Spring weather here has been true to form: one moment ominous clouds are gathering, the next moment it is sunny skies and lemonade stands. Financial markets too, have been true to seasonal form. They started the year worried about inflation, only to rally strongly in January on the hopes of an end to rate hikes. Then, fears of contagion spread after the failure of Silicon Valley Bank, only to dissipate again, as optimism took root once more over rate hikes that are on their way out, even if the economy is not.
What to make of it all? What is becoming clear as the year progresses, is that the story of 2023 will likely not be runaway inflation. That is in part a testament to the Federal Reserve and Central Banks the world over, who were willing to break with their post-Financial Crisis orthodoxy of “low rates forever” and take inflation seriously. Whatever threatens markets this year – a recession, stresses in the banking sector, (ever-present) geopolitical uncertainty, or most likely something yet unknown – I don’t believe it will be amplified by ever higher inflation and interest rate hikes. That in and of itself is a big positive, because higher interest rates objectively raise the cost of money and thus the attractiveness of financial assets. Truth be told, higher rates from time to time are needed, to flush out speculation and inefficient allocation of capital like real estate booms built on cheap money, and stock market returns driven largely by price momentum instead of profit expansion.
For about a week in March, it looked at least conceivable that the isolated bank failures of Silicon Valley Bank and the crypto-exposed Silvergate and Signature banks, would lead to more bank runs and stresses on the financial system. That did not happen. Rather, it is now clear that in addition to explicit FDIC insurance, there is an implicit deposit guarantee, as the Fed, regulators, and the big banks showed their commitment to shore up deposits for regional banks, if push came to shove. First Republic Bank was essentially bailed out by the Big 4 US banks and Credit Suisse was unceremoniously absorbed by UBS, showing that both regional and global bank failures will be resolved without sticking it to the depositors. You can read more about SVG’s failure on our website: https://bit.ly/SVBfailure
Investing in Democracy
In my last newsletter I wrote about ESG investing and how it is panned across the political spectrum for either its perceived wokeness or conversely, its greenwashing. Maybe ESG’s biggest failure, apart from being ambiguously defined and therefore easy to knock, is that in trying to please all it pleases none. If you want to invest with your values or de-risk your portfolio from corporate behavior that risks a company’s social license to operate, you should just do so and “yes” I think you can do equally well as investors without that “constraint.” The more targeted you can be, perhaps the more impactful your choice. ESG’s broad strokes certainly leave much to be desired.
One such targeted investment approach I recently came across is an exchange traded fund (ETF) managed by Democracy Investments (DMCY). This fund builds a globally diversified portfolio with country exposures weighted on the basis of a country’s democracy score according to the Economist Democracy Index. Whereas no industry would be excluded from this fund, it geotags companies on the basis of where their operations are, not necessarily where they are incorporated. If one’s overriding concern from a risk or values perspective is exposure to authoritarian societies then such a targeted approach might be of value. It also rewards countries for becoming less authoritarian as it would increase exposure to a country as it increases its democracy score. Not for everyone, but therein lies its strength in the ESG fund space.
For many of our clients we can target their specific values, risk concerns, and preferences with individual stocks. It is harder to do with funds, as they try to find the elusive common denominator: the values and risks that the greatest number of investors care about. Perhaps more fund managers like Democracy Investment will emerge and a broader set of targeted offerings will improve the ESG fund landscape.
For the record, my mention of DMCY does not constitute an investment recommendation. Rather, it is an interesting approach that I thought I would highlight in light of my recent ESG commentary.
Most Americans Have Not Saved Enough for Retirement
From time to time, I come across an article that highlights the dismal state of retirement savings and how many older Americans have little in the way of a retirement nest egg. Some of those articles or surveys are self-serving as they come from the investment industry itself and are thinly veiled calls to action to add money to retirement accounts. I feel conflicted because my business thrives on increased private retirement savings. At the same time, if we could turn back the clock, I wonder how many more folks would be looking at a well-funded retirement if they were still covered by traditional pension plans and had not been left to fend for their own retirement through private vehicles like 401(k)s and IRAs. Someone who receives even a modest pension of $3,400 per month would have roughly the same retirement income as someone who had a $1 million retirement nest egg and was taking a 4% withdrawal rate, widely considered a sustainable withdrawal rate. That is about 10x what the average Baby Boomer – the generation currently aged 59 to 77 – has in retirement assets, according to a study conducted by Natixis Investment Managers. An even more jarring statistic from a Credit Karma survey recently published: nearly 1 in 5 Americans aged 59 or older have zero dollars in retirement savings. A similar percentage of that age group reports a $0 net worth.
If you start young enough, save enough throughout your working years, invest it wisely, and life does not get in the way, you might very well build a nest egg that can generate a retirement income greater than what a pension fund might have provided for you a generation ago. But those are a lot of ifs.
