Luis Arenzana

Annus Mirabilis?

"Soon safe-deposit boxes are going to be a unexpected, albeit small, bonanza for banks. None of this bodes well for Euro sovereign bonds which low yields underpin so much of the current financial euphoria"


Annus Mirabilis?
Foto: Koji Sasahara| AP
Luis Arenzana

Luis Arenzana

Llevo 31 años subido al andamio de la industria financiera, los últimos 25 gestionando patrimonios. He vivido en Nueva York y en Londres, donde he tenido la gran suerte de conocer y trabajar con algunos de los mejores inversores de nuestro tiempo. A ellos y a mis socios les estaré siempre agradecido por la formación que he recibido.

Central bankers are far more comfortable about their ability to tame inflation than their powers against deflation. Other policy makers would be well advised to understand the political and social consequences of deflationary periods. This was certainly not the case in the wake of the great Financial Crisis as political leaders on both sides of the Atlantic embraced austerity drives too soon.  They did not seem to remember that Hitler’s ascent to power in Germany took place in a deflationary period perhaps because for decades the least principled Austrian School economists have misconstrued that period as a consequence of a hyperinflationary episode that took place many years earlier after WWI.

Hitler himself reflected that Chancellor Bruning’s austerity policies “help my party to victory, and therefore put an end to the illusions of the present system.” Austerity policies following the lost decade of the 1990s led to the rise of populist or communist nationalists in South America since the early 2000s. Austerity fuelled the recent political fracture in the periphery, which has led to Communists joining the Governments of Italy, Spain, or Greece for the first time and the rise of nationalist right wing parties in Germany, France, The Netherlands, and other countries. David Cameron’s austerity helped sow the ground for the success of the Leave vote in a non-binding referendum that became binding. The austerity policies of a Republican majority in both houses of Congress during Obama’s second term, propelled Donald Trump to a victory in what is for now his first term in office.

Thus, when many Governments decided to bring economic activity to a halt in order to prevent the collapse of their public health systems, they felt compelled to support taxpayers generously with future taxpayers’ money thus exacerbating the generational gap in incomes and wealth between baby boomers and the rest of us who are politically and otherwise, second-class citizens. Why do we say this? Just think for a minute about the inconvenient truth that while wages and salaries have remained stagnant in many countries since the GFC, pensions are often indexed to inflation with a floor at 0% increase even when inflation is negative. For instance, Spanish retirement pension benefits have increased 30% in real terms on average since 2007 while wages on average are 10% lower in real terms.  With the dependency ratio skyrocketing as the rate of ageing of the population is one of the highest in the world, we are not sure where this trend leads, but we would not take any risk. Thus, if you are young or wealthy in Spain the best course of action may be to move abroad while you can.

As further evidence of senior citizens’ political might we need look no further than their ranking at the top of the order of priority for vaccination.  Today, Spanish newspapers’ front pages display a photograph of a 96-year-old woman receiving the first Pfizer vaccine shot in the country. This is demagoguery at its worst.  If the policy goal is to prevent the collapse of the health system, it might be more practical to vaccinate first all health workers as well as those who are in direct contact with numerus people on a daily basis.  This group would include supermarket workers, bank tellers, taxi drivers, all delivery people, as well as employees of the hospitality and travel industries. Inoculating a 96-year-old woman first makes for a great Christmas headline, but it will do very little to reduce the rate of contagion. On the one hand, the number of social contacts that this person may have is likely to be low, and on the other hand, the efficacy of all vaccines decreases with the age of the patient. Pfizer has thus far provided no data on the efficacy by age group.  The use of military convoys to transport the vaccines at an unknown and unverifiable cost is one more reason to believe that the Spanish Government is staging a vaccination Potemkim Village. In the US, they make do with shipping the vaccines via UPS. The reality is that Spain has very few doses for the time being and therefore this low scale vaccination drive will have close to no impact for some time on the overall rate of transmission in the population, the famous R.

Many countries used triage protocols at the outset of the pandemic whereby access to ICUs or to hospital care in general was denied to certain age groups.  This was no wanton decision by faceless and heartless bureaucrats; it was a well-established protocol which ethics were previously reviewed and vetted by many parties from all disciplines. This policy applied in the UK, in the State of New York, or in Spain with unforeseen negative public opinion consequences. Why would this policy be any crueller than sending 18 year olds to the front in a war?  In an age of widespread amorality, prioritising very scarce medical care to those who had the highest chances of benefitting from it became anathema. The average age of the deceased from CoVid in developed countries remains well above 75 years old. In ancient times, this would have been interpreted as a sign of the benevolence and the powers of the forces of Good in their battle against the forces of Evil. Today, we are told this outcome is terrible. In any case, if our societies were truly compassionate with the plight of our elders, we would never have left senior citizens alone during their last few days. “I will keep them (the sick) from harm and injustice” remains the outmost responsibility towards the patient in the Hippocratic Oath. How is a patient not suffering irreparable psychological and physical harm when confined in isolation against custom and their will?

