The days when Australia “rode on the sheep’s back” may be long gone, but agriculture remains a critical component of the economy, generating valuable export income. While overseas investors understand its importance, for most local institutions it’s still a bridge too far.
For several years, investors, from institutional to retail, couldn’t get enough of the tech stocks with all their promises of future growth. But now the market has spoken and it’s saying precisely this – valuations matter again.
Beware unbridled animal spirits: Ruffer
This month’s Green Line comes from Ruffer’s office in New York, where temperatures recently hit lows of 10◦ Fahrenheit (-12◦C). Despite the winter chill, would-be patrons can be seen queueing around the block for a table at the city’s hottest restaurants. Those who are staying in aren’t slowing their spending either – Netflix recently added the most quarterly subscriptions ever.
And it is not just the everyday consumer who is keen to spend. Our office is a few blocks from Sotheby’s, the prestigious auction house, which recently sold an artwork by Maurizio Cattelan to a cryptocurrency entrepreneur for $6.2 million. Why is this noteworthy? Because the piece was a banana, duct-taped to a wall, and the new owner subsequently ate it.
The feeling of exuberance is palpable here. Across the retail sector, real-time spending indicators suggest US consumers have no intention of slowing. Business confidence is climbing. The new administration, emboldened by winning the popular vote, looks set to shake up an orthodoxy that many people feel needs to change. The promise to be pro America at the expense of everything else resonates strongly. These are winner-takes-all markets, and the US is winning.
Perhaps a key driver of the optimism is the US stock market. As this month’s chart shows, the value of personal financial assets dwarfs the size of disposable income. It is potentially the more important determinant of how well-off consumers feel. Given US equity markets are near all-time highs and households have a record overweight to the asset class, Americans have reason to cheer. And retail investors expect much more from their investments: a 15.6% annualised return above inflation over the long term.
But a world where animal spirits are running wild is also one that has temporarily divorced from fundamentals. Experience tells us this often doesn’t end well.
This matters because the US is now a hyper-financialised economy. Economic conditions and financial markets are inextricably linked. Consumers, business leaders and politicians take their cues from the stock market, and the feedback between the two can be highly reflexive. Much of the strength we see in the US economy today may depend on the level of asset prices.
To date, this reflexive loop has only worked in one direction. Up. But this comes at a price. US asset valuations are expensive. Only three times since the Second World War has the S&P 500 Index managed three consecutive years of double-digit returns. Are we really going to see a third year this time?
Asset prices scream optimism, and they have become a fundamental in and of themselves. We see the need for caution. Valuations, though not a good indicator of the timing of any correction, are at levels that imply poor long-term returns. Sentiment and positioning are stretched, and the potential for disappointment is high. Geopolitics and monetary and fiscal policy point to more volatility, not less.
The vibes on the ground are important, but so are the fundamentals. For now, the US consumer and US asset markets are feeding off each other. Yet the excesses can unravel quickly. At Ruffer, we think it’s crucial to be positioned for when, not if, the exuberance comes to an end.
