Lockhart Capital – Q3 2020

Bide “n” Time?


We do not invest in a vacuum, there is always a context, and with it a direction of travel.  As our clients know, we tend to view this context through the prism of socioeconomics and the ebb and flow of the political scene.

For a couple of decades our opinion has been that the momentum, if not necessarily an inevitability, was towards larger government, larger deficits, higher taxes, lower rates of trend growth, and debased currencies.  Some of this was baked into the pie early, due to negative demographics and unfunded future liabilities, with the, not unrelated, encouragement of electorates who tended to ask for more services than for which they were willing to pay.  With standards of living, previously reliably improving but coming under pressure, the way to bet was on a level of political change if not social unrest.

This direction of travel has been somewhat independent of political left or right, but arguably positive for the more interventionist or authoritarian end of both.  The “losers” perhaps being the fiscal conservatives, and more classical liberals.

To be sure, nothing happens in a straight line, but the general direction has, we believe, been maintained.  This can be challenged with the evidence from 2016, President Trump, even Boris Johnson and the last UK General election, but the counter is that these are either just bumps on the same road, or that actually some of the general tendencies we described are even then still apparent.

That is, one may easily suggest that President Trump is at least somewhat authoritarian, and prone to economic protectionism.  In the UK, the Conservative party has hardly been Libertarian or pro small government in recent years.  Jeremy Warner writing in the Daily Telegraph last week, remarked on recent shifts from the Tory government towards “State activism, or what used to be known as Socialism”.

Increasing bureaucracy tends to a more politicised system, and more politicised systems tend to greater levels of inequality.  Depending which side is in power, the generalisation is that either the rich get powerful or the powerful get rich, both then better able to avoid higher taxation and regulation, than the average person.

This trend has, as discussed in previous pieces, also facilitated “Corporatism”, seen in regulatory capture and higher barriers to entry (for budding entrepreneurs).  The ever-diminishing number of start-ups in the Western world is testament to these forces.  A point of note in our own industry is the lobbying power of Blackrock and Vanguard, for instance. Not to say that it is good or bad, rather that it is there.  One could suggest that there is also arguably rather more overlap between the top corporate echelons and the political and cultural elite than is necessarily healthy, a top 3% if you will.

In any event, we suggest that a collectivist mind-set, in the broadest sense, had and still has momentum, and irrespective of whether one believes that it is consistently prevailing at the ballot box.  It has been the free market liberals who have been less coherent or successful in articulating, promoting, and defending their creed, within public discourse.

The point is that what is true of both socialist and corporatist variants, is that they are capable of resulting in regulated monopolies, either explicitly or implicitly, and certainly the oligopolies that perhaps we see today (see Fig. 1.).  Commentators tend to focus on that x-axis of left and right more than the y-axis of authoritarian and libertarian, and we feel that this might be a mistake in analysing the world.

Fig. 1.

G.K. Chesterton wrote of a “centralised, impersonal and monotonous” society, whether under Capitalism or Socialism, both of which he felt had too much control over ordinary people’s lives.  His love of paradox – “too much capitalism means too few capitalists” – might confuse, but he had great sympathy for the common man.

Chesterton was an early, if brief, member of the Fabian Society, but remarked that humanity was forever disappointing progressives: “it is rather as if a nurse had tried a rather bitter food for some years on a baby, and on discovering that it was not suitable, should not throw away the food and ask for a new food, but throw the baby out of window, and ask for a new baby”.

He was equally dismissive of those who “seemed to know almost by osmosis what people at large wanted, without actually consulting them.”  This detour to the early 20th century is to suggest that history does rhyme if not repeat, or at least that human nature rarely changes.  The excesses of today are arguably on the left, but mirroring those of the right in the 1950s, during McCarthyism.

Global businesses have tasted the direction of the wind and, having no desire to get caught up in current “Cancel Culture”, have rather self-importantly trumpeted their “values” and made disingenuous “this is not who we are”-type statements, even when simply a widget maker for garage opening mechanisms (or whatever)!

