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01 October 2018

How to manage investment in a market with potential bubbles

Steen Jakobsen, Chief Investment Officer, Saxo Bank has a candid conversation with WEALTH Arabia about how investors should be approaching their portfolio this quarter

Steen Jakobsen

Is the global economy in a bubble? If so, how do investors navigate that?


First of all, we need to start discussing whether you can see a bubble or not. Mathematically it’s pretty simple—when things go super exponential, it’s a bubble. We don’t know when the bubble is going to burst, that’s not the exercise of Q1, it’s to tell people that everything is a bubble, except for agriculture, emerging markets as a relative value, and mining. Everything else—real estate, cryptocurrencies, and equities—everything is in a bubble. All of those businesses are driven by a huge dependency on debt issuance. We have $253 trillion worth of debt in the world today and we have no growth to show for it. The US Government is promising four to five per cent growth, which is never going to happen due to low productivity.


In the world right now there is an island called the stock market and assets. On this island, there is a party—the people there are beautiful, they are slim, they’re listening to good music, the sun is always shining. This island has no ferries to the mainland—the real economy. The problem is that we can stay on this island for a long time and ignore the people on the mainland, but the island is too small—once in a while you need to get provisions from the mainland. That provision has been debt but now there is no more debt to be issued. Now we’re going to have to build a bridge from the island to the mainland.


It’s a bubble. You can’t value anything when you have zero interest rates and infinite debt creation. As long as that exists, you have no bridge. What is the bridge? It’s the price of money, and the speed at which we issue the debt. The US Federal Reserve drives the price of money, but the first central bank in the world to tighten monetary policy is China. China’s PMI at this point in time is very bad, and we actually think China will slow down the rest of the world dramatically.


What is the current situation between China and the US, in your view, and how does that effect the situation you just described?


In geopolitical terms, we are already in a trade war. China’s export will go down to the US relatively, and will be rebalanced to other places such as India and the rest of Asia. There is a big recalibration of all trade flows, including dollar flows, in the world going on. Singapore’s Prime Minister said it best: traditionally you were able to navigate both sides of the rising China and economic power of the US. However, inside the next few years, he said, a lot of countries are going to have to decide whether they are with China or with the US. That is what’s going on.


The inability to reform, to renew the constant inequality and disposable income disparities, points to the fact that we are not getting solutions, we are getting scapegoats. The US’s current scapegoat is China which masks that the US is not productive. The tax law is nothing but amnesty for people politically to do the right thing—all the companies that should be talked about in monopoly conversations are making a show of taking money home to be good citizens. All of this is spin on spin on spin. 


The ferry to the mainland, to extend my metaphor, could be potentially high interest rates, the credit impulse, the change to credit, is negative. China has a credit impulse into the magnitude of minus 10 per cent. The last time we had this magnitude was right before the 2008-2009 crisis. China is 40 per cent directly and indirectly of the credit impulse or growth impulse of the rest of the world. Meanwhile, everyone looks west to the Federal Reserve, wanting to see whether they will do three or four rate hikes. Meanwhile, the Central Bank of China has already tightened monetary policy, President Xi Jinping has consolidated his power base, convinced they will be number one in the world. 


Are there any markets you find attractive to investors?


The only powerful play right now is Japan. It’s really gotten through such a crisis that there are cheap valuations relatively speaking. There are pockets of value that haven’t gone up in the latest cycle of debt, such as commodities, agriculture, and mining.


Are we better or worse equipped to weather another economic crisis than we were 10 years ago?


We’re worse equipped. Everything is highly leveraged. What people think is that we were saved by lower interest rates. We weren’t. The global economy was saved by China doing the biggest fiscal expansion ever in the history of mankind. Six months before the low in 2009, China was expanding the credit impulse massively, printing money, getting the public sector back online. The illusion is that the monetary policy helped, but monetary policy, every expert will tell you, is not proven to work. Everybody agrees that you cannot tell if quantitative easing (QE) works, but everyone also agrees that you have to do more QE if there’s another crisis. That’s what we’re left with! Central banks know they can’t prove that QE works. It cannot work, because credit can support a market but it cannot evolve it. You need to allow the business cycle to take place and let bankrupt companies go bankrupt. Instead what we’ve done over the last 10 years is to let all the businesses that shouldn’t be competing compete with all the businesses that can compete. You’ve crowded off productivity and innovation to keep businesses alive. It’s been about keeping jobs rather than creating jobs. All throughout many industries, it’s been about keeping and maintaining instead of creating. Leaders are worrying about maintaining the GDP per capita and the status quo of the current political systems.


What are your thoughts on cryptocurrencies? Is now the time to invest?


Cryptocurrencies are competing technologies. Only one will win. In my opinion, the cryptocurrency that will win has not been invented yet. What we’re seeing from South Korea, and what we’re seeing from national authorities from across the globe in the crypto space, is that to survive you need to be KYC (know your customer) compliant and every transaction needs to be public. Zero of the established crypto-world are able to do that. Secondly, no government will ever allow a competing currency to evolve. I think there will be a globally competing cryptocurrency, but I think it will be issued by someone such as the IMF or the World Bank, and it will be used with blockchain to control a global tax on corporations and a global tax on citizens, as it will allow you to reverse engineer every transaction that goes through on the ledger. Ironically, cryptocurrencies and blockchain will be used by governments to seize even more control over society.


How should investors be balancing their portfolio at this point in time?


Investors need to be proactive, and realise that we are in a bubble. You need to realise that there is a 50 per cent probability of a recession, and that’s important because the only time that you really lose money is in a recession with long-term assets. Recessions take away between 25 per cent and 50 per cent of your capital if you do nothing. I call this capital preservation mode. You’ve had a very good run, sometimes you need to be humble and realise how lucky you’ve been. My active strategy for wealth individuals is to do capital preservation—simply take your portfolio back to a balanced portfolio. I would go 25 per cent cash, which, if you’re dollar-based now, actually pays you two per cent. I would have 25 per cent in equities, with 50 per cent of that in emerging markets with an expected return of five per cent each. I would have mining in there as well, and on the commodities side I would have some gold, as always, silver, industrial metals for 50 per cent of that and the other 50 per cent in agriculture. I would then keep a fixed income portfolio tilted 50 per cent towards the US and 50 per cent in emerging markets. Some of the positive news in the world is South Africa, where you’re getting paid eight to nine per cent, the currency is cheap, and you can afford to make a play in that. Going into a 25-25-25-25 portfolio allows you to have cash if it goes down, a carry through the fixed income component and cheap commodities.


As an allocator, you only need to figure out the relative risk of assets, which, admittedly is not easy. An investor needs to rank the assets in their portfolio and say, what is the expected turn on equity? If you rank them in expected returns, you’re going to ask would you rather wager on something that has zero per cent upside or something that’s cheap and has a carry, such as mining where cash flow is improving and commodity prices are coming back up. In fixed income, look at the carry relative to the risk. With the South African rand for example, you have five to six per cent risk, but you’re getting paid eight per cent for it. If you’re in there long enough, you should be fine. It’s all about capital preservation, in my opinion.




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