Weeks ago I read the following post, which hit straight into my soul (I left the original Italian version, you can find the English version straight after):
Quante volte negli anni scorsi abbiamo ascoltato o letto che Europa e Stati Uniti si stavano avviando verso la “giapponesizzazione”.
Fiumi di parole sulle similitudine demografiche, dei consumi, delle politiche monetarie e tanto altro.
Il #Giappone era visto come una macchina del tempo che ci stava spiegando chiaramente dove saremmo arrivati.
Gestori di #portafogli obbligazionari costruivano strategie su quella narrativa.
Il Financial Times nel 2019 si espose in modo inequivobabile con argomenti anche convinenti.
Ma quella previsione intercettò in pieno il minimo dei rendimenti del Bund tedesco 😁 .
Ovviamente nessuno oggi ha il coraggio di rispolverare quella teoria, l’onda mediatica non è quella buona.
Ma nessuno ha nemmeno il coraggio di dire che in #finanza non si può prevedere il #futuro.
A un certo punto accade qualcosa che fa deviare dal percorso ideale una teoria che sembrava a prova di bomba.
Se abbiamo puntato tutto su quella strategia purtroppo il #tempo è qualche cosa che non ci verrà più restituito. Il Financial Times continerà a vendere copie e nessuno gli chiederà conto dell’errore di previsione, ma il nostro #piano di investimento potrebbe uscire parecchio ridimensionato.
Quante volte ammaliati da personaggi carismatici abbiamo creduto al realizzarsi di uno scenario (quasi sempre negativo – vedi il celebre flop del picco di produzione del #petrolio).
Ci abbiamo creduto perché la fonte era autorevole, l’analisi convincente e affascinante, le idee confermavano che quell’obbligazione a 20 anni al 1% di rendimento appena acquistata era un’ottima idea, oppure che l’azionario cinese ci avrebbe permesso di ottenere #rendimenti superiori alla media dell’universo.
Quando l’ego si mischia al desiderio di agire a tutti i costi, convinti di poter prevedere il futuro, avendo tutto sotto controllo… la delusione è un sentimento altamente probabile nel lungo periodo.
E fare ogni tanto un tuffo nel passato, verificando i fatti, è un ottimo esercizio per avere la conferma se quello che stiamo portando avanti è un processo di investimento corretto e immune da opinioni e sbiadite sfere di cristallo. Lorenzo Biagi
“How many times in recent years have we heard or read that Europe and the United States were moving towards “Japanization”. Rivers of words on similarities in demographics, consumption, monetary policies and much more. #Japan was seen as a time machine that was clearly explaining to us where we would go. Bond #portfolio managers built strategies on that narrative. In 2019, the Financial Times exposed itself unequivocally with convincing arguments. But that forecast fully intercepted the minimum of the German Bund’s yields 😁. Obviously no one today has the courage to revive that theory, the media wave is not good. But no one even has the courage to say that in #finance you can’t predict the #future. At a certain point something happens that causes a theory that seemed fool-proof to deviate from the ideal path. If we have staked everything on that strategy, unfortunately #time is something that will never be returned to us. The Financial Times will continue to sell copies and no one will ask it to account for the forecast error, but our #investment plan could end up significantly scaled down. How many times, enchanted by charismatic characters, have we believed in the realization of a scenario (almost always negative – see the famous flop of peak oil production). We believed it because the source was authoritative, the analysis was convincing and fascinating, the ideas confirmed that that 20-year 1% yield bond we had just purchased was an excellent idea, or that Chinese shares would allow us to obtain #returns above the universe average. When the ego mixes with the desire to act at all costs, convinced that we can predict the future, having everything under control… disappointment is a highly probable feeling in the long term. And taking a dive into the past every now and then, checking the facts, is an excellent exercise to confirm whether what we are carrying out is a correct investment process, immune to opinions and faded crystal balls.“
I was such a stan of the “Europe is the new Japan” movement that at a certain point I’d have tattooed that on me. But this post is more than that, let’s unpack.
Trend is your friend
As I have expressed multiple times in the past, cherry-picking what just happened to rates is not 100% fair.
I have raised billions in debt for the companies I worked for in the last 15 years. Different companies, different countries, different sectors and yet all of them had one thing in common: at least a member of the Senior Management to whisper in my ear “Rates cannot go lower than this”. And yet they did, every single time.
Cannot recall how many times I have celebrated the issuance with the lowest coupon in company XYZ history. Like we had any merit in that.
Issuing (or swapping to) floating debt saved lot of interests to any company that did it for more than a decade. Conversely, investing in fixed income generated income and capital gains for investors for a long time (plus the diversification benefits when paired with stocks). You should always benchmark your statements against that. Yes, floating/short-duration debt is a choice that is paying now but tell me what you did in the past and what you are going to do in the future…cause I have a century of data that shows how long duration outperformed short duration.
And this:
It is really easy to mark a turning point after the fact, a bit less so when and where it really matters (i.e. outside social media). Sure, at a certain point rates had to turn but…how many times did you say that in the past?
We can always find an article, a cover that we can point to, after the fact, and:
That narrative floated around for such a long time not only because it made (at least partially) sense but also because it worked financially.
Why Europe might still be the new Japan
I was still living in London when TopTradersUnplugged hosted a couple of episodes with Cem Karsan and Alfonso Peccatiello around the outlook for inflation. Is a Japan-like demographic path leading to higher or lower structural inflation? They both have competing yet valid arguments. Then, it is not even sure that demographics will be the driving force. What if a country opens up (willingly or unwillingly) to immigration so that the demographic path would fundamentally change? What about monetary policy? What about fiscal policy?