The irony is that they have probably helped to create problems for social justice when offshoring jobs, supply chains and industries, while going to the legal limit to minimise their tax liabilities.  The extraordinary ratio of CEO to average employee salary, has had consequences for both blue and then white-collar workers, while the process of adding to corporate debt to buy back shares, only to then distribute these via share options to the same senior executives, has created little shareholder value.

This has also led to some interesting juxtapositions, such as for Henry Ford III.  The Ford Motor Company derives huge revenue from selling patrol cars to the US police, in which it has 65% market share, while at the same time the Ford Foundation donates millions to the “Defund the Police” movement.

So, we do not believe that economies are as vibrant or investment opportunities as compelling, as they might have been, due in part to this overall “direction of travel”.  Nevertheless, we do not cut off our nose to spite our face and of course invest accordingly.

Fig. 2. Price of Gold in USD – 1933 vs 2020

Just two quick examples.  Our exposure to gold is partially predicated upon the current and future debasement of fiat* currencies (see Fig. 2.), and the likely inflationary outcomes of deficit spending and monetization.  Equally, corporatism and the tough environment for small and mid-sized businesses, while disappointing, does mean that we are satisfied with our basic global market capitalisation approach to the core of our portfolios.  This is also supported by our original interpretation of the impact of the marginal investor being passively orientated, which also favours larger companies, and those with momentum.  So much for prices being information.

The additional driver here is that of activist central banks and their extraordinary monetary policies, post the 2008/9 crisis.  So-called Financial Repression has been a disaster for savers, but a boon for investors as inflation is nowhere but in asset prices.  One could and should look to benefit from this (and we did), while still being critical of the wider impact, especially upon those who don’t tend to own assets in the first place, and instead live with an anaemic economic recovery and low rates of wage inflation.

Supressed interest rates also lead to a misallocation of capital and the survival of “zombie” firms.  Nearly 30% of US listed stocks have reported losses for three consecutive years, and nearly 20% are zombies (can at best cover the interest on their debt, but with no real hope of repaying the principal).  “Creative destruction” has been delayed, but only delayed, and with other consequent costs.

This has resulted in lower rates of productivity and hence becalmed standards of living.  That also means a stagnant economic environment and the circular proposition whereby, yes, it is appropriate for interest rates to be “lower for longer”, and where secular growth stocks are prized above all others, and continually so. Hence, stick with the trends and beware angry voters.

Therefore, again, the winners take almost all and the “global market cap” approach to investing continues to make great sense.  So, we are at ease with our original thesis and still believe that the dominance of passive investors and algorithmic trading in “thin” markets, results in trending.  Also, that there would be periodic bouts of extreme volatility that would need to be sensibly managed and understood.

We often state that “culture trumps everything”, and there has been an apparent cultural wave within the recent protests; an almost religious awakening, acquiring social media “likes” from the enlightened as modern day saints’ bones, assuaging one’s sins.  This has emerged from the chrysalis formed by the “social experiment” of lockdown.

Valid questions exist over US police training and tactics, lack of independent oversight, reform of qualified immunity, rates of incarceration and so on.  However, also, surely, over the level of inequality in a country as rich as the US, be it inequality of wealth, education, or access to healthcare.

The dynamic of the protests though, seems to have been almost hijacked, by an element of society perhaps desirous of moral purpose amid the thrill of forced conformity.  This echoes what, in the 1960s, the political theorist Herbert Marcuse described as tolerance via intolerance.  Everything is now viewed as literal and there can be no context.   At first blush, this seems likely to create a polarised society rather than a more empathetic one.

*Fiat money is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it as is the case for commodity money. Most modern paper currencies are flat currencies, including the U.S. dollar, the Euro, the GBP, and other major global currencies.

