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Modern capitalism tends to create duopoly and monopoly market structures. This can be seen in market valuations for the very largest businesses. Apple, for example, is now as large as the entire Russell 2000 index of US mid-caps, or alternatively all 100 stocks in the UK’s FTSE.
This statistic may seem asinine but it drives a broader point, that there is no such thing as absolute valuation, only relative valuation. Investors always choose between different homes for their capital. This cycle, the fact that bonds offer zero returns trumps most other considerations, and demand for stocks has risen in response. Cash holdings pay you zero, and bonds offer similarly negligible returns, with far higher risks.
This situation, of financial assets being compared to cash itself, has driven massive inflation in these asset prices. This has been renewed as walls of cash flooded into the system in response to the pandemic. In the last crisis this cash was funneled through the financial system, and this time it has come directly through retail investors, particularly in the US.
This will not lead to “Main Street” inflation as there is little trickle down effect. Those who already own assets, or are wealthy enough to buy them, are the main beneficiaries, yet also have the lowest marginal propensity to spend the windfall profits. Perhaps it is hoped that Robin hood investors will exit their tech stocks in time to spend the profits on goods and services. Historic examples do not bode well, however.
The lack of Main Street inflation is self-referential to asset price inflation, the lower it stays the higher asset prices can inflate, safe in the knowledge that interest rates will not rise. If they did, this would drive prospective bond returns higher relative to stocks.
When does this end? Still with inflation which, if not led by wages, will have to be led by higher commodity prices or higher import costs due to lower domestic exchange rates.
We have made some meaningful changes to the portfolio in early September and will provide an update on these in next month’s factsheet.