What if in two years’ time we are back in a low inflation/low rates environment? Would an FT journalist pick Lorenzo Biagi’s post and go:
The “transitory inflation” debate might sound silly at this point to many but what if it turns like that?
High rates have not broken anything yet. Maybe in one year we will realise that the system was indeed choke-full of debt that it could not afford and rates would go down because of that. Who knows. Maybe the Europe = Japan was the most likely scenario and yet it did not happen. Do you remember Hillary having a 60% chance against Trump? Was it 60% or 0%? Brexit won by a few % and look where is the UK now…did it happen because of the referendum or because of the series of nut heads that led UK parties since (let’s not forget Labour was run by Jeremy Corbyn at a certain point)?
Passive Investing
Going all-in on a particular scenario or forecast is rarely a good idea. I am not here to poo-poo on Lorenzo’s post because I think his message was more of that kind and I agree.
But at a certain point, you as an investor have to make a decision. Ain’t no passive investing as such.
Often the mistake is to read it backwards, i.e. investor XYZ had duration in their portfolio…therefore they believed in the new Japan theory. I have duration in my portfolio because from an asset allocation point of view it worked in the past. And by “worked” I mean that it provided diversification, a portfolio with a better risk-adjusted profile. That is the best agnostic view I can take but I understand that agnosticism is in the eye of the beholder.
Think about all the discussions you read about Emerging Markets or commodities. There are plenty of investors out there who call themselves “passive” while they do not have any exposure to those assets. They have an opinion and it might turn out as the right one. Pursue the opinion witch hunt deep enough and you will end up with all your money in a weird place (hopefully under your mattress).
I understand that buying 10-year or longer bonds when rates were 0 feels extremely silly…today. The new Japan narrative might be the reason why some investors accepted, or justified to themselves, why they were buying those bonds. The wrong narrative does not invalidate the base case, if you wanna call it this way, though. Historically, the 10yr has returned more than the 1yr and provided a peculiar correlation profile to stocks. One day, maybe not tomorrow, maybe not the next month, the market will turn and high duration will pay again.
If having 10yr bonds was part of your “passive allocation”, keeping it was the right thing to do, narrative or not. Not doing it would be the opinion, the crystal ball thing. In other words, market timing. And the issue with market timing calls is that you have to nail the entry AND the exit points. The clock is on you: the more you wait to change your stance after the market turns, the more you are going to lose.
Question your beliefs and be open to changing your friggin mind
As I said, I was a firm believer in the Europe is the new Japan narrative. So much so that I put my mortgage, not my money, where my mouth was. For me, the mortgage was the biggest bet I could make.
These were my principles:
- floating debt is cheaper than fixed debt, all things being equal
- if rates fall further (see…Japan) I am happy
- if rates go up, they can only do so at a very moderate pace, given the amount of debt around
It was 2012 and I didn’t foresee any reason why inflation would explode. Do you recall PIMCO’s New Normal? I was “enchanted by the charismatic character of Bill and Mohammed” but…I also had a plan if rates would go up. I just did not have one if rates would explode 😉
I bought my first apartment in Luxembourg that year with a floating-rate mortgage. The plan was to buy it back/renegotiate it if and when rates would start to go up. At the time, I was managing a billion in cash instruments plus 250 million in bonds so, willingly or not I had my eyes on the ball. In my professional life I had to take a stance on rates (or at least pretend to in order to justify my salary); crucially, that plan included a chapter on what to do if shit hits the fan. I was not expecting Bill Gross to ring me if he changed his mind but I knew there was a (super remote eheheh) chance I might have been wrong.
The Luxembourg housing market was hit pretty hard by the GFC. The monthly instalment on my mortgage would have been cheap compared to my salary even if I chose the fixed option. I won because I bought at the bottom but I wanted to “win more”. Choosing the fixed option would have been safer but that’s what the non-pro do; I was better than that. I did not even use what I was saving to invest, I spent it all.
Let’s say that my process might have been fine but everything around it had some…flaws 🙂 Anyway, two years later I left the country, sold the apartment and repaid the mortgage.
Fast forward to 2020, I bought my second apartment in London. Again, floating with the option to reneg after two years (rules for mortgages in the UK are peculiar, if you are curious go check). Skill or luck? Sure, had my window reset a year later I might have faced a harsher reality. But I learned the lesson from my first ride: this time I invested all the extra I saved and again, I had a sensible margin of safety compared to my salary. Plus, as soon as I sensed the change in the air, I started to harass my bank to reneg. I called brokers. By February 2022 I had a seven-year deal fixed at 2.26% (starting in May). Skill or luck?
We should not feel guilty for holding an opinion.
Maybe we should not bet the house on it 😉 Sometimes I ask myself how much wronger things could have gone. Did I really face the worst possible scenario? Was my process as sound as I thought? Was it reasonable to take that type of risk?
At the end of the day, investing is about beliefs: belief in the equity risk premium, belief in the “system” (everything that makes the crypto-bros mad), belief in optimism…ultimately belief in Lorenzo Biagi. Investing is about finding a Michael Lewis and then being disappointed by him. Investing is about finding Nassim Taleb, a constant pull and push between fascination and chagrin.
We might fool ourselves with rigorous processes but deep down we need narratives around those processes, innit (except…if you work for RenTech)? Anyway, I found it a curious coincidence that Lorenzo picked up that particular example and I wanted to offer a bit of a spin to it. For every buyer, there must be a seller.
What I am reading now:
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