Political commentator Andrew Sullivan calls this cultural shift the “new orthodoxy”, and essayist Wesley Yang describes it as the “successor to liberalism”, though it is somewhat worrying that any disagreement from the agenda is seen as an act of “violence” (upon an oppressed group).  In this way, “moral clarity” requires there to be no need for objectivity, or to see all sides of a story, when just the “correct one” will do.  Sullivan points out that this may have moral clarity, but it lacks moral complexity.

This new orthodoxy, should be taken seriously, for what it is and what it may portend, even if in a moment of bathos, Douglas Murray writing in The Spectator, suggested that no one wants “to be seen by the woke eye of Sauron”.

Our point here though is this episode does fit with our suggested socio-political direction of travel, and probably puts further weight on the scales when assessing how far down the Modern Monetary Theory path we are likely to go.  This is because we believe that governments will have to do more to placate activists and their electorates at large, who either feel some sense of injustice, or at least that they have been missing out  – Wall Street vs Main Street. This is going to manifest itself, we believe, in further deficit spending (see Fig. 3.), with the Covid response a co-conspirator, if not a helpful fig-leaf.

Fig. 3.

This is critically important to investors.  For example, Dylan Grice, the former Société General investment strategist states that if “MMT” ( defined by Mike Green at Logica Advisors as “abandoning the pretence that we actually need to pay for things” ) is the future then “be bullish of risk assets”, irrespective of current valuations and the dire state of the economy.  Traditional investment techniques and portfolio construction may not cut it.

The bottom line is that we believe that our original thesis has been more or less correct, by some mix of luck and judgement, and that the new variable here is simply time, in that consequences and outcomes will now occur more quickly and to a larger extent.  So, yes, we are more convinced than ever that, for example, there will be huge infrastructure spending, globally, that the pressure valve for imbalances will be fiat currencies, and so on.

Consequences to recent events are already unfolding.  New York City kicked off by cutting its police budget by an initial 16% and dismantling its 600-strong plain clothes division, and, coincidentally or otherwise, homicides are now at a five year high, and part of the bloodiest June for twenty five years – a repeat of “The Ferguson Effect”? (as coined by St Louis police chief Dotson in 2014).  Ironically, fatal police shootings had been at an all-time low (latest data, 2018).  The New York Post reports that the number of police applying for retirement was last week up 400% (year on year).  In Chicago, FedEx is now refusing to deliver to some areas.

A surely related outcome of both Covid and this social unrest is that there appears to be an acceleration in the post 2015 trend of movement away from cities (and offices) and into suburbs, itself a reversal of the previously dominant trend.  A week after the Minneapolis protests and riots, fully 20% of houses for sale listings had appeared in those previous seven days.  Will this trend last or dissipate? This is an important question for us as investors in real estate, and as we watch New York rents and sale prices decline. This also has significant implications for city budgets – no one wants to see a re-run of the early 1970s, you would think.

We have been running a low exposure to Real Estate, and, despite its attractive inflation-hedging qualities, we have been in no hurry top this up.  That is not to say that cell-phone towers and logistics warehouses are unattractive, on the contrary they are, but City centres, and both retail and office premises, are riskier propositions today.

Historically-speaking, spasms in culture wars have tended to fade, unless co-opted by a demagogic leader (e.g. some of the most infamous characters of the past), though can indeed change cultural and societal conventions without necessarily needing to seize political power. So, what you cannot have at the ballot box you can sometimes take by simple assertion, via street-level action and with de facto institutional approval.

Now, it is crucial for us as investors, and minority shareholders, that freedom of speech still exists, and a free press and independent judiciary.  This has been our major concern with China’s direction of travel of recent years.  Whether the “sovereignty” of the individual is really under threat from populist identity politics or “generational warfare” is a debate that can be had, but free markets and fair governance are potentially getting squeezed, we feel, and on a global basis.  Squeezed that is, between the populist left and the populist right, with the latter perhaps exemplified by Viktor Orban in Hungary, and the “illiberal democracy” model.

