Wealth Management Quarterly: Toilet Paper Markets

Q: Can you give us an example of markets discounting outcomes during war?

A: Sure, during World War II the US stock market made its low on April 28, 1942, the day of Roosevelt’s 21st Fireside Chat—Economic Sacrifice. The US had just lost at Bataan.

From a military perspective, the Allies were not exactly winning the war in April, 1942. Yet the market sensed that was the inflection point. Why? The full text is available thru the link, but here are a few of his words I wanted to highlight.

Source: Bloomberg as of 12/31/19

“But there is one front and one battle where everyone in the United States — every man, woman, and child — is in action, and will be privileged to remain in action throughout this war. That front is right here at home, in our daily lives, (and) in our daily tasks. Here at home everyone will have the privilege of making whatever self-denial is necessary, not only to supply our fighting men, but to keep the economic structure of our country fortified and secure during the war and after the war. This will require, of course, the abandonment not only of luxuries but of many other creature comforts. Every loyal American is aware of his individual responsibility.

Whenever I hear anyone saying “The American people are complacent — they need to be aroused,” I feel like asking him to come to Washington (and) to read the mail that floods into the White House and into all departments of this Government. The one question that recurs through all these thousands of letters and messages is “What more can I do to help my country in winning this war”?

To build the factories, (and) to buy the materials, (and) to pay the labor, (and) to provide the transportation, (and) to equip and feed and house the soldiers, sailors and marines, (and) to do all the thousands of things necessary in a war — all cost a lot of money, more money than has ever been spent by any nation at any time in the long history of the world.”

We are now spending, solely for war purposes, the sum of about one hundred million dollars every day in the week. But, before this year is over, that almost unbelievable rate of expenditure will be doubled.

All of this money has to be spent — and spent quickly — if we are to produce within the time now available the enormous quantities of weapons of war which we need. But the spending of these tremendous sums presents grave danger of disaster to our national economy.

When your Government continues to spend these unprecedented sums for munitions month by month and year by year, that money goes into the pocketbooks and bank accounts of the people of the United States. At the same time raw materials and many manufactured goods are necessarily taken away from civilian use, and machinery and factories are being converted to war production.

You do not have to be a professor of mathematics or economics to see that if people with plenty of cash start bidding against each other for scarce goods, the price of those goods then goes up.”

Q: Is this why last quarter you used the word “hyperinflation”?

A: Absolutely. It is an unavoidable reality that our dollars will be worth less in the new environment—already the Federal Reserve’s balance sheet has expanded from $4.5 trillion to $6.5 trillion. Fortunately, paper dollars can substitute for the missing luxury we previously mentioned.

Government, of course, will do its best to contain the coming price shocks, as Roosevelt explained in the rest of the speech, but it will not be able to completely stop them.

Q: So, what should an investor do?

A: Naturally, traditional fiat currencies are likely to lose value against hard and virtual currencies in the new environment, so one can diversify the forms of one’s “cash” savings.

I think in the stock and bond markets one will find things uneven. As Roosevelt said, things will be taken away from civilian use and other things will be converted. This means that certain segments of the economy will die but new opportunities will also open up.

The BIG THEME I see opening up is Made In America 2025, as the competitor to Made In China 2025. The industries included in various reports include: Aviation Equipment, Robotics, Electrical Equipment, New-Energy Vehicles, High-End Numeric Control Machinery, Medical Devices, Next-Generation IT, High-Tech Maritime Vessel Manufacturing, Advanced Rail, Agricultural Machinery, and Biomedicine.

Inside the stimulus bill was a lot of money for things like rural broadband to support remote work and telehealth. There was money for zoologics and other healthcare items. There was money for the aviation industry and small business.

I also see a BIG THEME in the transition from the Baby Boomer Economy to the Millennial Economy. What do I mean by that? Online, local, just in time purchases from short supply chains, with a focus on efficiency. Millennials are now the primary purchasers in many categories including homes. Businesses better know what they want.

Q: Any final thoughts?

A: Wars can be quick, or they can be long.

Wars can be internal, between countries, or global, and wars can be successful or unsuccessful.

Wars always usher in new societal norms, patterns of behavior, and remake the economy.

Finally, It is tough for us Generation X types, but during “wars” government grows, the private sector shrinks, and individual liberties get restricted, and the young people fall in line.

Let me be specific. The very first Amendment in the Bill of Rights states that “Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof or abridging the freedom of speech or of the press, or the right of the people peaceably to assemble and to petition the government for a redress of grievances.”

The way government is getting around this restriction currently is by allowing health officials and State Governors to restrict the people’s ability to peaceably assemble. Congress hasn’t done anything to create this shutdown, but it most certainly has happened.

Or what about the fourth amendment and one’s right to secure your persons, house, papers, and effects against unreasonable search and seizure?

How do you think governments are going to treat your biological data now? Millennials grew up with cell phones, and some do not give much thought to their data being tracked and shared. Generation X grew up with computers and computer hackers, and with movies like War Games and Red Dawn where the world is brought repeatedly to the edge of total destruction by government, only to be saved by a free-thinking individual at the last second.

Tactical Equities

Due to the extreme conditions in core fixed income and equity markets, we think that tactical equity strategies may offer investors the best risk/reward trade-offs. Tactical equity strategies, like long/short equity, option based strategies and market neutral strategies have historically weathered bad bond markets and buffered bad equity market storms. We believe tactical equity strategies are becoming increasingly attractive on a relative value basis given low interest rates and the likely structural changes to the economy.

Source: Bloomberg as of 03/31/20

Other Markets

Other markets like gold, cryptocurrency, and real estate do offer diversification benefits to traditional portfolios, but some suffer from the same valuation issues as stocks and bonds. We are concerned that recent events will accelerate trends towards online purchasing and remote work, which will increasingly pressure certain real estate sectors. In addition, outside markets have their own risks, rewards, and implementation issues, but they may have a role depending on investor specific considerations.