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Arete’s Observations 8/7/2020

By David Robertson | August 7, 2020

Market observations

One of the hardest things about managing this market is determining which price moves are informative and actionable and which ones are not. A huge part of the problem for long-term investors is that there is so much short-term trading and so much momentum that big moves can appear more meaningful than they are.

Major Market Buy Sell Review, Arete’s Observations 8/7/2020
Major Market Buy Sell Review, Arete’s Observations 8/7/2020

It isn’t exactly rocket science, but when something has happened “never times before” like the performance of gold over the last few weeks, there is a good chance the activity is extreme.

John Authers discussed the gold phenomenon at some length in his “Points of Return” email from Aug. 6. He revealed a model indicating “that fair value [of gold] has risen sharply to reach its previous record in recent weeks, and that the actual price is significantly higher.”

There are lots of different models that say different things, but this strikes me as about right. It also illustrates a couple of important investment challenges right now.

One of those challenges is reconciling how both gold and the Nasdaq can be realizing the same kind of parabolic appreciation at the same time. One possibility is that Nasdaq stocks are actually defensive, but that is a huge stretch. More likely in my mind is that reasons don’t really matter right now – flows do. What sets the price is simply a significant enough contingent of investors willing to chase a trend. Such inconsistencies are just one more indicator of how untethered from economic reality prices have become.

That raises another challenge. If long-term investors like the defensive characteristics of gold but are concerned about overpaying in the near-term, what should they do? It is an excellent question and there are no great answers. Primarily it depends on one’s current exposure and opportunity cost.

That said, when any asset becomes popular and people buy it simply because others are buying, those are typically not “strong hands”. In other words, when the going gets a little tougher, or when the price just stops going up so much, many of those people will sell just as quickly as they bought. In addition, such times are also often associated with forced selling which exacerbates any decline. These situations create much better buying opportunities.


In order to establish the most robust perspective on a subject, it helps to observe it from different angles. This is especially true in the economic environment right now when so many traditional metrics do not provide a clear view.

FEDUPBIZOWNER posted a terrifically insightful thread beginning with the tweet at the right on small business lending. In short, the banks aren’t doing it.

Major Market Buy Sell Review, Arete’s Observations 8/7/2020

Some of the highlights of the thread include evidence of a collapse in the pace of funding for small businesses, reluctance to lend even with the 80% guarantees of the CARES Act, and efforts to increase loan guarantees from 80% to 90%.

It doesn’t take long to appreciate just how “stuck” opportunities for small business growth are. It also doesn’t take long to feel sick about the role of banks in impeding progress. The irony is that by taking such hard positions on government loan guarantees, banks may also be sealing their own loss of autonomy in the future. Why should banks be allowed to earn any profit if the government takes the vast majority of the credit risk anyway?


It is interesting in hindsight that so many people and policy makers responded to the pandemic by simply suspending expectations for about three months and then expecting things to magically pick up where they left off.

While it was always possible for such an outcome to be realized, what was almost universally overlooked was that it would take good planning, communication, and widespread conscientiousness to happen. In short, expectations were established on hope and without giving any consideration to what needed to be done to execute on those expectations.

Now that it is obvious we came up short on all of these counts, a good baseline assumption at this juncture is that a second wave will emerge and will be even worse than the first …

Avoiding a Second Wave

 “there’s a growing likelihood that the remainder of the year – if we’re not careful – could bring far larger disruptions than most people seem to envision.”

“The problem is that the pool of infected cases has expanded again, and it remains large enough to keep us teetering right at the edge of a second exponential outbreak. It’s important to understand how bad this could get, and how quickly the situation could deteriorate in response to even a slight easing of containment – unless we shrink the infective pool first.”

One point is “the 1918-1920 influenza pandemic … occurred in multiple ‘waves,’ where the second episode was markedly worse than the first.” There are good reasons for this. An important variable is the size of the infective pool and it is larger the second time around. It’s really just math.

Another point is that policies and communications regarding pandemic response are still woefully inadequate and inconsistent. John Hussman has been one of a handful of people who have consistently provided useful insights. The commentary listed not only provides a helpful framework for managing transmission of the coronavirus, but also highlights some important considerations for reopening schools.

It is also interesting to observe that the phenomenon of establishing expectations based on hope rather than well considered plans is par for the course in the corporate world as well. The blurb at the right came out of the second quarter earnings presentation for Borg Warner, but is representative of many companies. The company provides high and low scenarios for production for the remainder of the year, but the low scenario assume there is no second wave. Doesn’t sound very low to me.

