QUARTERLY INSIGHTS - Q1 2021 - Dear Clients, Colleagues and Partners - LeifBridge
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QUARTERLY INSIGHTS – Q1 2021
Dear Clients, Colleagues and Partners
Do we finally see some light at the end of the tunnel? Whilst the EU is experiencing greater
challenges with the roll-out of their vaccine programs, the view in the UK and the US seems to
assume that the positive effects of a successful vaccine roll-out will inevitably lead to a return to
“normal” this year. The optimists are buzzing and even the pessimists are joining in! All the
anecdotal evidence would suggest that everyone is suffering from Zoom-fatigue and most people
can hardly wait to get out of lockdown and book a weekend away.
Thanks to a combination of science, innovation and sheer determination it would appear that we
are slowly getting the upper hand against the pandemic. Active COVID-19 cases in the US and UK
have been on a decline since the start of February, perhaps an indication that successful
vaccination programs are having positive results.
Given their accepted function of discounting future news, capital markets have reacted with
understandable optimism to vaccine developments. It would appear that when it becomes
possible, consumers will either be rushing to the pub or going on holiday……or both! And if flying to
a holiday destination proves too tiresome then apparently a cruise would seem a suitable
alternative. As evidence of this the S&P 1500 Hotels, Resorts and Cruise Lines Index hit pre-
pandemic highs on March 17th. Encouraged by the continued wave of money printing, these
“opening-up” trades have driven airlines and cruise lines to valuations where they are now flirting
with new all-time highs.
The Fed’s new policy of targeting average inflation over a cycle, combined with the $1.9 Trillion
American Rescue Plan, have driven up both growth and inflation expectations, resulting in a rapid
steepening of the yield curve. After a record quarterly decline in US GDP of -9% in Q2 last year, real
GDP growth is expected to hit another record rise in Q2 this year, of +11.4%. Full year US GDP
growth estimates has been revised up from 4% at the end of last year to +5.7% at the end of Q1,
with the growth differentials perhaps the primary reason behind a stronger Greenback during the
quarter. These revisions are very much the consequence of an efficient vaccine roll-out by the
Biden administration, an ultra-dovish Fed not apparently minded to budge despite a significant
uptick in leading indicators, and a very accommodative Treasury Secretary in Janet Yellen who
apparently believes that too much fiscal support is “not possible”.
“The narrative coming from the White House, Treasury and Fed has
resulted in a consensus belief that, notwithstanding higher inflation,
the economic recovery will be strong enough to mitigate any negative
impact on markets, with reduced tail risks as a given”
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Whilst we also believe the positive momentum in the weeks and months ahead will likely be
significant, especially in places like the US and UK where the vaccine roll-out has been hugely
successful, we are not quite so sanguine as the consensus view as regards hidden risks in markets.
It will come as no surprise to most people that over the last year in particular government debts
have soared. Not a single country in the G7 had a budget deficit of less than -4% at the end of 2020,
with the US and UK “boasting” -15% and -17%, respectively. With the exception of Germany, all G7
nations will have Central Government Debt of more than 100% of GDP this year. Policy rates in all
developed economies remain near zero, and the amount of negative yielding debt remains close
to $14 trillion US Dollar. Credit markets in particular face serious challenges in the years ahead if
interest rates keep rising. US non-financial Corporations have outstanding debt-to-GDP of 83.5%,
and as Chart 2 shows, it does not look as if this trend is likely to slow! Add this to household debt at
78% of GDP, and government debt of 128%, and you end up with total US debt to GDP of 290%!
Chart 1:
Source: Shard Capital, Factset Research Systems, 31/12/20
Chart 2:
Source: Bank for International Settlements, Factset Research Systems, 30/09/2020
Whilst leading indicators may be continuing to rise monetary and fiscal responses to the Covid
pandemic means that their armoury is very depleted and, should another exogenous crisis hit,
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there is little of real effect they can do to fight……except perhaps to print more money! In addition,
pension deficits continue to soar as, primarily the west, investors continue to borrow from the
future to fund expenditure today. And that’s where consumption spending is coming from……debt!
