Vincent’s blog | Q3 2018 update – Time waits for no one

i-Cthru’s consolidated time-weighted return over Q3 2018 is USD 1.93%; EUR 2.62%. This result is unleveraged, net of all trading costs, fees, dividend-tax withholding for non-US clients, and cost of protection of individual portfolio holdings.

“Time waits for no one” – it is such a simple fact, but sometimes so complicated to comprehend. Everything we do seems to have an element of time in it and it is always humming along, unstoppable, uncontrollable and always moving forward with its atomic precision. But, we also know time is relative, as proven by Einstein, and subjective because a minute spent in front of a traffic light when we are late feels quite different than a minute sound asleep. In Asia they know time better. They even have a term for its relativity: “flexible” or “rubber time”.

In the financial world of i-Cthru, the value of time is best expressed in the 10-year risk-free rate, which currently stands at 3%. You would think the value of time is a constant, right? Well no, the value of time too is relative or rubber. On September 14, 1981 the risk-free rate stood at 15%, a 12% difference with today’s level. Thus, the value of time fluctuates and is mostly driven by the Federal Reserve’s expectations of inflation and growth of our economic activity. If you invert the current risk-free rate, it compares to a price to earnings ratio (P/E) of 33, whereas the S&P500 currently trades at a P/E of 25, a comparison in favor of the stock market.

Having said this, we see red flags waving at us:

  • One is simply the length of time the current bull market has been running for. It is certain it cannot run on forever because everything runs in cycles and if history is a guide, we should expect a reversal somewhere in the next three years;
  • Absolute valuations in the stock market are high compared to their 10-year averages;
  • Future corporate earnings will taper off to a normal 8% average growth after the recent 25% boost from lower corporate taxes on earnings;
  • Interest rates are rising and consequently the yield curve is flattening;
  • Trade wars: they are not necessarily bad if kept short, but with more than 40% of the S&P500’s revenues earned outside the US we would think it constitutes a negative outcome for earnings and consumer spending if not solved within the next 24 months;
  • Total debt is high against historic averages and rising: public debt now stands at $20 trillion (T), household debt stands at $13T of which $9T in mortgages, $1.4T in student loans (mostly carried by Federal entities) and a growing whopping $1.3T in car loans (mostly carried by banks and shadow banks). Yes, your neighbors very likely drive that brand new $30,000 truck with a fat short-term (subprime) loan in the backseat. But hey, groceries never had a better ride…

You know, debt is fine as long as it can be serviced (paid for), but we know it is the consumers who ultimately carry the debt service on their shoulders. Consumers pay for the majority of all taxes, which service all the public debt (corporate taxes are just 9% of total tax revenues); Consumers pay monthly mortgage payments, their student loans and their monthly car loans. We are watching total debt and consumer delinquency rates closely as lending rates continue to go up. We all better keep our jobs. Otherwise, who else is going to pay?

So yes – where were we? What do we do with all those waving red flags? Well, for one we have (re)read our history books and concluded, time and again, that there hardly is a consistent trigger to predict a sharp fall of the stock market. Liquidity in the markets is like oxygen to men: when it is gone, it is too late. At this point in the cycle, we can only increase our prudence and we are working with our clients to review their cash positions as we move into the next phase of the bull market. By doing so, we also want to create, through holding cash, a natural option to buy at cheaper levels when there is a sharp correction.

Our strategy is designed not to overpay for our assets and to limit the impact of a sudden systemic negative event in the market. To see if that would have worked in the past, we backtested our strategy from 2001 until 2014. The initial results, although those of a backtested environment indicate we can sleep sounder.

What about green flags? Do we see any? Yes:

  • The Chinese market is trading in bear market territory and as we said in the past it makes sense to shift some of our assets to Chinese-based companies. The Chinese markets trades at much lower valuations than their American counterparts and have significant earnings’ growth potential. Since the beginning of this year we have held positions in Chinese companies listed on the main exchanges in the US. These positions have underperformed, while the trade war gathered momentum and held back our performance. However, we see these positions as a credit against a future appreciation that undoubtedly will play out in the near future.
  • Another green flag is the “productivity paradox”, which points to a likely delayed productivity gain from innovation, especially Artificial Intelligence (AI) driven innovation, much like we saw from the introduction of desktop computers to the workplace around 1987. A slow, but accelerating productivity boom might be developing and may well carry us into 2025, boosting productivity by 2-3%, which would be significant. Unbeknownst to many of us, the smart AI-based automation of business processes is well underway and is changing the way we work and our productivity.

We, at i-Cthru, constantly try to stretch our notion of time. Investing over a longer time-horizon makes the outcome so much more predictable. Long-term horizons have a tendency to clean and filter out all the short-term fluctuations. Then, the upward path becomes very clear to us. At i-Cthru, we try to think in blocks of ten years: this way it is a lot easier to comprehend time. We strongly believe you will be much more likely to achieve your investment objectives if you know what to expect along the long way.

Your own psychology and ability to handle the short-term emotional ups and downs of investing are likely to be important determinants of your long-run investment success.

Thank you for your trust. It means a lot to us.