Capital Flows and Asset Markets
Capital Flows and Asset Markets
YOU CAN'T HANDLE THE TRUTH
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YOU CAN'T HANDLE THE TRUTH

Or why young and old managers outperform middle aged managers

1992 film “A Few Good Men” is a classic. Jack Nicholson, Tom Cruise, Demi Moore, Kevin Bacon and Kevin Pollak are all fantastic. And the scene we all remember - Tom Cruise demanding the truth, and Jack Nicholson telling him “You can’t handle the truth”. The irony of this statement, where Colonel Jessup tells him the truth - that you don’t want “nice” guys to be soldiers on the front line, makes him the perfect bad guy - as you can understand why he does what he does even if you don’t accept it. The irony of this scene is that Daniel Kaffee then gives Jessup a truth that he could not handle either - that no one is above the law.

One great things about markets is that there is always a price - and that price in the truth. Fund managers only get into trouble when they don’t believe the price - when they can’t handle the truth. The long bull market in the US has had many underpinnings. Share buybacks, a very forgiving Federal Reserve, supportive tax policy, deficit spending, nobbling of Chinese competitors, but the truth, which I chose to ignore was that US political system is set up to be very supportive of large corporates. Even when I read Lina Khan’s papers on the Amazon Antitrust Paradox, I took from it that US regulators will tolerate almost any business activity as long as prices to consumers do not rise. The corollary of this policy, is that businesses that serve other businesses are able to build cartels with relatively little regulatory scrutiny. App stores make money from other businesses, as does Google and Meta. Same with Visa and Mastercard. Thinking of tech as cartels makes understanding these charts make more sense. In 2000, the US moved against Microsoft, and perhaps recent moves against Apple will be a new watershed moment. But the price today is that the end of cartel systems is not the “truth” - not yet at least.

Thinking of a cartel boom, rather than a tech boom helps us square tech performance against the recent performance of the ARK Innovation ETF. The truth is that large cap stocks have dominant positions, pricing power, while also buying back shares. ARKK Innovation ETF is not invested in established cartels, and so the truth is plain to see.

For many years bonds were telling the truth of deflationary government policies. I did well when I embraced the deflationary message of JGBs. For years investors and traders had called the JGB markets a bubble, or irrationally priced, but in this case I could handle the truth, I embraced its message and prospered.

The problem for middle age managers is that truth changes. A very good example of this is Italy. In the early 1990s, Italy needed to pay a big premium of German bonds. Obviously, Italy was not Germany, and was far riskier investment. And then the Euro was introduced and Italy came to be seen as risky as Germany - and this was the truth at the time. Now what is interesting, is that from 2006 onwards the market was saying that Italy was not as safe as Germany, but I remember clearly that middle aged managers kept buying Italian debt, as they spread “was a bargain”. They could not handle the truth - which is that Germany was not offering unlimited backstops to Italy. If I was asked what the truth of current pricing was, it would be that the market reckons Italy is too important to be cut loose by the EU, but there is always a risk that spreads may be allowed to widen to teach them a lesson.

Having been around awhile, I often think that the best opportunities come from trying to find a truth that investors cannot come to accept. I have found old managers and young managers far more accepting of price action. Mid career managers often make their names by avoiding collapses, like the GFC or the dot com bust, or China or commodities in recent years, and typically don’t want the world to change. Older managers that have survived know that things can and do change, so have learnt to embrace it. What truth can people not handle? Almost certainly that interest rates and yields are going much higher. US 30 year treasuries yield 4.4%, which is high by recent standards, but look likely they are going higher to me.

Despite yields not being that high investors hare poured money into TLT - a long dated treasury ETF.

So why can’t investors handle the truth? Having talked to a lot of people in recent months, the truth is that most people have built their financial plans around yields staying low, or even worse have large mortgages that they cannot finance at higher levels. Of course young people, who are often renting, probably have no fear of higher interest rates, particularly if causes house prices to fall. Older managers will likely have paid off a mortgage. But it is easy to see how middle aged manager might reject the idea of higher interest rates if it would mean they need to change their mortgage plan or even worse, investment plans. Better to stay with what has worked for the last 15 years, right? 10% interest rates, you’re joking right? You can’t handle the truth.

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Capital Flows and Asset Markets
Capital Flows and Asset Markets
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