about half a century. Astonishingly enough, it is also true that every single fiat currency in history has gone to zero, eventually. The only exceptions are today’s crop of currencies with which we are all familiar. On which basis – the current monetary system’s days could indeed be short-dated. Who knows?

What I would say about this, however, is that if there is some kind of monetary collapse or systemic change, it is even MORE important that you are invested – i.e. that you have legal ownership of stock-markets and gold. Even if there is some huge systemic change or reset in how the world uses money, I would suggest that companies that do things and make things will retain a significant chunk of their real-world value through that change – far better than pretty much everything else at least – and cash in particular – particularly any “cash” that doesn’t survive into that new system, obviously.

As long as some kind of legal title endures in our culture, you will be better off as one of the all too small minority of people who actually own shares as against everyone else who will get killed in cash – the value of which may have gone to zero, or not far off zero.

Science fiction time?

I would also say that if legal title does not endure, financial markets will very likely be the last thing you will care about because the world will have descended into the kind of awful dystopic future so beloved of science fiction films. In that scenario you better hope that you own a big rural ranch somewhere like Argentina, or perhaps Montenegro or Croatia, with a tonne of arable land, livestock, perhaps a decent sized lake or river stocked with fish and lots of guns and ammo. And you best invest in one of those wilderness survival courses at some point in the near future and learn how to skin a rabbit.

My view is that this kind of scenario is highly unlikely, however. I say this based purely on the corroborating evidence of history: Because, quite simply, the pessimists have been wrong for centuries. I think Moore’s law and the incredible, uplifting and continuing progress it implies for humanity as a whole is the primary reason for this and it isn’t going anywhere.

Ultimately, money and financial markets are just philosophical constructs that we use in an attempt to ascribe economic value based, broadly, on merit (effort and innovation in the main). They aren’t perfect but they’re the best system we have yet managed to develop. As Professor Niall Ferguson explained in his fantastic book (and TV series), “The Ascent of Money”, they have been one of the most fundamental pillars of human progress as a whole. Without the “killer apps” of the bond and stock markets, humans would not have been able to pool capital, specialise and achieve any of the incredible elements of modernity that we take for granted and that make our lives so fundamentally better than they were for every previous age of man.

Longer term - I don’t think that the current coronavirus situation is going to change any of that in any massively fundamental way – even if certain financial markets continue to crash or there is some kind of systemic change to our monetary system. Moore’s law and human progress will be vastly more important for our futures than whether we’re using dollars, gold, bitcoin or even something entirely new that we don’t have a word for yet – to ascribe economic value across our culture.

In the meantime, now is not the time to sell and it is not the time to panic, no matter how horrible this global pandemic may or may not be. A far better idea is to work out the right mix of assets for you based on your age. Get your affairs nicely set up to invest by direct debit each and every month and then completely and utterly ignore the news. Truly...