Five years after the first pandemic of over a century, it is beneficial to remember how labor habits have been covered, leisure time has been reduced, and family relations have been cut due to the Covid-19 lockdown.
Similarly, restaurants, theatres and holiday trips are now lively once again to understand how the investment climate has fundamentally transformed.
Before the pandemic, production and inflation had little volatility. But the Covid-19 lockdown has changed everything. Central bankers have done well to curb subsequent surges in inflation without giving a significant increase in unemployment, but inflation has proven difficult to return to target levels. At the same time, higher volatility is becoming endemic in the market.
Much of this reflects the confused policy decisions of the new Trump administration in Washington. Most notably, it relates to on-off suggestions to impose 1930s-style tariffs on US friends and enemies. “We’re looking forward to seeing you in the process of TS Lombard’s Chief Economist,” said Stephen Blitz.
Despite Donald Trump and his ability to self-harm, we cannot escape the reality that geopolitics poses significant challenges for investors. But one of the immense benefits of the Trump administration’s unwavering commitment to NATO is that it has caused dramatic policy changes in Europe, particularly Germany. Friedrich Merz, the winner of last month’s German election, has pledged to retreat from his country’s longstanding fiscal conservatism and aversion to defensive spending by amending Germany’s constitutional debt brakes.
This is an incredible fork, part of the broader perception in Europe, and it means there is a need to significantly increase military and infrastructure spending. A postwar settlement, where Europeans enjoyed peace dividends that helped them fund a generous welfare system, encouraged funding for a generous welfare system while defence costs fell under the protection of US security guarantees.
After years of economic stagnation in the eurozone, this oceanic change has embraced hope that a financially expanding remarriage will bring Europe back to business. And after years of lower European stock valuations compared to the US led by the European defense sector, the surge in stock prices suggests that global capital is reassessing Europe’s outlook.
That said, a key factor in the market is the early period of the pandemic’s debt legacy and ultra-low interest rates. Public debt is at record levels across developed countries.
Government budgets will be further expanded by the need to support health spending and pensions in the aging population, along with higher defense and climate-related spending. Since the rise in inflation rates, interest rates have been normal, so the borrowing costs for all of this debt rise, causing pain and increased defaults as the debt is refinanced over time.
The good news regarding this interest rate normalization is that defined contribution pension plan members can earn substantial returns as they risk the pension pot by moving from stocks to bonds and cash before retirement. This contrasts with pre-pandemic times when bonds (probably safer investments than stocks) were seriously overvalued.
The bad news is that these levels of debt can become financially unstable. In the ruling of William White, a former economic adviser to the International Bank for the Bank of Settlements, continued inflationary pressures and higher real interest rates are likely to last much longer than most people currently expect. Therefore, he says there is likely to be a serious global debt crisis.
He also observes that all three recessions ahead of the pandemic were caused by financial disruptions, each continuing a long period of time when debt rises faster than GDP and asset prices are rising rapidly. This reminds me of how finance has become the heel of Achilles in the real economy.
Another notable change in the investment climate over the past five years is the complete victory of passive funds over aggressively managed funds in terms of market share. This has been a boon for private investors as it ensures that the very low fees of indexed funds will strengthen profits over the long term compared to the charging reserve funds, which have on average been independent in recent years.
An additional benefit of passive investment is that it eliminates home bias (investment preferences for assets in their country’s domestic market) with the most defined contribution pension funds that effectively invest in a benchmarked global equity portfolio. It tends to improve performance, but there is growing political concern about the pension fund’s neglect of UK stocks.
However, indexing involves new risks of investment concentration. The proportion of MSCI and MSCI US stocks has long been high for all countries’ global indexes. This partially reflects the enormous market capitalization of large US high-tech stocks, particularly the so-called “The Magnificent Seven,” Nvidia, Apple, Amazon, Alphabet, Meta, Microsoft and Tesla. As such, the market is vulnerable to the performance of only a handful of corporate giants. This also raises questions about systemic risk.
Additionally, Elroy Dimson, Paul Marsh and Mike Staunton of UBS Global Investment Returns have established that more than a century of investors have overestimated the initial value of new technology, overvaluing new technology and underestimating the old ones. Also, US stocks outperformed the European market from 2010 to 2020, but US performance has deteriorated in the previous decade due to Dot.com’s bubble and the bursting of the subprime mortgage crisis.
In short, we are in a new world of geopolitical friction, increasing volatility, increasing vulnerability to inflation, excessive debt, and comfortable equity valuations. How should investors respond to this toxic mix?
