Stock Investment - Inflation, Predictions, Disruptions

Important and Unknowable

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Economic predictions have always been highly variable and uncertain, and, for some reason, relied upon as if the future were a magical algorithm. Essentially, economists would make one fundamental mistake. They thought they were practicing a science. Data could be collected, inputted, and a predictive algorithm could be generated. Even Nobel Prize winners like Paul Samuelson believed that with enough data we could come to understand the economy and how it functioned.

This is nonsense. As Daniel Kahneman and Amos Tversky have shown us, human behavior and irrationality, combined with unpredictability and randomness (thank you Naseem Taleb) make this even a questionable social science. Using existing analysis and algorithms to reliably forecast is a fool’s errand, essential for someone’s tenure, and maybe even a Nobel Prize, but doesn’t add much that is useful. Some of the more laughable Nobel Prizes have been given to people who determined that markets were efficient. They are not. Economies can be predicted with useful data input. They cannot. A couple of inputs about inflation and the unemployment rate, and we know how to manage an economy. We can’t. That last one is the Philip’s Curve – true for a limited time and then it goes spectacularly wrong – a lot like most risk and market prediction models.

Investment Principles

Stimulus and silliness

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The world economy is struggling to escape the Covid-19 economic shock. During the worst of this pandemic, the world’s developed economies provided an enormous fiscal stimulus on a scale not seen since the second world war.

Now, however, the US is proposing to more than double its already generous fiscal stimulus. Is this a good idea or excessively risky?

Go Big, But Where?

For its proponents, the idea of “going big” is designed to be a transformative political moment. But too much appears allocated inefficiently, and it may simply be irresponsible.

An easy money era produced only anemic growth. But the scale and direction of additional stimulus look more like irresponsible fiscal policy leading to significant overheating and the waste of resources. While there is a strong case for a more aggressive approach to fiscal policy, that policy still needs to be grounded in economic realities and reasonable priorities. These are not.

Portfolio Strategy

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The government is providing a backstop for all government-backed securities. The Fed is also going to be extremely active in the markets, buying not only fixed-income securities but also stock index funds. They are working very hard to keep the market aloft and preventing it from cratering (they still may not be successful). This is an election year and this administration will do everything it can to make sure things look as good as possible through November.
I understand there is riskiness, but I expect economic activity and fed support to continue to increase. Even if we have an increase in coronavirus cases, people will remain optimistic – justifiably or not.
There will be extreme volatility. Economic activity will waiver, increase suddenly, pull back, and the pattern will continue for some time to come.
Market volatility is our friend because we have a stable source of cash flow that protects our capital base. On top of that, the speculative strategy will profit from volatility while the equity investment strategy will play for the long term – it is a multi-year long-term perspective.

Although there are a handful of investments where confidence in the five-year curve is justified, and now is a great time to make these long-term investments, it is still very unpredictable.
The short- and long-term state of the economy, how this massive amount of debt gets repaid, how we reopen businesses, etc. is unknown, volatile, and any attempt to predict seems fruitless. But, understanding how to adjust for risk, accept, and ultimately take advantage of volatility, will be powerful. Along with a long-term perspective, this will be the most effective investment strategy. The Fed is printing more money. We’re going to see a lot of capital injected into the global economy. But the presence of money is not the important factor. It’s the velocity of money – how people are spending it and is that money chasing after other goods. That will drive inflation. We didn’t see it in the past even though we had a massive capital injection. Deflation and recession are much bigger concerns. Inflation is not on the horizon. The Fed’s enhanced bond-buying, which includes high-yield bonds and other fixed-income securities is unprecedented and has boosted the value of debt portfolios. However, these portfolios (mostly just above or just below investment grade) still yield attractive disproportionate risk-adjusted returns.