A conscious effort to focus on positive things this week, given the current environment. So let’s start with sport. Rugby Union and tonight’s World Cup Final. It may not be the final the organisers would have wanted but the good news for any English, Irish, or French rugby fan is: at least you can’t lose this weekend.

Where to find team spirit?

Abraham Lincoln said the best way to defeat an enemy is to make them your friend. This starts with communication, an opportunity to walk in their shoes, build empathy and understanding. Despite being a long way off becoming ‘friends’, the fact the US and China are ‘talking’ again is good news and directionally positive. Both countries would benefit from stronger alignment, not least to help tensions from escalating further in the Middle East and elsewhere.

But to aid a sense of ‘togetherness’, perhaps they should add a little alcohol? Where I’m from (New Zealand), team spirit was often found at the bottom of a pint glass. Rugby teams, for example, would conduct “court sessions” where players would be “charged” with humorous or fictitious offences and then "sentenced" to a penalty, often involving alcohol consumption. When I played overseas it was not until these early season “court sessions” that people got to know each other better and began to gel as a team. 

The same was true when I started work. Social engagement improved working relationships. Why? Because face to face interaction taps our reward networks by releasing oxytocin — the hormone involved in social bonding. Now, I had assumed traditions like team-drinks and “court sessions” had been cancelled, or confined to history. Not so. It appears they are making a comeback in European politics. Apparently things have got so bad between the French and German cabinets, their governments have planned a weekend boating and drinking trip, with no media present, meetings or formal agenda, save the objective of “team-building’. We are yet to hear how things went, but assuming it goes well, this could become the template for future nation building-exercises. It’s certainly better than the alternative.

Current positioning

Little change in thinking re: market positioning. As the market readjusts to a world of inflation volatility and higher compensatory yields, we will continue to fade promises for profits, remain wary of long-duration in favour of shorter payback periods and add to supply-constrained beneficiaries of state largesse. As mentioned in previous editions, the scarcity, and therefore value, still lies not so much in the ‘ethereal world’ but in the 'material world’ underlying it. And when you combine a return to manufacturing growth in the US (where PMIs are close to expansion again), more muscular industrial policy (IRA), a more forceful fiscal response from China, and the world’s largest ever construction project (climate transition) the potential mean reversion from technology into industrials/commodities, or regions with claims thereon (UK, Japan, Brazil) still looks attractive. And while not a great context for bonds (and yes, it’s the end of the credit cycle), even bad investments can be made good, by price.

Bargains must first endure pain

I still think you will lose money, in real terms, holding 10Y bonds to maturity. The four-decade bull market in bonds is over thanks to decarbonisation, demographics and deglobalisation. That’s not to say you can’t make money in them from time to time. Indeed sideways markets are great news for active bond managers, especially those with good selling discipline (a rare muscle indeed). And so while I’ve beaten-up on bonds all year, we could be getting to the point where they look attractive – for a trade. As Rob Arnott says ‘you can’t have a bargain until you have inflicted pain’. Well, the world’s risk-free (ahem) asset as proxied by TLT is down nearly 50% from its peak. Painful, especially for those adding vigorously earlier this year, with consensual fears of recession. Bonds are down three years on the trot which is rare – I’m not sure we’ve had a fourth? And this just as consensus is now beginning to look the other way on growth. Here’s hoping what WPP said this week is a one-off. Advertising is one of the first things to go in a slow-down.

Demographics are destiny depressing

Demographics are depressing, or so we are led to believe. We face a demographic cliff. We are running out of babies. Siberian women can’t find men, Chinese men can’t find a woman (hello Dating App!). By the end of this decade there will be more grandparents than grandchildren and not enough workers to pay the entitlements of the retiring boomers. As a consequence, most western government debt will be junk status. We retire more builders, drivers and miners than are being replaced, just prior to enacting the world’s largest ever construction project. Instead we have a surplus of gaming and dog-walking ap developers, few of which know how to hold a hammer. And Generative AI can’t spot-weld.

Yes, it’s grim. At least that’s what the media suggest. But things are never as bad as they seem. For example, if you live in Hong Kong you will get a cash handout of HK$20K for each new baby (plus a tax reduction and priority on housing lists). Singapore is offering trips to Bali for would-be parents to ‘get them in the mood’ for baby-making. The “grey market” is seeing an enormous pay rise (thanks to higher interest on savings). Seniors still own 80% of the World’s wealth and contribute to a $20T economy (per Mauro Gullien), yet surveys reveal they are being ignored by business, advertisers and see above: software developers.  While I’m less positive around the productivity benefits of AI than some, lest Generative AI, Goldman Sachs estimates it’s a $7T opportunity, which combined with $8T they penned for Metaverse (gulp) could add 15% to global GDP by the end of the decade. Perhaps more encouraging (read believable) is the unintended consequence of GLP-1 weight loss drugs. According to Professor Scott Galloway, not only can these drugs weaken addictions, lower alcohol and calorie intake, they could lower the spend on obesity related healthcare costs, a figure the Milken Institute estimates at some $1.7T. There’s a lot of fat we can take out of government spending, it seems. Lower deficits might also mean lower yields? Now wouldn’t that be nice!?

Oil prices have doubled

Olive oil, that is. 

Since Jan 1 2022, olive oil futures have doubled. But it’s not the only food price rising. South of the Mediterranean, cocoa futures have jumped to the highest levels in 44 years, up nearly 50% in 12 months. Orange juice has doubled this year with frozen concentrate having tripled since 2021. Now we can’t blame demand. Not with Wegovy suppressing our appetites and the cost-of living, our wallets. The reasons are supply. Often it’s climate, fires and sometimes disease (note a pandemic is threatening to destroy the global banana crop and a poor crop of beech nuts has led to a record number of bear attacks in Japan. True story!). But the point is: supply disruptions are wreaking havoc and this will likely continue. This logic applies more broadly, something advocates of the Capital Cycle have been arguing for years. While billions have been poured into technology sectors, our infrastructure and commodities complex has  been starved, meaning supply shocks (and bear attacks) are likely to be more common going forward. This, they argue, justifies a higher structural premium for materials which are critical for a modern functioning economy. I can’t disagree. They are essential. Increasingly rare. And too cheap. 

