I’ve come across four separate people over the past few months as part of work activities. All were in a similar situation – good jobs, good incomes… and sizeable share portfolios.
Whilst I didn’t get to personally interrogate them (or actually see their specific portfolios), it was clear to me from decisions they were making that they all shared another similarity – they were all sure the good times will continue.
Separately, I recently came across a financial planner taking out a sizeable margin loan to increase his managed fund exposure. I recently saw another financial planner recommending a margin loan strategy for clients.
To be clear, I’m not suggesting that any of these decisions (or recommendations) are “inappropriate”. All individuals were what you’d consider “long term investors” and therefore having a large weighting to risk assets with a long-term horizon is entirely appropriate.
Ultimately, in my view, what all these investors have concluded is that there’s virtually zero chance that they experience durable losses. They all have conviction that markets will continue to deliver something resembling “historically average returns”. Of course the markets will have sell-offs occasionally, but if we’ve learnt anything in the last 16 years it’s the fact that every dip should be bought as the market will soon reward you by making new highs.
I believe these investors typify much of the investor sentiment in the U.S. and Australia.
Conviction is a rather controversial topic in investment-land. Many believe that having a capacity for conviction is a necessary trait for any decent investor or trader.
But the reality is investing is always and forever about making decisions based on incomplete information. Even in this modern data-overloaded, “AI-fuelled” world, you will never have all the information you need to make a decision. Never.
In reality, successful investors require two attributes:
The ability to take action
The ability to change their mind
History – our own conviction
As I often mention, I’m a student of financial history. Whilst you never have all the information required to make investment decisions, historical precedent provides us with a valuable roadmap.
With the benefit of hindsight, identifying a market environment destined to end badly is actually pretty straightforward. All have had various similarities – excessive optimism that’s often associated with a new technology, rampant speculative behaviour, a major influx of new retail investors and valuations stretched well beyond historical trend. All of these characteristics have been present in the current U.S. market environment for some time.
My conviction has been that this speculative period will end the same as all the others that have preceded it – a reversion to something resembling “trend”.
This conviction has been costly in the last couple of years. Whilst I take comfort in the adage “opportunities are easier to make up than losses”, the opportunities missed over the past several years have been costly.
Gains now!
A popular observation made recently is how value-insensitive the market has become. Gone are the days where value-conscious investors controlled the capital that influenced shorter-term market moves. Today, the vast bulk of the capital that is fuelling the daily price changes in assets is held by investors fixated on short-term price changes.
They are the high-frequency trading firms chasing momentum and trading Trump’s press conference, the hedge funds betting on next quarter’s earnings report and the army of individual investors getting their trade ideas from Tiktok influencers and Chat GPT “research”.
Separately, when longer-term investors passively buy the market – as has become the trend – they automatically buy an outsized weighting of those largest companies that are currently a huge component of the major indices – those “magnificent 7” tech darlings.
As mentioned last time, we’re in very good company asserting that the market is not running on fundamentals.
Alas, this environment can continue for a long time – it already has.
The great mutation
The U.S. economy has mutated significantly over the past two decades. The massive “twin deficits” – a trade deficit and government fiscal deficit are now entrenched. Applying some math to terms of trade accounting identities reveals these are very much linked.
A major beneficiary has been the U.S. financial sector. The world has been recycling the dollars received from trade surpluses into U.S. financial assets – helping fuel the rolling asset bubbles we’ve see over this past two decades. The (politically influential) financial sector have benefitted enormously. Wealthy Americans have benefitted enormously.
Indeed, the U.S. economy has been “financialised” to the point that asset price inflation very nearly is the economy – feeding the wealth, incomes and spending capacity for the top 10% who account for somewhere close to half of consumer spending. The lower and middle class are straining under the weight of accumulated inflation and muted wage growth. Inflation isn’t a thing for the wealthy.
Trump talks about wanting to fix all this. He talks about America being ripped off. He (and his economic team) talk about giving Main Street a go. But the reality is the pain associated with a true economic rebalancing is greater than Trump will be willing to bear.
Trump and his family know the score. For all the talk about an American manufacturing renaissance, I don’t see them racing to build factories. No, they’re busy grifting in crypto and whatever else they can extract a profit from without actually having to build anything of value.
That said, it does seem that Trump is committed to trying to do something to restore some balance in the U.S. (and by extension global) economy. Remember that the tariffs now implemented are in many instances not all that far off those announced back on “Liberation Day” when the markets had a meltdown.