The triumph of hope over experience is also clearly evident in emerging markets. The FT published a good overview of the situation in Turkey on Tuesday noting “The government is betting that the economy will not be hit by a second wave of infections.”

The report goes on to quote Brad Setser from the Council on Foreign Relations who says Turkey is coming “about as close as it gets” to what he calls a “classic first generation emerging market financial crisis”. So, this is one more data point suggesting a slow-motion accident in Turkey. It is also part of a broader pattern of what at least appears to be a routine of either desperation or incompetence rather than effective leadership in response to the pandemic.

Commercial real estate

Almost Daily Grant’s, July 30, 2020

“According to the Manhattan Chamber of Commerce, overall foot traffic across the Big Apple is down 46% from its pre-pandemic levels.  As of last week, only 8% of employees at downtown office buildings managed by CBRE Group had physically returned to work.” 

“The buyer and seller expectations are not aligned,’ Simon Mallinson, an executive managing director at RCA, told Bloomberg last week. ‘Sellers aren’t being forced to the market because there’s no realized distress and buyers are sitting on the sidelines thinking there’s going to be distress’.”

“It’s becoming clearer, especially with the resurgence in [virus] cases across the country, that a three-month forbearance is not really going to satisfy the situation.”

There are several great insights in this one note from Grant’s. One is yet another indication of how much activity has declined in New York City, which seems to be bearing disproportionate harm from the pandemic.

Another is the state of limbo in commercial real estate nationwide. The data show “commercial real estate transactions fell 68% in the second quarter compared to a year ago”. Grant’s explains why: Three-month forbearance policies have delayed the realization of distress. Not only does this obfuscate metrics for monitoring current conditions, but also as I pointed out last week, “is a latent deflationary force.

The third point is a broader one. When the pandemic first started taking hold, it was reasonable to believe that it could be managed in a way that involved severe but short-lived constraints on activity. For a number of different reasons, this did not work and therefore transformed what could have been an acute challenge into a chronic one. This means different policies will now be required and expectations for a return to normalcy will also need to adjust. John Dizard explains this very clearly …

Hope will not save US commercial properties

“So CMBS sponsors and holders are killing time by creating two fictions for everyone to believe. The first is that the US only needs a month or two to get back to a V-shaped boom.”

“Commercial real estate will have to be entirely restructured in the US. More equity and less . . . hope. Starting next year.” 

Systemic risk

Ex-BoE deputy governor fears ‘utter mayhem’ from clearing house reform

“Their vital role, standing between parties trading trillions of dollars a day and dealing with defaults, has raised concern that they are ‘too important to fail’.”

One of the big problems in the GFC was transmission of risk through the financial system. One institution would become weak or collapse and suddenly several other organizations were also infected. As a result, a core effort by regulators since then has been to reign in systemic risk.

Many of the areas – bank capital, interconnected organizations – have been addressed if not completely resolved. However, in the efforts to shift risk from banks to capital markets, the sources of systemic risk have also shifted in the direction of clearing houses.

It is true that they “are absolutely at the centre of the modern financial system” and it is also true that “there would be utter mayhem” if one collapsed. Although this story has not made headlines, it has not escaped the notice of astute market observers either. Four years ago, for example, John Dizard raised the issue in the FT where he recognized: “The problem is that in volatile or discontinuous markets, clearing houses do not eliminate risks, but rather concentrate them on the clearing house’s own balance sheets.”


The graph at the right from the does a nice job of capturing where inflation is in the mindset of the general public. Clearly, the amalgam of public policy initiatives and increasing commentary on the subject have done more than just restore concerns about inflation to earlier levels, but have raised them to even higher levels.

Major Market Buy Sell Review, Arete’s Observations 8/7/2020

While this is certainly consistent with what Russell Napier has been saying (see Public policy), another eminent economist, Gary Shilling, is emphasizing the short-term impact from the pandemic. He thinks a “second wave” of deflationary forces are in store. While the two views are not necessarily very far apart, it will be interesting to watch the tug-of-war between inflationary and deflationary forces in upcoming months.

Gary Shilling: Stocks May Start Sliding About 7 Weeks From Now

“The recent Treasury bond rally fits with our forecast that the recession has a second, more serious leg that will extend well into 2021, despite massive monetary and fiscal stimulus.”

Public policy

Central Banks have Become Irrelevant

“But let me be precise: It will be governments who will act to stop bond yields from going up. They will force their domestic savings institutions to buy government bonds to keep yields down. The bit of your statement I disagree with is that central banks will put a cap on bond yields. They won’t be able to.”