The top priority must be diversification and a more defensive portfolio stance. Modern Portfolio Theory (MPT) shows that investors can enhance returns and reduce risk if they add assets that are not correlated to their portfolios. This is the only free lunch for investment, according to the late MPT pioneer Harry Marcowitz.
What caught my eye was that even a highly diversified portfolio could not make money due to sudden market declines. In market crashes, stocks and bonds tend to move in lockstep. They stop correlated negatively.
This is today arguing about assets that were paralyzed during the pre-pandemic period: cash. Cash revenues were disastrous at the time. And in the long term, cash is below stocks and bonds. However, in an age of extreme volatility, it offers true diversification for bonds and equities. And in periods of low inflation, it is a highly valued repository. Therefore, for private investors, cash is a significant portfolio hedge in the current situation.
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Another obvious hedge against many post-pandemic high-risk post-pandemics is gold. Yellow metal is, in a way, a paradoxical safe haven. It is a purely speculative asset that does not produce income. As the great investment Sage Warren Buffet once stated, “Gold is dug out of the ground in Africa or somewhere else. Then we melt it, dig another hole, fill it again, and pay people to stand around defending it. There is no utility. Anyone who sees it from Mars will scratch their heads.”
Well, yes. However, gold takes a form that dates back to the ancient Greeks who associated it with the gods. And, as economist Willem Breiter pointed out, Gold was worth a positive value for NIGH in six,000 years, which became the longest-lasting bubble in human history. Its lineage means it is a genuine hedge in the current financial turbulence against future inflation and geopolitical risks.
The problem is that gold prices continue to reach new peaks despite the fact that the opportunity costs of holding non-revenue production assets have increased significantly with interest rates normalising.
This is probably not the time to head to the exit, especially as central bank reserve managers around the world are seeking an alternative to the dollar, the world’s financially challenged reserve currency. However, investors should recognize that gold prices tend to overshoot both upward and downward over the long term. Those who bought at the metal peak at the bull market peak in 1971-81 suffered more than half of the actual point of view in the next 20 years.
So, what is the quality of crypto as a portfolio hedge? The key point is that it has even less fundamental value than gold. Saul Eslake and John Llewellyn of independent economics say that these instruments do not represent claims (unlike stocks or mortgages) in relation to assets and do not have alternative uses (unlike gold, other goods, and property). They add that their primary use is to enable payments by criminals, allow payments to fraudsters, and provide more feed to speculators. They are worth only what their collective wisdom people think they are worthy of.
Meanwhile, Maurice Obstfeld, former chief economist at the IMF, argues that the underlying problem with most cryptocurrencies is that, with the exception of Stablecoins, they are separated from the real economy and operate beyond the scope of public policy. Therefore, they create significant uncertainty in financial transactions and provide an unreliable basis for economic decisions. He says even Stablecoins are just as good as the assets that support them.
Therefore, this is a very immature and low quality bubble compared to gold. But the judgment about that is complicated by Trump’s declaration that he hopes the United States will become the “planetary code capital.” This comes with many stories about the creation of a Bitcoin Reserve to purchase US government debt. Again, investors and speculators are hostages in potential policy making that is confusing. We encourage criminals and trusting retail investors to take a break from punting in bubble-up meme stocks.
My advocacy of an inherently defensive portfolio positioning is overly cautious and cautious. Good reasons to raise this issue include the outlook for a fiscal lift across Europe in light of almost certainly unsustainable debt-driven expansion in the United States under Trump and the shift towards accumulation of European defences. Equally important, we live in an asymmetrical world of monetary policy, rushing to put safety nets under the markets and banks when central banks collapse, but we do not impose a cap on rising asset prices. This is a potentially common anesthetic for perm bears.
However, the level of debt in developed countries is very high. Global debt hit a record high of 318 tons in 2024, according to the International Financial Institute, a banker’s trade institution. The meaning is that Bond’s vigilantes could make a comeback. If this is correct, we are heading into an era of interest rate instability and potential financial shocks, as the UK experience of the short-lived Liztrus government suggests.
In this new world, value has become less like a disaster than growth. Government bonds that provide positive real yields are no longer the pre-pandemic cemetery they once were. The boring stocks look modestly interesting compared to the Whizzy Tech stocks. However, in the face of unusually high uncertainty, mantras must be diversified. For many private investors, it was a 5 years of favourable wildlife. Now, cash should definitely be back on the agenda