Keeping zombie firms alive and putting money in consumers’ wallets so that they can bet on
shares like Gamestop does not constitute investing!
And then we need to consider inflation. Investors appear to be ignoring the collective negative
impact of ZIRP and QE, but the fact that we have printed so much money and encouraged so
much leverage in the system is a very real and present danger to the global economy. The
quantum of debt globally has had (and continues to have) a very significant deflationary impact.
The amount owed is now so big, that raising interest rates becomes almost certainly untenable.
The situation is so dire that the White House and US Treasury are actively discussing whether to
embark on Modern Monetary Theory (MMT). How markets would react if this came to fruition is
hard to know but our instinct is that it would not go down well and would result in a much weaker
US Dollar, alongside significant inflationary pressures it would bring to the US consumer. That step
is, however, the last throw of the dice. In the meantime, the Fed has one more “weapon” at its
disposal, namely Yield Curve Control (YCC). But let us be clear, YCC involves a commitment to buy
unlimited bonds at a specified price, which is very different from QE where there is only a limited
commitment at the prevailing market price. Once that line in the sand has been drawn the Fed
would be obliged to defend it at all costs or lose all credibility. It is not a step thy will take lightly.
“Whilst we believe inflation is transitory, the benefits of investment in
long term structural growth should not be underestimated”
Money Supply data in major developed economies shows a very sharp increase over the last year,
and longer-term interest rates have followed suit and inflation expectations have increased.
Chart 3:
Source: Shard Capital, Factset Research Systems, 28/02/2021
Money supply numbers would suggest higher inflation is inevitable, but disinflationary forces
remain very strong. Whilst higher inflation would help to relieve some of the very real pressures
caused by our very high debt loads it can, and most likely will, have very negative effects on our
overall standard of living, particularly for the working class and income dependant. The COVID-19
pandemic has only exacerbated what were already unsustainable levels of wealth inequality. It is
therefore imperative that any benefits deriving from governments efforts to provide fiscal stimulus,
through infrastructure or other project, are more equally distributed within society. Whilst this may
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Q1 2021
sound vaguely Marxist to some, it is in fact merely a sensible policy to ensure that resentment felt
by many, particularly younger and income dependant members of society, do not spill over into
greater polarisation and nationalism.
Furthermore, we require strong governments to support and encourage investment into green
initiatives, in order to avoid the many environmental disasters currently staring us in the eye. The
ESG acronym continues to face many critics, but we need to start somewhere. Whilst we are very
much against greenwashing, the responsibility of differentiating between good and bad ESG
strategies lies with both the owners and allocators of capital, and less so with journo’s trying to get
a headline! We believe it is better to have more parties – which includes all stakeholders – involved
in discussions than excluded from them.
This is one area where the US government is perhaps heading in the right direction. The recently
announced $1.9 trillion US Dollar, American Rescue Plan, was designed to help those affected by
the COVID-19 pandemic and its economic and social consequences. Similar relief packages in
mainland Europe, the UK and Asia have gone a long way to ensure most of us can return to a life
resembling normality sooner rather than later. But fundamentally these packages have been
expenditure, not investment! However, on the last day of the quarter, President Biden announced
his $2.2 trillion US Dollar Infrastructure and Jobs plan. A comprehensive overview can be found on
the official website of the White House: FACT SHEET: The American Jobs Plan | The White House.
The plan can more or less be broken up into 4 areas:
1. Improving and modernising transportation infrastructure, including support in the
transition to EV’s,
2. Increasing the quality of “life at home”, which includes retrofitting more than 2 million
homes and buildings, upgrading the nations broadband infrastructure, improvements to
the electricity grid and the water infrastructure,
3. Affordable and community-based care for the elderly, which includes expanding Medicaid
and boosting pay for caregivers, and
4. Increasing innovation, R&D and improving the manufacturing sector
Whilst the proposed corporate tax hike from 21% to 28% will hit corporate profitability, and
potentially market multiples, the benefits are likely to be felt by the middle and lower class as well
as the environment. What we believe is crucial about this plan is that the proposals are considered
investments, not just expenditure! Time will tell the extent to which these investments both
modernise old and outdated US infrastructure whilst at the same time ensuring sustainable
demand resulting in growth within the US economy, which should benefit shareholders and US
consumers alike.