The November elections in the US are coming into view, and the Democrats would like a referendum on President Trump – which they may well get – as opposed to a binary choice between Trump and Biden, in which the President would have at least a slugger’s chance, especially with head to head debates.  Coincidentally or not, we note that social unrest does seem to reliably chime with the electoral cycle.

In 2016 a huge factor was people voting against Hillary, or at least Democrats not being enthused enough to turn up and vote for her in key States.  This time around an anti-Trump vote will be powerful, although somewhat irrelevant in the coastal states that are already strongly blue.  More concerning for the President will be whether enough suburban women in swing states are sufficiently enthused to “turn up” for him, in a parallel to that 2016 narrative, and this is currently in some doubt, unless it really becomes a law and order election.

Fig. 4.

In terms of the economy, simply vast numbers abound (see Fig. 4.).  The Bank of England suggested that the hit to the economy from the virus will be less severe than feared, but then proceeded to slip another £100bn into its QE programme.  Investors, possibly quite rightly, take the view that the worse the economic prospects, the greater the chance of more monetary and fiscal stimulus, and have been buying dips, most consistently in Technology companies.

Central banks are proactive these days, rather than re-active, and this creates its own dangers.  The Bank of England appears to be buying gilts faster than the Treasury can issue them, which must surely meet most definitions of “debt monetization”. Meanwhile, on the fiscal front the US may well create another stimulus bill this month, and Rishi Sunak still tinkers away in the UK.

It seems plausible to us that, in due course, inflation, which is not priced into the markets at all, could rise higher than the level of interest rates that policy elites can live with (hint: not a very high bar), with the interesting parallel that of the student protests of the late 1960s being followed by the inflation of the 1970s.

Low or negative real interest rates are traditionally very good for gold, and there is a decent chance that this is what we could see for some time.  To the extent that we are already living in a world of MMT, if it does not work then yes gold should be a resulting winner, and even if it does work, then the reduced supply of government bonds might also support gold as there would be less safe haven assets around.

However, one way or the other MMT may soon be complemented, by digital currencies, upon which most central banks are still working, and with only ever more reason to use (for control).  China has now proposed a private sector-run digital currency based upon the Japanese yen, South Korean won, Hong Kong dollar, and of course the Chinese yuan (the PBOC is already testing a digital yuan).  Such a digital currency would presumably create some sort of powerful (free?) trade block.

Let us conclude by finding a point to this note and draw some conclusions.

We do think that our original assessment of “direction of travel” is intact, and even accelerated by recent and ongoing events.  To that end we are comfortable with how we are invested, albeit at a generally uncomfortable time for all investors.  That is, cautiously invested, on a global market capitalisation basis, and with an overweight position in Real Assets, especially gold. This is especially so given our expectation, as of today, that Joe Biden will win the US Presidential election, and that there is a significant possibility of a Democratic clean sweep, flipping the previously Republican Senate, which the market will perceive to be a negative.

We accept that the impact of social media and “cancel culture” (etc) may be concerning at first glance.  However, we remind that the nation state is a relatively new concept in the arc of history, and that humans have tended to be more comfortable within a tribal context.  Points of reference here might include David Berreby’s 2006 publication of “Us and Them – Understanding Your Tribal mind”, and William Ophuls’ “Why Civilizations Fail”.

We do not mean to downplay the implications of the cultural shift at hand, where perception, feeling and narrative supersede empiricism and fact, or the general lack of kindness in evidence today.  Joseph Goebbels was quick to suggest that people will believe any lie if it is repeated long enough and loud enough. However, our job is to observe and then invest appropriately while on this shifting carpet, to defend against the risks, and to make the most of opportunities as presented.

2020 has clearly been a challenging and extraordinary year, so far, and we hope that all our clients are safe and healthy.  Perhaps we will end with a quote attributed to the Marquess of Salisbury: “Change? Change? Aren’t things bad enough as they are?”



Andrew Wilson, Chief Investment Officer, July 2020

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