Lest I sound depressing, I do think there are always ways to move the dial and improve your financial picture in retirement. A nest egg under $500,000 can supplement social security income and provide for emergency funds. If you have between $500,000 and $1 million, a more generous retirement might be possible if you offshore it (i.e., retire abroad). $1-$3 million can fund the retirement you see in the brochures: gracefully aged, smiling retirees on the beach with a dog, or perhaps lakeside in an Adirondack chair, glass of wine in hand. In my experience working with clients saving for or in retirement, there is no dollar figure below $10 million where someone feels totally free from having to think about money wisely. And even $10 million doesn’t unburden one from having to think about money, perhaps in a different context with legacy issues adding complexity. Whereas it can be challenging to solve a retirement puzzle, I find it both interesting and rewarding. I cannot wish pension funds back into existence, but I derive meaning from helping folks realize a retirement that is better than perhaps they thought was possible.
Goodbye Crypto, Hello AI
I have felt compelled to talk about crypto currencies on occasion in this newsletter, perhaps more than I should have. Crypto is no longer top of mind for investors and has been displaced by AI, much like some fear we will all be. I am happy to move on from crypto, as I never felt like the expert and always like a bit of a crank in my skepticism. I have had several client conversations in the last few months about AI and how to invest in it. I am not (as much of a) skeptic when it comes to this latest investor infatuation, which both worries me and makes me feel like I get it for once.
To be sure, I think AI is a gamechanger, possibly a technological leap forward on par with the internet, which has real world applications and yet unimaginable future use cases. Which AI companies should we invest in? Well, if AI were truly intelligent it would probably make more sense to ask AI what AI to invest in and I can pack it up. But we are not there yet, in terms of making ourselves obsolete, outsourcing human thought, and putting everything on autopilot. Nor do I think that is necessarily where we are going.
It is not hard to imagine a dystopian AI future: self-driving cars – though safer – get to make life or death decisions, justice is adjudicated by algorithms, all art forms are computer generated, white collar work is only modestly intelligent and thus replaced, and labor is fully automated out of existence. Then again, perhaps AI anxiety is just a refreshed version of our age-old fear of being replaced by machines. To me – perhaps taking the glass half full – I think AI is more about enabling human potential by placing very powerful data processing tools at our fingertips that give us insights heretofore obscured by complexity, save us time by speeding up routine tasks that are just glorified internet searches, and unconstrain our imagination and creativity. Case in point: I have digressed too far already, letting my imagination run wild, so let us get back to the realm of investing.
As would be typical of nascent industries, the most promising investments are likely early stage, venture capital funded businesses. There are some publicly traded pre-profit companies as well and beyond that, many of the large tech players have meaningful AI exposure. To invest in standalone AI companies in the hopes that they are the golden ticket, is a risky proposition. It is difficult to make money in industries with a high rate of change, because today’s leaders may not be the companies that will profit from tomorrow’s AI. So, whether private or public, I would be careful not to go all in on any one AI company. If you shouldn’t go “all in” on any one AI company, should you go “in all”? There will be – probably there already are – thematic funds that will gladly take your money and invest it in a broad set of AI opportunities. But this probably won’t work either. There will be winners, but also a lot of losers and historically the home runs don’t make up for the losers in funds that invest (passively) in their namesake theme. For comparison, I looked at funds targeting cyber security, blockchain, cloud computing, 3D printing, and Cathie Wood’s ARK innovation funds line up. The most common denominators I observed, were very high volatility and an eventual underperformance to the stock market, with the possible exception of cyber security.
So, is AI a big punt? No. I believe the best way for investors to participate in AI, is to look at some of the big tech companies with outsized exposure to AI relative to their peers. What is AI, if not data processing in overdrive? A beneficiary of the enormous computing power needs of AI is semiconductor company Nvidia. Alphabet and Microsoft are also clear leaders in AI, with enormous native data sets and the well-honed ability to extract value from that data. Moreover, they can acquire promising AI companies and succeed inorganically. Other big tech beneficiaries include Adobe, Crowdstrike, and Meta Platforms, with AI enhancing their ability to create content, snub out nefarious online interactions, and serve ever more targeted content, respectively.
But perhaps the biggest takeaway is that AI, like the internet, will touch everything. Therefore, in many industries, how proactively companies embrace it and invest in it to improve their own businesses will have a big influence on how competitive they will be in the future. From that perspective, AI is here to stay and something all investors should take note of, whether they are investing in it directly or not.
I made it my personal goal this month to finish my newsletter before King’s Day (April 27th). And to the other 99.78% of the world’s population who aren’t Dutch and have room on their bucket list: do consider visiting the Netherlands in April if you like tulips and regal festivities.
To schedule a time to review your portfolio or discuss financial matters, please do not hesitate to reach out: email@example.com, (650) 597-9798, http://www.calendly.com/jan_s
Jan P. Schalkwijk, CFA
JPS Global Investments