This article is extracted and edited from a discussion between Hamish Douglass, Chairman and Chief Investment Officer at Magellan Financial Group and Tom Piotrowski of CommSec.
The most important risk at the moment is the pandemic. Usually, you can assess an economic crisis and a policy response and make a decision off the back of that, but this is intersecting with a scientific issue and a medical crisis. The science is very hard to handicap at this stage and the economic crisis will depend upon the depth of the health crisis and we don’t know when we’ll have a vaccine. The science will guide how long this goes on for and it will guide the economic outcome. That’s the number one issue.
Watch the US Senate, not Trump
The second issue is the election in the United States. There is a possibility of fundamental change. Most people assume “Wouldn’t it be great for Trump to get voted out” but be careful what you wish for. There’s an important element in the Senate that people don’t understand. For the United States to get non-budgetary legislation through, they effectively need 60 votes not just 51. There’s something called a ‘filibuster’ where somebody in minority can hold up legislation forever. Obama is advocating that the Democrats change the rules to get rid of that rule and make the Senate a simple majority.
And once they do that, they could change the number of states and include two more states in the Union, being Puerto Rico and DC. Then every state gets two Senate seats and they could change the balance of the power. This may give unlimited ability to implement legislation and that could be radical and progressive on taxation and healthcare and unwinding regulatory reform. Some of it could be very positive such as on climate change but some could have a huge economic impact. So while most people are focused on the White House, we’re focused on the Senate race.
The other two major risks are the China-US situation and Australia has its own tensions with China as well, and longer term, the consequences of this world of enormous monetary printing. It looks like everybody’s got a free lunch at the moment.
When something is too good to be true …
It’s extraordinary what the central banks have done. The US Federal Reserve is not just buying government bonds and mortgage-backed securities but they’re wading into other asset classes here like ETFs. People are starting to believe that there are no consequences—it’s Modern Monetary Theory and interest rates can be held at zero forever. They can keep printing money and spending money.
If something is too good to be true, it normally is too good to be true, but it can go on for a long time before the party ends. It isn’t today’s issue, but some countries will get into the point where these deficits are effectively beyond their savings. It could lead to a runaway inflation and a collapse in their currencies. So they need to be very careful that they’ve got an unlimited pool of savings. The United States as a reserve currency of the world has an advantage because it has a global pool of buyers. We’re not all treated equally here and ultimately this experiment could end very badly with high inflation and collapsing currencies.
But if you’re convinced it’s going to happen, and therefore you’re going to sit out of markets for the next five plus years, that could turn out to be a very expensive decision to make.
Portfolio positioning amid a pandemic
Since the middle of March, we’ve been cautious, running at around 15% cash. We really do not know what’s coming in the next 12 months or so. I’m just being very honest with people. I haven’t got a crystal ball that’s going to tell me when we get to a vaccine. If it’s rolled out through 2021 with all this fiscal support and monetary support, that should support markets grinding higher.
But if we don’t get to a vaccine in a reasonable period of time, and we see a spiking in the latter part of this year in the Northern Hemisphere leading into the winter, and emerging markets come under more stress, we could find ourselves really testing the limits of what central banks can do. The economic scenario could get materially worse than it is today.
Between those two market views, either grinding higher or collapsing, I can’t tell you which one’s more likely. So in a strange way I’m sitting on the fence. I can see both scenarios.
We still own a lot of growth, with technologies in our portfolio that are doing very well like Microsoft, Alibaba, Tencent and SAP. We’ve got some strong defensive businesses such as Reckitt Benckiser and Nestle and our US utilities have all confirmed the guidance.
This virus is creating winners and losers. It’s accelerating trends that were working for or against businesses, such as traditional media losing to streaming services. Microsoft services such as Teams have received far more users and they aren’t going to suddenly turn it off when we’re through this pandemic. More businesses want their IT infrastructure in the cloud. We’re talking a multi-trillion-dollar market opportunity that is probably a few hundred billion into it at the moment.
Last year, I had the privilege of interviewing Howard Marks and Ray Dalio at the Sydney Opera House, and I asked them their views on gold. Howard Marks gave a classic investment view that gold isn’t an asset because it doesn’t produce an income, it’s a speculative investment. Then Ray Dalio said it’s not an equity because it’s a currency. It’s an exchange of value, and gold gives a protection against inflation. With the massive trend to printing money, people are buying gold and gold ETFs. But I’m not saying buying gold is the right thing to do at this price of over US$2,000 an ounce.
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Remain optimistic about humanity and future generations
I’m still optimistic on humanity although it sounds a little strange with a pandemic, a cold war developing with China, uncertain political environment in the United States, printing money and running deficits. But remember what’s happened in the last 120 years. We had the 1918 Spanish flu, two world wars, cold wars, oil crises, stock market crashes, financial crises. But every decade, the world has become richer. And society has got better with fewer people living in poverty. Our younger generations are benefitting from technology across the world and it will advance artificial intelligence and medical science.
So, I look 30 years or so into the future, it will be more technically advanced, we will probably live longer than we do today. We’re in a period where the noise looks overwhelming with a poor political environment and the inequality. But if you look how we live today compared with 100 or so years ago, I would say that most of us live better than the Rockefellers. It’s an extraordinary statement but did they have video, iPhones, air conditioners, etc?. We’re looking into space travel again. There are so many things such as the standards of education that we now have in the world. So while there are many problems, I have hope in what the human race can do. Let’s keep educating our young people. Let’s keep investing in venture capital. Let’s not destroy the machine that created so much for humanity over time.
There’s a risk we will go through a period where we start reversing. I know that capitalism isn’t perfect, but you don’t want to stop innovation and progressing while we address inequality issues. We should not kill the system that has created so much benefit for the world.
Hamish Douglass is Co-Founder, Chairman and Chief Investment Officer of Magellan Asset Management, a sponsor of Firstlinks. This article is for general information only and does not consider the circumstances of any investor. The full discussion can be viewed here. Extracts taken with permission of CommSec and Magellan.
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