One week / one topic: Goth Goldilocks

What happened?

‘Nihilistic investing’ has taken over. Nothing seemingly matters anymore:

• Not macro (growth slowdowns, tenuous employment data, ever-rising debt burdens, challenging demographics…)

• Not micro (expensive valuations, potential misallocation of capital on a gargantuan scale, refinancing cliffs…)

• Not geopolitics (I don’t even need to say it)

Over the last week, I had a chance to geek out with my colleagues for two days to discuss all things markets, and also to compare notes with two esteemed external strategists.

What stood out to me the most is that – while there is consensus that politicians will keep borrowing and spending no matter what, that the current debt trajectory is ultimately unsustainable*, and that this all likely ends in tears at some point – what to do about it remains unclear.

(*: my colleague Robert summarized the debt challenge very well here)

While the obvious path of least resistance is to inflate away the debt burden, markets remain nonplussed about the risk of structurally higher inflation.

Ultimately, the real challenge might well be that… this all makes sense?

In the near term, fiscal and monetary tailwinds are quite powerful and can keep propelling equities higher – while also putting a lid on bond yields, especially at the short end of the curve.

US financial conditions are a clearly imperfect gauge, but the below picture looks quite supportive.

While the cautionary tale of Chuck Prince remains very vivid, the recent ‘everything rally’ is hard to pick a fight with.

What can we do then, to balance remaining invested with not getting carried away?

Our observations

• Fundamentals: Financial transactions take place because people have different opinions about the price of an asset. Opinions, indeed… and for now, markets are not worried.

• Price action: What stands out to me the most remains the price action in gold. Fine, you can’t value it and it might be behaving more like a risk asset than a safe haven at the moment… but it is screaming that something big is going on.

• Investor beliefs: 90% of people think they are better than average drivers, so why should investors feel any different? Of course we are all going to head for the exit before other people… right?

So what?

The portfolio remains invested with healthy allocations to equities, but with intentional diversification across regions.

Implicitly, this reflects constructive views about Japanese and (certain) emerging markets equities, with an additional tilt towards non-US banks.

When it comes to fixed income positioning, we also remain well-diversified across regions – but with a clear preference for inflation-linked bonds, in light of the above observations.

Not too hot and not too cold, then… and the porridge just boils higher and higher.

Mood music: Metallica – Nothing Else Matters