“If most bonds do not provide sufficient protection or any real income,
then we can safely say that their primary purpose is effectively
redundant – has the 60:40 era finally come to an end?”
But what does all this mean for your portfolio?
Firstly, our base case continues to be that the role of bonds in multi-asset portfolios has to be very
carefully assessed. For now, at least short dated Government bonds provide ultra-liquid optionality
albeit this comes at a small negative loss in real terms. At the other end of the spectrum Emerging
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Market bonds, whilst much less liquid, provide better risk adjusted exposure to elusive income
streams. Our long-term hypothesis for capital markets continues to be that the cost of capital will
ultimately trend towards zero. Capital markets are currently underpinned by the belief that long
term growth prospects are positive, and bond investors have created liabilities on the back of this
belief. For that reason alone, the cost of capital today is not actually zero but interest rates cannot
remain pinned at zero indefinitely. They must normalise at some point, but it will not be an easy or
pleasant path to walk.
It is no exaggeration to say that ultimately bond yields will have to rise for capitalism to survive. For
this reason it is likely that pension funds and insurance companies – the biggest owners of bonds –
will see their bond allocations cost them significantly, especially if inflation does turn out to be
structural. With this in mind, we believe era of the 60:40 portfolio is coming to an end as the
benefits (such as they ever were) no longer apply. As and when interest rates actually normalise
(perhaps a few years away), it is likely that alternatives will take the place of bonds within more
open-minded portfolios, or at the very least what today is reflected in a 60:40 portfolio, will slowly
transition to, for example, an 80:20 portfolio or even a 90:10 portfolio. Ultimately the supply-
demand dynamics for bond markets, which existed over the last 40 years, is unlikely to be
sustained.
Given current equity market valuations and the implied discount rate in a zero-interest-rate world,
one might reasonably ask where best to invest in order preserve purchasing power? We believe
Real Assets, including renewable infrastructure, property and commodities, like precious metals,
offer a solution that will preserve capital as inflation push prices up, whilst demand for these assets
should remain robust. Shares in high quality companies with the ability to pass through inflation
and benefiting from growing structural demand should also be able to maintain premium
valuations. That said, this approach necessitates a high conviction and active allocation approach.
Index trackers will likely face significant headwinds as market multiples price in higher discount
rates. This may result in a significant “innovation-correction” as we might see shares in many early-
stage growth companies fall in price. Crucially, business models dependant on external funding,
will probably struggle to survive!
The best example I can use is Tesla: a fantastic product, but a capital-intensive business heavily
dependent on external funding. In a zero-interest rate world, they were able to tap capital markets
and find the required funding…because money was cheap! However, if they had to repeat the
same “trick” over the next decade, they most likely would have failed.
And that brings us to the value-vs-growth argument, although it should not really be an
“argument” as there is clearly room for both types of companies within any well-constructed and
balanced portfolio. Certainly many “value” companies will end up becoming proverbial “value
traps”, but likewise many “growth” companies, which have ridden the current zeitgeist whilst
generating zero revenue, will also be cruelly exposed in time.
In the near term however, as highlighted below, the Equity Risk Premium and equity market
valuations are perhaps not at extreme levels, once one has factored in the opportunity cost. There
are also many attractive, growing markets which investors can get exposure to, through high
quality, active investment propositions. These include as mentioned before, alternative and
renewable infrastructure and digitalisation, but also end markets in the life sciences space or the
growing, and crucially – underleveraged – Asian consumer.
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Chart 4:
Source: Shard Capital, Factset Research Systems, 31/03/2021
“In an inflationary world encumbered by financial repression, the
benefits of digital assets might prove irresistible to many”
There is no way to avoid some of the valuation risks currently posed by financial markets. Inflation
seems to be the elusive objective of central bankers around the world, but they should be careful
what they wish for as out of control inflation can cause existential damage to capital markets. Yield
Curve Control has already been implemented in both Australia and Japan and is likely to be
pursued elsewhere. One of the consequences in our opinion of an increased reliance on YCC by
central banks will be an increase in currency volatility with the possibility of stagflation as the final
outcome. Whilst not our base case, stagflation in the west is not unlikely, and could put significant
pressure on currencies like the US Dollar, the Pound Sterling and the Euro.
