The Dawn of a New Era

One of the most interesting things I’ve ever seen is occurring right now.

The European Investment Bank (EIB), according to Bloomberg, is selling “Digital Bonds” on the Ethereum blockchain. The EIB is the lending arm of the European Union. They are the biggest multilateral financial institution in the world and one of the largest providers of climate finance. Ethereum is the second largest cryptocurrency blockchain protocol, with only Bitcoin having a larger market capitalization.

This digital bond offering is the first of its kind. Goldman Sachs, Banco Santander, and Societe Generale are underwriting the offering, which consists of €100 million (roughly $121 million) issuance of two-year notes that are set to be priced next Tuesday.

The Ethereum protocol’s unique value-added proposition in the cryptocurrency/decentralized finance space focuses on their “smart contracts” which are embedded in the transactions on their blockchain. The long-term usefulness of these smart contracts are being tagged as revolutionary to the business world as they could save time and expense on any transaction that involves any type of contract between buyers and sellers. For instance, these digitized contracts could streamline the home buying process.

I find it beyond fascinating that the world’s largest multilateral financial institution, with a very large focus on combating climate change, has teamed up with some of the most powerful global investment banks for the first ever digital bond offering through a cryptocurrency protocol.

This is a clear sign that the dawn of a new era in finance is upon us.

Interest Rates

Yesterday, Fed Chair Powell gave a press conference to update the world on the Fed’s thoughts regarding monetary policy.  I have been a critic of Chairman Powell’s ability to communicate and, more specifically, his phrasing of things as it relates to the market.  I will never forget his careless comments in late 2018, which led to one of the worst 4th quarters in market history and the worst Christmas Eve trading day ever!

Nevertheless, I think he did a good job yesterday.  He calmed the market’s anxiety regarding the potential for interest rate hikes by reassuring investors that the Fed would not flip from an easy policy stance to a tight one.

However, I cannot for the life of me understand why any market participant feels that the Fed would move towards instituting any policy that would choke off the liquidity from the markets.  It seems completely clear to me that our debt-based global economy needs stable, if not rising, asset prices in order to function.  If the Fed were to begin a process of raising interest rates, then asset prices would be sure to fall, hard.  This, of course, is exactly what the Fed will do anything to avoid.

With this as a backdrop, I expect to see easy monetary policies for the foreseeable future, even if that means some inflation will be brought into the system.  The Fed would welcome some inflation showing up in our CPI numbers, as opposed to seeing asset prices fall significantly.  This bias towards easy money is something that I think will continue to provide fuel for the markets.

Central Bank Hubris

In late 2017, I wrote a research report entitled “Central Bank Hubris.”  In it, I quoted a line from C.S. Lewis and that quote was; ‘It is not the assumptions that are discussed in society that are dangerous, but the one’s that are implied.’

At that time, I felt the implied assumption in the market that the Fed (and other Central Banks around the world) was infallible and could do no wrong was a massive issue then. And to be completely frank, I think this situation has only gotten worse.

Because of this implication that the Fed was infallible, I wondered aloud in that report what a mistake by the Fed could look like. In fact, here is a quote from that piece…

“What happens if the Central Bankers make a mistake?” Looking beyond the accepted ideas of what a Central Bank mistake looks like, I can see that they already have made a mistake! And that mistake is that they have meddled so deeply into the functioning of the markets that there is no way they can stop without completely disrupting the same markets they’ve been trying to “save.”  

This mistake of over-meddling is leading us down a path of massive money printing and currency debasement and a pile of debt that, in my opinion, can never be paid back. And with this, the door is open to things like Bitcoin, Modern Monetary Theory, and a strong basis for more and more Central Bank control of the economy.

In this type of environment, some asset classes and specific investments are truly attractive while others, even though traditionally thought of as essential parts of a portfolio, become truly unattractive to many investors over the long term.

Regardless, this market environment isn’t boring as we appear to be on the precipice of major social and geo-political change.

Valuation?

While watching CNBC the other day, I saw one of their guest speakers make a comment regarding the valuation of a stock she was talking about.  And her follow on comment regarding the valuation of the stock was, “if you care about that kind of thing.”

I think this comment embraces a lot of the sentiment in the market right now.

The Magic of the Central Banks

In our research, we’ve been mentioning that we believe the most powerful force in the markets right now are the world’s Central Banks.  And, in fact, we think the economic and financial maneuvers they are making are taking us further and further away from traditional economic principles.  These “new” economic concepts are designed to provide more flexibility and options for Central Bankers in their attempt to grow the global economy.

These new economic concepts can cause traditionally trained economists to have serious issues with how much debt the global economy has accumulated.  However, there are some interesting caveats and, dare I say, tricks embedded in their strategies.

Ask yourself this; our Central Bank (The Federal Reserve) has been accumulating assets on its balance sheet.  What happens when the U.S. Treasury bonds they own mature?

Well, one scenario is that the bonds mature and the Treasury makes good on their obligation to pay the principal to the Fed in full.  But if the Fed elects not to roll those funds into more bonds, they, by mandate, must pay that money back to the Treasury.  In this case, the bonds/debt disappear and the Treasury is paid back in full.

Magic!

Update on the U.S. Dollar

In our last quarterly newsletter put out in October, we mentioned that the biggest risk to the United States financial system was the dollar losing its status as the world’s reserve currency.

Yesterday billionaire investor Sam Zell seemed to echo our thoughts almost verbatim and was widely quoted by many media outlets.

https://www.marketwatch.com/story/the-single-greatest-risk-facing-americans-could-hit-within-a-decade-billionaire-warns-11608578905

Keep an eye on the International Markets

As we’ve mentioned in the last newsletter, we thought International Markets would outperform U.S. Markets if Biden were to win the presidency. As we type this now, since the election, the S&P 500 is up 6.5% while International Markets (as measured by IEFA) are up 11.8% and emerging markets (as measured by IEMG) are up 21.5%.

One month is not necessarily a trend, but something to keep an eye on.

The Markets – Post Election

As we’ve been discussing all year, we thought the markets would rally after the election. After the election, the month of November saw the S&P 500 appreciate approximately 11%. This was one of the best months in stock market history.

However, two things to watch are 1) short interest in the market is at an all-time low and 2) November saw a record amount of cash flow into stocks.

Nevertheless, we think 2021 looks like a potentially great year for the market.

Election Update

Election Update – November 16, 2020

In regards to the election, we still do not have complete clarity on who will be president. However, the markets have been quite strong. We believe this is because it appears the government will be split; with the house controlled by the democrats, and senate controlled by the republicans. Generally, with a split government there is not a lot of radical changes and the market likes this. As we’ve been discussing, we don’t think the president impacts the markets (regardless of who it is) as much as people think because we believe the central banks are the primary driver of the market.