If there’s one thing that most people would agree on, it’s that having an economy that benefits both the worker and the business owner is a good thing – the best of both worlds. There is opportunity for those who want to risk their capital in pursuit of greater financial success as well as for those who want to earn a good living with the security of a steady job. Unfortunately, this ideal balance between capital and labor proves elusive. Without going into a long white paper as to why this is the case, we’ll simplify by saying that when conditions exist that favor one over the other, those benefiting most gain power and govern in a way that perpetuates the imbalance. Today, those with the power and money are those most closely tied to large corporations and capital markets. As a result, laws, policies, and actions have generally favored the large corporations and markets as well as the perpetuation of their profitability.
This isn’t inherently bad, except for the fact that it tends to leave others behind, which is exactly what it’s doing. Trends are very hard to spot in the moment, but if we look back 20-25 years, the one relating to capital and labor becomes clear to see. The drive to maximize profits leads to offshoring of products and labor. This hurts manufacturing jobs here at home. Capital markets (stocks and bonds) benefit as a result of the increased profitability leading to markets becoming central to our economy and culture. Markets get too expensive and crash. This hurts those with the capital (those with assets). The Federal Reserve and government coordinate to arrest declines by lowering interest rates, spending lots of money (by borrowing and growing debt levels), and bailing out corporations. Markets go up again drawing in more and more capital and making those with assets even wealthier. Now markets are so central to our culture that we depend on them for our wealth, retirement, and general sense of financial well-being. Those with assets and wealth want to protect them by any means possible which has perpetuated the policies and actions that have led to the imbalance and dependency on markets in the first place. Meanwhile, those with fewer or no assets have been left behind. Policies that support capital markets and corporate profitability generally don’t favor them. A purposeful and intentional effort to create inflation in order to keep global economies and markets from crashing being one of the most clear and egregious examples. Increasing the cost of living for the average person on purpose makes very little sense and only serves to widen the wealth gap.
So why is this important? Because it creates context for much of what we’re seeing in the world today. Riots, social movements, political and social divides. These don’t happen to the extent they are now when there is greater equity and fairness across society. This is important to understand because it can help us find actual solutions to the issues of the day rather than allow the anger, blame, and messaging to be confused, defused, or deflected. It’s also important because it can inform where we may be headed. Those in power tend not to give it up easily. Corporations, individuals, and governments will continue to act in ways that perpetuate the status quo. Fractions and divisions continue – things can get ugly. This has tremendously important implications for markets and your portfolio. What seems a bullet-proof investment strategy today could become a fatal one very quickly if the volatility and unrest we’re seeing in this battle between capital and labor bleeds into capital markets. Our sense is that it’s just a matter of time; and believe it or not, this gets us to the optimistic part of all of this.
The way cycles work is that they tend to get worse before they get better. Cold days get colder when we’re in December, the sniffles can turn to fever before the fever breaks. Regardless of where we are in this socioeconomic cycle, and whether things need to get worse before they get better, they will get better. Markets will again be investable for our children at some point, homes more affordable, and the cost of living more comfortable. We’ll get there. Part of getting there will most likely resemble prior points in history where power and wealth transitioned incrementally from capital to labor – the 1930’s and the 1970’s. In the former, asset prices deflated tremendously creating a more level playing field for all. It got ugly, but in the end, most would agree that more of the wealth and opportunity moved to the middle. The 1970’s were different in that there wasn’t a large wealth divide coming in, but there was a twenty year period of capital markets doing very well – to the point where valuations, policies, and actions supporting them were relatively extreme. One could argue that the inflation that ensued in the 1970’s was partly due to the efforts made to maintain the capital markets and related socioeconomic status quo. Regardless, markets experienced multiple crashes in the 1970’s as it turned out to be one of the worst decades for stocks in a very long time. To make matters worse, we also got inflation. It was difficult, but again, it led to a much more balanced environment as we moved into the 1980’s and set the stage for two of the best decades in stock market history.
And so what does the trip to greater balance look like this time around? In our opinion, it probably resembles parts of both of those prior periods in that capital markets stand a very good chance of declining significantly and commodity prices, particularly precious metals prices, could do very well. When and how much is a fool’s errand, but both history and common sense lead us to these potential outcomes. The shift back in the direction of labor will most likely be partly driven by uncontrollable market forces that exert themselves most strongly at price and valuation extremes, and the rest by social pressure. Corporations and profits would not benefit from this shift, hence the likely pressure on markets. With the Federal Reserve (and other central banks) support for markets scrutinized more heavily for its part in the wealth divide, continued rescues and bail-outs would be less certain.
On the other side of the investment coin, when capital flees the markets that are now re-pricing (falling), it tends to go into things that provide more certainty and safety; particularly if those things are reasonably priced. Government bonds and precious metals are typically on that short list. If inflation is present, precious metals and commodities tend to be at the top of it. Both did well in the 1930’s where inflation wasn’t a problem, whereas in the 1970’s only precious metals and commodities (not government bonds) did well because there was unusually high inflation to contend with. However, regardless of whether inflation becomes a problem this go round, precious metals seem poised to benefit from the transition. To what degree depends on how much of a problem inflation turns out to be.
Part of navigating this transition successfully for our clients requires us to realize and accept the fact that regardless of how diligent we’ve been analyzing the data, studying history, and applying common sense, things could play out differently – either because we failed to see something properly or for reasons outside of our control. Nothing is certain. Although an outcome may be extremely likely, it is rarely certain. Some of the questions we ask ourselves to make sure we’re seeing things in the right light and not succumbing to myopia or existing biases are:
Am I being open-minded to alternative facts, scenarios, viewpoints?
What is the risk/reward of our given viewpoint or strategy?
- What is the reward if we’re right relative to the risk of loss if we’re wrong?
- Can we still obtain some reward even if things play out differently?
Am I willing to change my viewpoint as the data changes?
As it turns out, asking ourselves these questions with respect to non-financial issues might also be appropriate, especially given the context of the bigger picture transition we’re in the midst of. In a world that’s angry, confused, and extreme as a result of the historic imbalance between capital (those with wealth) and labor (those generally without it), it’s easy to get distracted. Whether it’s because we’ve been spun around and made dizzy, mistreated, or lulled into complacency and a false sense of security within our investment portfolio, the more objectively and clearly we can view reality moving forward, the better off we’ll be. Especially in the midst of a generational transition that should leave the world a much calmer, kinder, and more balanced place in the end.