Absolute Return Partners letter for the month of February 2017. titled, “Who Really Knows? – An Open Letter To Howard Marks.”
“Forecasts usually tell us more of the forecaster than of the future.” – Warren Buffett
Each week during American football season the New York Post proudly presents the Bettor’s Guide to its readers. The Post’s 11 (so-called) experts advise the newspaper’s readers as to which teams to bet on. The Post introduced the service in 2015, and the results of the first full season covering 256 games were as follows:
- The best picker was right 55.1% of the time.
- The worst picker was right 48.8% of the time.
- On average, the pickers were right 51.6% of the time.
Flattering? Not really. One could argue that a coin toss would deliver a more profitable outcome after costs so, in that respect, it is not that different from our industry.
Absolute Return Partners - Crucified by Howard Marks
The example above is – almost word for word – taken from Howard Marks’1 most recent client memo, aptly named Expert Opinion (see here). It came through my letterbox a few weeks ago, and I began to read it almost immediately, as I almost always do when receiving his commentary. Howard is one heck of a smart guy. He is also very nice and very approachable – a true gentleman as I learned, when I ran into him in Munich a few years ago.
The gist of Howard’s recent letter is Who really knows? As he points out, we all spend so much time trying to figure out what is going to happen; yet little do we know how it will all pan out. Do I need to say more than Brexit or Trump?
When I put his letter away, my first reaction was to retire from writing. Then I started to think. What is it we actually do at Absolute Return Partners? Are we wasting everybody’s time by focusing on things that are, almost by definition, unpredictable?
If you have followed my writing for a while, you will know that I spend only a limited amount of time on cyclical trends. Why is that? Because I happen to agree with Howard that trying to predict currencies, interest rates or equity prices over the short term is largely a mug’s game (my words, not Howard’s).
However, there is another way, and that is what we do at Absolute Return Partners. We largely ignore shorter term cyclical and behavioural trends (we call those trends tactical trends) and instead tune into structural trends. Almost all of them are longer term in nature, so don’t plan to turn yourself into a day trader armed with the knowledge and information I am about to share with you.
Let me give you some examples but, before I do so, I should stress that the three examples below are only a subset of all the structural trends we have identified. I should also point out that we distinguish between what we call structural mega-trends and structural sub-trends.
The examples below are all mega-trends, and we have identified a total of six of those. In addition to them, we have also identified eight structural sub-trends. Think of the mega-trends as the trends that provide the big picture and the sub-trends as the trends that drive the investment strategies we end up investing in (or stay clear of).
I have written about all these trends over the years so, if you have been reading the Absolute Return Letter regularly for years, none of this will be new to you. The following trends are the three most important mega-trends that we have identified in recent years – at least as far as financial markets are concerned - and they are all likely to have a significant impact on financial asset prices in the years to come. They are as follows:
- The retirement of the baby boomers.
- The declining spending power of the middle classes.
- The end of the debt super-cycle.
Howard is not correct when he says – or at least insinuates – that no one really knows. We certainly know that certain things will happen, given the mega-trends just referred to. On the other hand, I would totally agree that none of these trends are of much use, if it is about guesstimating what is likely to happen to the dollar (or any other financial asset class) over the next few weeks.
The six mega-trends that we have identified again drive a number of sub-trends. I will give you an example of such a sub-trend, so you can see how these trends interact. Take the declining spending power of the middle classes, which continues to suppress economic growth. Governments will, as a result, be forced to put more emphasis on fiscal policy as opposed to monetary policy; i.e. that becomes one of our eight sub-trends.
That again has wide-ranging investment implications, the most obvious one of which is an emphasis on infrastructure via increased public spending. The beauty of this entire set-up is that ‘our’ structural mega-trends are certain to happen (most of them are actually unfolding as we speak), whereas the structural sub-trends that we have identified are exceedingly likely to happen so, in that respect, Howard is wrong. It is actually possible to make fairly accurate predictions about the future, as long as you approach the subject appropriately.
Can the US economy really grow as fast as Trump has promised?
Because of the shrinking spending power of the middle classes, because demographics are increasingly adverse, and because more and more capital that really should be employed productively is instead used to service existing debt, we know that economic growth will, with 99.9% likelihood, be quite soft for years to come.
That doesn’t mean we cannot enjoy a phenomenally good year every now and then, but it does mean that Trump’s promise to the American populace that he can deliver 3.5-4.5% annual GDP growth consistently is a pie in the sky.
Trump has already promised that he will reduce the tax burden; he has in fact declared that he will make tax cuts across the board – to individuals and to corporates. The Congressional Budget Office has done some interesting work around the current proposal, and they have found that – if implemented – the tax cuts will benefit the top 1% of income earners the most. No less than 75% of the proposed tax change will fall into the pockets of the top 1%, whereas the bottom 80% - many of whom voted for Trump – will hardly benefit at all (exhibit 1).
However, if you read the December Absolute Return Letter (see here), you will know that it is the spending power of the global middle classes – which would include the vast majority of US income earners – that needs to be boosted, if we want the economy to get going again, and Trump’s tax plans do absolutely nothing to fix that problem.
Adding to that, Trump also wants to reduce the corporate tax rate, but that is about the least effective policy tool he could come up with, if the intention is to accelerate economic growth. Where infrastructure spending leads to a significant increase in national income,