The general consensus right now seems to be that these tariffs won’t have any adverse side-effects. Plainly, I see this as far too complacent. It is inevitable that these actions will have some undesirable consequences – whilst these are hard to spot right now, expect them to rear their head periodically. And remember the market isn’t priced to tolerate risk and uncertainty. In other words, expect more “volatility”.
Don’t forget “AI”
Any current comment about the U.S. economy and financial markets would be incomplete without some comments about AI.
As we all know, the “magnificent 7” big tech companies are currently spending billions on AI research and infrastructure. Billions. Enough to add around half a percent to recent GDP growth.
Investors are captivated by this – rewarding these companies and many other AI- related companies with lofty valuations based on the wonderful earnings growth that will surely come from all this capital expenditure.
Let’s look at software firm (and current market darling) Palantir Technologies as an example. Their market capitalisation has grown to around 660 Billion Australian dollars. To put some context around this, their market capitalisation is equal to the sum of all these Australian household name companies:
Company
Approx market cap (AUD Billion)
Qantas
17
QBE
32
Telstra
56
Coles Group
28
Woolworths
39
IAG
20
Carsales
15
Stockland
14
Cochlear
20
Brambles
32
Medibank Private
14
Sonic Healthcare
14
Aristocrat
43
Amcor
34
News Corporation
29
BHP
212
Rio Tinto
44
Palantir’s valuation on a “price to sales” basis looks like this:
A price to sales of over 100 is just absurd. But hey I’m sure they will grow into their valuation, right?
At the end of the day, all those big companies investing heavily in AI need to generate a return on their investment otherwise the money is just wasted. Similarly, those companies benefitting from all the spending – the Nvidias of the world – need the spending to continue lest they turn out to be the equivalent of the guy selling the shovels at the peak of the gold rush.
Once again, markets don’t seem to be thinking too far into the future at the moment. What happens when one of these behemoths mutters the inevitable – “we’re nearly done with our AI investment program for now, we’re just focused on making a return on what we’ve invested already”.
Run it hot
It has been amusing to watch President Trump pick on Federal Reserve Chairman Jerome Powell. Distressing, but amusing.
Trump thinks that the USA deserves 1% official interest rates. He is outraged that Powell doesn’t just re-set rates to this. Trump thinks interest rates are just a made-up number so they should just make up a lower number.
It’s just another example of the administration’s “go fast and break things” mindset. Sometimes you tend to think that Trump doesn’t understand anything about economics. But then you realise that he just doesn’t care. If he were to break things too badly over the coming few years, he simply blames everyone else and then just hands the keys back and walks away.
The July CPI inflation reading was taken to be a positive. Despite inflation being stuck around 3% with signs it is accelerating, the fact it didn’t jump had everyone conclude that tariffs aren’t inflationary and therefore the Fed can stop worrying and start cutting interest rates. Indeed, at this point markets are pricing in a very high chance of a cut in September.
Trump does seem to have a plan. They’re going to continue to run eye-watering government spending deficits. If they can get interest rates applicable to government debt appreciably lower than nominal GDP growth, then the U.S. government can out-grow its debt.
Run it hot… Capture the Fed, instil loyalists and make it happen…
The Fed’s historical 2% inflation target isn’t a thing anymore. To Trump and his team, who cares if inflation remains stubbornly in the 3 to 4% range? Yeah, sure, this means inflicting massive further pain on the lower and middle class but who cares?
That’s much of the bull case here. That the U.S. is going to remain in an inflationary world with low – even negative – real interest rates and this is going to translate into continued asset inflation.
Final thoughts at this moment in time
Investors often slip up when they become too attached to their views – when they lack that ability to change their mind.
With this in mind, I keep reflecting on my viewpoint. Am I too attached to my views? Am I being excessive pessimistic? Is “AI” going to truly usher in a spectacular period of economic growth? Will the U.S. administration succeed in their “run it hot” plan to continue to inflate the economy without any negative consequences?
Will asset markets continue to run it hot without any hiccups?
I’m increasingly convinced that the “wealth effect” will be a major factor in the next economic cycle. It’s looking pretty clear that the U.S. economy has stalled and might be rolling over. I’d suggest it would have already rolled over and be heading south at a faster clip if it weren’t for the wealthy spending their windfall investment gains. There’s a lot riding on asset markets remaining aloft in the clouds.
To all those investors that expect to generate a “historically average return” in the coming years, I want to say that in order to expect a “historically-average” return, you need to be investing at a “historically-average” time.
Today is not a “historically average time”. Valuations are multiple standard deviations above “average”.
As always, the near-future is unclear. But I’m confident that now remains a time to be fearful and not greedy.