In a stagflationary environment, assets that can preserve purchasing power, or act as real stores of
value, will see a significant rise in demand. The place crypto currencies and digital assets will have
in society are perhaps more important than many would’ve guessed even a few years ago.
Whilst Bitcoin might still be seen as a speculative asset by many, perhaps the most consensus
view today is its Digital Gold narrative. Up until now, access to Bitcoin by large and institutional
asset owners has been limited, but its place in a multi-asset portfolio, as a source of diversification,
is perhaps now undeniable. Regardless of whether demand is driven by the Digital Gold narrative,
or as a speculative long duration growth asset, or a technical theory about stock-to-flow model and
Bitcoin halving cycles, Bitcoin demand remains significant and seems to be increasing. We believe
this demand will see a significant rise when the US approves the first Exchange Traded Product
(ETP) to be backed by Bitcoin.
The crypto-community is very tribal, and if you spend a few days “offline” you miss a new
development. But the speed at which this space is developing is astonishing and the potential
even more so. Whilst in-depth research and a keen understanding is crucial, its also important one
does not get sucked in and you retain a broad perspective. The crypto world is a truly paradigm
shift from the 20th century financial system we live in. It is a world with games, social gatherings,
sports…even art! What is undeniable is that it requires a different perspective. Looking at it through
a traditional capital valuation framework is perhaps unwise and it requires a lot of research in order
to truly understand the potential of non-fungible tokens, web 3.0 and the metaverse. And whilst it
might prove to be hype, or hope, we cannot deny the flaws of an outdated financial system and
the longer-term benefits of the Blockchain.
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Finally, and perhaps still the most important store of value of our day – for now at least – is gold. As
a store of value, its perhaps the only asset that has truly stood the test of time…at least, 4000 years
of collective social agreement. Money printing doesn’t seem to have come to a close yet, and the
likelihood of more central government debt, if only to support dying business models, is highly
likely. As chart 5 below shows, US Federal Debt alongside the price of gold reflects its “store of
value” characteristics. Centrally held debt has doubled six and half times in the last 50 years. It is
therefore perhaps not unrealistic to assume it might double again over the next decade…and if
history is anything to go buy, gold still has significant upside.
Chart 5:
Source: Federal Reserve System, Factset Research Systems, 31/3/21
“Our investment philosophy gives equal priority to the management
of risk as it does to management of return!”
As outlined above, we believe risks within the global economy, financial markets and across asset
classes are both greater in magnitude and probability than markets are pricing in. However, there
are also significant investment opportunities, including: innovative new technologies disrupting
traditional business models, the advent of stakeholder capitalism or policy driven changes in
supply-demand dynamics. In the current climate we firmly believe that our focus on short term
capital preservation and long-term wealth creation will both protect and grow our clients’ wealth.
“Qui Curat Vincit”
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Q1 2021
CONTACT US
For further information on any of our services, or if you would like to arrange a meeting with an
investment manager to see how we can work with you, please find get in touch.
LeifBridge Investment Services Telephone: +44(0)20 7186 9900
Shard Capital Partners Email: Info@Leifbridge.com
23rd Floor, 20 Fenchurch Street Web: www.leifbridge.com
London, EC3M 3BY
United Kingdom
IMPORTANT INFORMATION
LeifBridge is a trading name of Shard Capital Partners LLP. Shard Capital Partners LLP is a limited
liability partnership, registered in England with registration number OC360394. Shard Capital
Partners LLP Registered office: 23rd Floor, 20 Fenchurch Street, London, EC3M 3BY. Shard Capital
Partners LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom,
reference number 538762.
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any security or other financial instrument, credit or lending product or to engage in any investment
activity.
Past performance is not a guide to future performance. It is important that you understand that with
investments, your capital is at risk. The value of investments, as well as the income derived from
them, can go down as well as up and investors may get back less than the original amount invested.
It is your responsibility to ensure that you make an informed decision about whether to invest with
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