One of the things about Russell Napier is that he is such a good thinker and careful communicator that his presentations are often so rich as to demand a couple of passes to fully appreciate. In my latest blog post I focused on Napier’s belief that control of the money supply is shifting to governments – and that shift will eventually cause inflation.

What I didn’t have room to expand on in the blog are the subtle implications of how financial repression will be implemented. As Napier states, “governments … will act to stop bond yields from going up”. Governments, not central banks. This is a key distinction. Politicians, not central bankers.

The way governments will act to suppress bond yields will be to “force savings institutions to buy government bonds”. In other words, these institutions will be forced to provide so much demand for Treasuries to overcome flat demand from outside the US and still sufficient to suppress yields.

Mind you, these are the very same savings institutions that have been struggling to even come close to meeting their return targets that will allow them to satisfy their liabilities. Their futile effort to earn higher returns by investing in riskier assets like private equity, hedge funds, and real estate will be further obstructed by obligations to own even more low yielding Treasuries.

It is interesting to observe all of this. While most investors seem laser-focused on what the Fed is doing, which ultimately is not going to matter much, they also seem to completely overlook what the government is doing, which will matter a lot. It is almost like a magic act that employs intentional misdirection. Regardless of intent, it will be important to maintain attention on what counts.

Implications for investment strategy

Russell Napier: The coming credit crisis will be outside the U.S., MacroVoices, January 23rd, 2020

“So I think we can all go back and look at that period in history [1945-1980] as a sort of guide to what to do and how to invest and where to make money. Maybe I can just leave you with one idea of what some of the real winners of that period of history in equities, were companies with very large fixed assets.”

One of the broadly successful investment themes of the last forty years has been high duration because it benefits from declining interest rates. Stocks that have high growth and big potential payoffs far into the future fit the profile well. Platform companies that can scale quickly also fit the bill. Indeed, good times have been rolling for “asset-light” companies.

As the landscape transitions to a more inflationary one, however, “the winners and the losers are likely to be very different in this new world”. The new beneficiaries will be “asset-heavy” companies, especially ones that do not have substantial ongoing reinvestment needs.

Napier says this change in investment environment “couldn’t be more profound”. That sounds about right. Look across the largest stocks in the S&P 500 and how many have substantial fixed assets? Conversely, look at the asset-heavy companies and most of them are small and midcap names now.

Another interesting implication will be on the ESG field. Some strands of ESG rate asset-light companies highly because they inherently have less impact on the environment by having fewer tangible assets. If these types of companies begin to significantly underperform asset-heavy companies, it could cause a major re-evaluation of ESG principles.

One of the implications I am most confident of is that there will be a massive reordering process that will wreak havoc on passive portfolios that have no way to respond.


This publication is an experiment intended to share some of the ideas I come across regularly that I think might be useful. As a result, I would really appreciate any comments about what works for you, what doesn’t work, and what you might like to see in the future. Please email comments to me at Thanks!        – Dave

Principles for Areté’s Observations

  1. All of the research I reference is curated in the sense that it comes from what I consider to be reliable sources and to provide meaningful contributions to understanding what is going on. The goal here is to figure things out, not to advocate.
  2. One objective is to simply share some of the interesting tidbits of information that I come across every day from reading and doing research. Many of these do not make big headlines individually, but often shed light on something important.
  3. One of the big problems with investing is that most investment theses are one-sided. This creates a number of problems for investors trying to make good decisions. Whenever there are multiple sides to an issue, I try to present each side with its pros and cons.
  4. Because most investment theses tend to be one-sided, it can be very difficult to determine which is the better argument. Each may be plausible, and even entirely correct, but still have a fatal flaw or miss a higher point. For important debates that have more than one side, Areté’s Takes are designed to show both sides of an argument and to express my opinion as to which side has the stronger case, and why.
  5. With the high volume of investment-related information available, the bigger issue today is not acquiring information, but being able to make sense of all of it and keep it in perspective. As a result, I describe news stories in the context of bodies of financial knowledge, my studies of financial history, and over thirty years of investment experience.

Note on references

The links provided above refer to several sources that are free but also refer to sources that are behind paywalls. All of these are designed to help you corroborate and investigate on your own. For the paywall sites, it is fair to assume that I subscribe because I derive a great deal of value from the subscription.


This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization’s particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

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David Robertson CFA is the CEO of Areté Asset Management and founded Areté with the mission of helping people to get the most out of their investing activities. Most of his career has focused on researching stocks and markets, valuing securities, and managing portfolios for mutual funds, institutional accounts, and individuals. He has a BA in math from Grinnell College and a Masters of Management from the Kellogg School of Management at Northwestern University. Follow Dave on LinkedIn and Twitter.

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