I have conviction that you will get a better opportunity to deploy capital in the future.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
Register your interest in this Fund
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Conviction
I’ve come across four separate people over the past few months as part of work activities. All were in a similar situation – good jobs, good incomes… and sizeable share portfolios.
Whilst I didn’t get to personally interrogate them (or actually see their specific portfolios), it was clear to me from decisions they were making that they all shared another similarity – they were all sure the good times will continue.
Separately, I recently came across a financial planner taking out a sizeable margin loan to increase his managed fund exposure. I recently saw another financial planner recommending a margin loan strategy for clients.
To be clear, I’m not suggesting that any of these decisions (or recommendations) are “inappropriate”. All individuals were what you’d consider “long term investors” and therefore having a large weighting to risk assets with a long-term horizon is entirely appropriate.
Ultimately, in my view, what all these investors have concluded is that there’s virtually zero chance that they experience durable losses. They all have conviction that markets will continue to deliver something resembling “historically average returns”. Of course the markets will have sell-offs occasionally, but if we’ve learnt anything in the last 16 years it’s the fact that every dip should be bought as the market will soon reward you by making new highs.
I believe these investors typify much of the investor sentiment in the U.S. and Australia.
Conviction is a rather controversial topic in investment-land. Many believe that having a capacity for conviction is a necessary trait for any decent investor or trader.
But the reality is investing is always and forever about making decisions based on incomplete information. Even in this modern data-overloaded, “AI-fuelled” world, you will never have all the information you need to make a decision. Never.
In reality, successful investors require two attributes:
History – our own conviction
As I often mention, I’m a student of financial history. Whilst you never have all the information required to make investment decisions, historical precedent provides us with a valuable roadmap.
With the benefit of hindsight, identifying a market environment destined to end badly is actually pretty straightforward. All have had various similarities – excessive optimism that’s often associated with a new technology, rampant speculative behaviour, a major influx of new retail investors and valuations stretched well beyond historical trend. All of these characteristics have been present in the current U.S. market environment for some time.
My conviction has been that this speculative period will end the same as all the others that have preceded it – a reversion to something resembling “trend”.
This conviction has been costly in the last couple of years. Whilst I take comfort in the adage “opportunities are easier to make up than losses”, the opportunities missed over the past several years have been costly.
Gains now!
A popular observation made recently is how value-insensitive the market has become. Gone are the days where value-conscious investors controlled the capital that influenced shorter-term market moves. Today, the vast bulk of the capital that is fuelling the daily price changes in assets is held by investors fixated on short-term price changes.
They are the high-frequency trading firms chasing momentum and trading Trump’s press conference, the hedge funds betting on next quarter’s earnings report and the army of individual investors getting their trade ideas from Tiktok influencers and Chat GPT “research”.
Separately, when longer-term investors passively buy the market – as has become the trend – they automatically buy an outsized weighting of those largest companies that are currently a huge component of the major indices – those “magnificent 7” tech darlings.
As mentioned last time, we’re in very good company asserting that the market is not running on fundamentals.
Alas, this environment can continue for a long time – it already has.
The great mutation
The U.S. economy has mutated significantly over the past two decades. The massive “twin deficits” – a trade deficit and government fiscal deficit are now entrenched. Applying some math to terms of trade accounting identities reveals these are very much linked.
A major beneficiary has been the U.S. financial sector. The world has been recycling the dollars received from trade surpluses into U.S. financial assets – helping fuel the rolling asset bubbles we’ve see over this past two decades. The (politically influential) financial sector have benefitted enormously. Wealthy Americans have benefitted enormously.
Indeed, the U.S. economy has been “financialised” to the point that asset price inflation very nearly is the economy – feeding the wealth, incomes and spending capacity for the top 10% who account for somewhere close to half of consumer spending. The lower and middle class are straining under the weight of accumulated inflation and muted wage growth. Inflation isn’t a thing for the wealthy.
Trump talks about wanting to fix all this. He talks about America being ripped off. He (and his economic team) talk about giving Main Street a go. But the reality is the pain associated with a true economic rebalancing is greater than Trump will be willing to bear.
Trump and his family know the score. For all the talk about an American manufacturing renaissance, I don’t see them racing to build factories. No, they’re busy grifting in crypto and whatever else they can extract a profit from without actually having to build anything of value.
That said, it does seem that Trump is committed to trying to do something to restore some balance in the U.S. (and by extension global) economy. Remember that the tariffs now implemented are in many instances not all that far off those announced back on “Liberation Day” when the markets had a meltdown.