Supply constrained real assets

This is why it now pays, I believe, to have some commodity exposure in your portfolios to diversify returns and even hedge against tail risks (like a Chinese recovery and/or oil at $150/b). We’ve shown how commodities are negatively correlated to bonds, lowly correlated to equities and are a statistical hedge against that thing they create: inflation. And, if you can’t buy the underlying commodities, buy those companies with claims thereon, especially if listed in the UK where you pay at least a 20% discount for similar assets doing similar things elsewhere. Perhaps this explains Canada’s current obsession with buying British wealth managers (Canaccord is the latest pursuer). Apparently Canadians know a thing or two about commodities. At least they should. 

60/40 is dead...according to the Fed and BIS

In this new world, bonds won’t diversify returns (to be fair, they never did except for the past 20 years). But don’t take it from me. Take it from Jerome Powell.  When asked his view why long-bonds yields were rising, Powell gave several suggestions recently, one being: “If we’re going forward into a world of more supply shocks, rather than demand shocks, it could make bonds a less attractive hedge to equities, and therefore you need to be paid more, and therefore the term premium goes up”. Earlier, the Bank for International Settlements (BIS) urged investors to “hunker down for an extended spell of unpredictability in global interest rates”. And in a warning to those expecting a return to normal: "business models, trading strategies, that were predicated on that assumption (of rates coming down quickly) are particularly vulnerable to current conditions". The better “alternative” is not PE or PC (the key is in the name) but supply-constrained real assets. Like gold.

Gold and reserve assets

Since gold has no yield the opportunity cost of holding it is high when real rates are positive. So why is gold so strong now? Could it be forewarning of a future where the Fed is forced back into the market to control the curve, in turn supressing real yields? Or one where the volatility of said bonds – the world’s reserve asset – rises to such an extent it forces central banks to search for safer alternatives? Assets that are not anyone else’s liability at the end of a credit cycle. Well, the latter may already be happening. According to Tavi Costa of Crescat Capital, for the first time in 45 years US Treasuries have exhibited higher downside volatility than gold. At 15-20% of current reserves, central banks have a long way to get back to their long-term average (40%), further still to the level of the ‘70’s: the last time we had a sustained period of inflation volatility.

Gold’s dirty little secret

The problem with gold is the little known fact it’s the most carbon-intensive material in the world according to consultant TSE. By this measure, it’s worse than silicon carbide and polysilicon, suggesting even bitcoin could be the ‘cleaner’ store of value. Silver, which is critical in solar production, is the third-highest. Now, of course, gold and silver are not alone in this. Many other products have carbon-intensive supply chains, although some we consider to be ‘clean’, ‘green’ and ‘good’. This façade is slowly disappearing however. This is thanks to the efforts of story-tellers (Ed Conway’s Material World), academics (Shue and Hartzmark) and now progressive legislators. Earlier in October, California’s Governor Newsom passed legislation requiring any company generating more than $1B to start disclosing Scope 3 (i.e. supply chain) emissions by 2027. Shining a light on such might, if little else, force a rethink about what we consider to be ‘green’ and ‘good’. It might also encourage companies to think more about ‘insetting’, the potential Next Big Thing in carbon reduction, according to the FT. Such tools could expedite the decarbonisation of dirty supply chains and the fortunes of transition plays: those travelling from brown to green. Supportive context, I suspect, for what I believe to be one of the greatest value transfers in markets: out of expensive tech, into cheap and rare industrials/commodities (the US vs UK, Brazil, Japan or Apple vs every miner on the planet).

Disappearing into reality

ESG is facing an identity crisis. Demand is colliding with pressures for legitimacy and now performance. Since I wrote An Inconvenient Truth (unless you’re British) we’ve seen more US states actively oppose investing in ESG, Blackrock has dropped the acronym in fear of politicising it, and now the SEC has dropped it from their list of compliance priorities for 2024. Aswath Damodaran in the FT argues ESG is beyond redemption and Bloomberg’s weighed in with The tyranny of ESG has run its course, arguing “if it can't make you money, it can't last”. Outside those managers actively pursuing Transition or Impact strategies (who unsurprisingly are seeing inflows) many now view ESG more from a process perspective, than a product one. I expect we see more money flow towards engagement or abatement strategies. For example, Artemis have converted a European sustainable fund into non-sustainable strategy to provide "a wider opportunity set". Another firm I know has created an ESG ETF that negatively-screens out non -ESG stocks, but includes fossil fuels; see the PWP ESG ETF. Their muses? Shue and Hartzmark.

Now, just imagine if this caught on more broadly. What might that do to oil stocks – that is, if there are any left after the industry seems to be disappearing into itself? E&P companies are arbitraging their high multiples by locking in high prices to take stock in cheaper companies still geared to higher oil prices. Take Hess, which is up 160% over five years and trades 2x the market multiple of Chevon, who despite absorbing this are increasing their own buy-back to $20B (Bloomberg). In other words if you, transition funds or abatement strategies don’t buy these shares, they might simply buy themselves.  

Finally, to repeat sentiments in the previous edition of The Weekender and once again end with a statement of the obvious, the movements of markets seem of trivial importance compared with the value of human life. I write with thoughts and prayers for all friends and colleagues impacted by recent saddening events in Israel.

Thanks for reading.