We are afraid nothing good may result when it is in the hands of a political class not very different from that which first contributed to the Great Financial Crisis. Embracing banking deregulation without any understanding of banking or regulation turned out to be a major problem. Subsequent perverse fiscal austerity policies that withheld social spending benefits when most needed pushed some societies to the brink of civil strife.  Today, politicians apparently believe that the sky is the limit for how much we should borrow from future generations. Inevitably, this borrowing binge will lead to inflation or a deflationary depression, but that will become somebody else’s problem.

There are differences, though. While the Congress of the US insists on putting money into people’s pockets so that they may spend it as they see fit, Eurocrats have designed a scheme that will convert a countercyclical Keynesian stimulus into an experiment in social engineering and centrally planned economy. We augur a very bad ending to this course of action. Yet, financial repression coupled with some promising technologies is propelling the value and the valuation of financial assets to new highs even when, or perhaps because, the average company has never had more debt on their books. Global stock markets have an equity market value of at least $95 trillion, an all-time high; we may safely assume that the equity value of private companies is at least another $50 trillion.  We estimate that banks account for $6 trillion.  Bank for International Settlements (BIS) date reveals that the amount of debt outstanding for non-financial corporates is $202 trillion (this may be a low-ball figure for all financial liabilities because not all companies include leases as of today). Thus, we have a Global Firm Value of c. $345 trillion, which compares with Global Corporate non-financial corporate profits before interest and tax of $3.5 trillion (source FRED).  Even more interestingly for a number of years a new phenomenon adds complexity to valuation. Private companies are routinely valued at higher multiples than public companies, thru the standard exit strategy for crystalizing the value of a private investment is no longer available and thus many private valuations are vetted by private sales.

Finally a word on technology. Transportation as a Service (TASS) is not a new idea. We first read about it in several years ago when it was met by general indifference. In 2020, Tesla has been anointed the winner of the TAAS revolution and the energy source revolution both. Exxon developed lithium batteries in the 1970s because management feared peak oil was close and they wanted to remain in the mobility industry.  Soon after, we saw the biggest decline in oil prices in modern history as high oil prices made offshore and tar sands reserves economically viable. Elon Musk got excited about electric vehicles in 2003 when he was pitched an electric aircraft business plan over lunch by J.B. Straubel and Harold Rosen, and the former mentioned how he could pack ten thousand laptop batteries into a car. There were more EVs than ICE vehicles on the road until Henry Ford revolutionised manufacturing and rolled out the Model T in 1908.

Very few people in the energy industry saw initially the impact of shale oil and gas. By the time they saw religion and invested hundreds of billions, shale soon became a bad investment. Nothing works best to decrease investment returns than massive capacity additions. Yet, many people are throwing caution to wind investing hundreds of billions in renewable energy projects that only work on paper. In other words, fortunes are easily made and easily lost when investing in new technologies.  The net result to society is reflected in the growth in productivity. In spite of all the hype about the Internet and the mobility revolutions, productivity growth in developed economies has been falling steadily for decades. As it turns out, no recent technology has an impact on productivity anywhere near those of the railroads, electrification and refrigeration, commercial aviation, or the Interstate Highway System. Perhaps this is because the base keeps going up and it is harder to move the needle, perhaps because internalizing functions that were hitherto specialized is self-defeating, even detrimental, to productivity.  David Ricardo is certainly not in vogue in the Age of the Internet and the massive fiscal deficits. You will soon hear much about him, we are afraid. In addition, as was the case at the market peak in 2000, the market is currently discounting uncritically too many successes and paying whatever the asking price to participate. There aren’t enough profits in the foreseeable future for all of them because the World’s GDP is not large enough to accommodate such high revenue and profit expectations and because Global GDP will not grow fast enough either as the productivity increases and the supply of skilled labour are not large enough either.

A final word on unintended consequences. As the euro yield curve becomes flatter by the day in its sub-zero habitat, USD fixed income returns are becoming more attractive (hedged to euros). As are bank notes compared to Government Bonds. Soon safe-deposit boxes are going to be a unexpected, albeit small, bonanza for banks. None of this bodes well for Euro sovereign bonds which low yields underpin so much of the current financial euphoria.

We wish you all a Happy and Healthy New Year. We hope 2021 will become one of the best years in our lives as we regain the warmth that we used to enjoy in our frequent and carefree social contacts. We not only miss shaking hands, hugging, or kissing friends and family but also doing so with total strangers as you meet for the first time as sign of peace and goodwill.

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Brave New Financial World

«The issue here is that some monetary areas are more likely to reflate than others are. We have far more faith in the US or the UK reflating than we have on China or the EU doing so, unless China devalues or the euro breaks up»


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