The general consensus right now seems to be that these tariffs won’t have any adverse side-effects. Plainly, I see this as far too complacent. It is inevitable that these actions will have some undesirable consequences – whilst these are hard to spot right now, expect them to rear their head periodically. And remember the market isn’t priced to tolerate risk and uncertainty. In other words, expect more “volatility”.
Don’t forget “AI”
Any current comment about the U.S. economy and financial markets would be incomplete without some comments about AI.
As we all know, the “magnificent 7” big tech companies are currently spending billions on AI research and infrastructure. Billions. Enough to add around half a percent to recent GDP growth.
Investors are captivated by this – rewarding these companies and many other AI- related companies with lofty valuations based on the wonderful earnings growth that will surely come from all this capital expenditure.
Let’s look at software firm (and current market darling) Palantir Technologies as an example. Their market capitalisation has grown to around 660 Billion Australian dollars. To put some context around this, their market capitalisation is equal to the sum of all these Australian household name companies:
Palantir’s valuation on a “price to sales” basis looks like this:
A price to sales of over 100 is just absurd. But hey I’m sure they will grow into their valuation, right?
At the end of the day, all those big companies investing heavily in AI need to generate a return on their investment otherwise the money is just wasted. Similarly, those companies benefitting from all the spending – the Nvidias of the world – need the spending to continue lest they turn out to be the equivalent of the guy selling the shovels at the peak of the gold rush.
Once again, markets don’t seem to be thinking too far into the future at the moment. What happens when one of these behemoths mutters the inevitable – “we’re nearly done with our AI investment program for now, we’re just focused on making a return on what we’ve invested already”.
Run it hot
It has been amusing to watch President Trump pick on Federal Reserve Chairman Jerome Powell. Distressing, but amusing.
Trump thinks that the USA deserves 1% official interest rates. He is outraged that Powell doesn’t just re-set rates to this. Trump thinks interest rates are just a made-up number so they should just make up a lower number.
It’s just another example of the administration’s “go fast and break things” mindset. Sometimes you tend to think that Trump doesn’t understand anything about economics. But then you realise that he just doesn’t care. If he were to break things too badly over the coming few years, he simply blames everyone else and then just hands the keys back and walks away.
The July CPI inflation reading was taken to be a positive. Despite inflation being stuck around 3% with signs it is accelerating, the fact it didn’t jump had everyone conclude that tariffs aren’t inflationary and therefore the Fed can stop worrying and start cutting interest rates. Indeed, at this point markets are pricing in a very high chance of a cut in September.
Trump does seem to have a plan. They’re going to continue to run eye-watering government spending deficits. If they can get interest rates applicable to government debt appreciably lower than nominal GDP growth, then the U.S. government can out-grow its debt.
Run it hot… Capture the Fed, instil loyalists and make it happen…
The Fed’s historical 2% inflation target isn’t a thing anymore. To Trump and his team, who cares if inflation remains stubbornly in the 3 to 4% range? Yeah, sure, this means inflicting massive further pain on the lower and middle class but who cares?
That’s much of the bull case here. That the U.S. is going to remain in an inflationary world with low – even negative – real interest rates and this is going to translate into continued asset inflation.
Final thoughts at this moment in time
Investors often slip up when they become too attached to their views – when they lack that ability to change their mind.
With this in mind, I keep reflecting on my viewpoint. Am I too attached to my views? Am I being excessive pessimistic? Is “AI” going to truly usher in a spectacular period of economic growth? Will the U.S. administration succeed in their “run it hot” plan to continue to inflate the economy without any negative consequences?
Will asset markets continue to run it hot without any hiccups?
I’m increasingly convinced that the “wealth effect” will be a major factor in the next economic cycle. It’s looking pretty clear that the U.S. economy has stalled and might be rolling over. I’d suggest it would have already rolled over and be heading south at a faster clip if it weren’t for the wealthy spending their windfall investment gains. There’s a lot riding on asset markets remaining aloft in the clouds.
To all those investors that expect to generate a “historically average return” in the coming years, I want to say that in order to expect a “historically-average” return, you need to be investing at a “historically-average” time.
Today is not a “historically average time”. Valuations are multiple standard deviations above “average”.
As always, the near-future is unclear. But I’m confident that now remains a time to be fearful and not greedy.
I have conviction that you will get a better opportunity to deploy capital in the future.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
Register your interest in this Fund
Lorem ipsum dolor sit amet, consectetur adipiscing elit. Ut elit tellus, luctus nec ullamcorper mattis, pulvinar dapibus leo.