Markets are living in 'Lalaland'

Jerome Lander


The Merriam-Webster dictionary defines 'Lalaland' as: 'a euphoric, dreamlike mental state detached from the harsher realities of life'. 

'Lalaland' is also how I described the state of markets during my discussion with Alan Kohler on his podcast. While Alan may not see things the same way, I see equity markets trading at a PE close to 40, or a market cap to GDP ratio of 180%, at a time of deep global crisis, as the very definitions of Lalaland. 

After a five-month-long policy-induced surge, markets are starting to stumble once again. It is critical right now to understand the potentially treacherous environment you are navigating if your portfolio is going to survive - let alone thrive - over the next few years. 

Here's my discussion with Alan on why you can't afford to stay in Lalaland, and how to plan for the harsher realities of markets instead. 

Are we in a bubble?

Edited transcript from Podcast with Alan Kohler and Jerome Lander, 8th September 2020. 

Alan Kohler: Jerome, you think we’re in a bubble? I’m quoting from your quarterly now, where you say, "Simply put, prices have become divorced from their fundamentals, we refer to this as a bubble, quite possibly the greatest bubble the world has ever seen.” I mean, I haven’t read anything quite as clear and definitive as that – well, not many things anyway – and so, that’s what you think? Explain…

Jerome: Yes, I actually really think that we are operating in a bubble in the financial markets. It’s driven by many years of pushing interest rates down to very low levels, financialisation of the economy, and pushing asset prices ever higher. 

Then coronavirus comes along, the markets get absolutely smashed and in order to get them to recover, you need to provide unprecedented stimulus. The amount of stimulus that’s been applied to these markets to get them back up to where they are today, is extraordinary. We would be in a depression were it not for the abnormal stimulation and policies that have been enacted.

Asset prices now are extremely high if you look at it on a valuation basis. We’re looking at S&P or the US stock market being on 40 times this year’s earnings. Who knows what next year is going to be like, but presumably they’ll be a bit better versus the long-term average of 16 times.

We’re looking at market-cap-to-GDP (the size of the markets versus the size of the real economy) being at all-time record highs and a few days ago was approaching 180 percent. It’s just huge versus what you might argue they should be around. 

There’s a huge bubble in traditional defensive assets such as cash and bonds. Cash is yielding next to nothing and bonds are yielding next to nothing and clearly, those prices don’t resemble a reasonable return for those assets given real inflation in the economy or a reasonable return on capital for people wanting to invest in those things.

They require, basically, speculation on the fact that interest rates will go lower and that even more stimulus will be provided in the future and will be required in order to justify those prices. When you’ve got the risk-free rate being basically manipulated by government policy to such a low level and everything else basically priced off that, then I think you can quite easily, as I do, argue that we are in the biggest bubble of all time because it affects so many things across asset markets.

Alan Kohler: You also say that a market that depends solely on government largesse to go up isn’t a safe market, but can you see that there is an argument to say that maybe a market that depends on government largess is quite safe, in fact?

Jerome: Well, I’ll tell you why I don’t think it’s safe, Alan. Because a lot of people believe what you've said, right? It’s a really important point to address directly…

Alan Kohler: No, but arguably the market that depends on the capitalist system or the market itself and investors going along as per usual is not safe, because that’s what we’ve found in the past.

Well, I don’t really agree with that. I’ll tell you what would be a safe market or a more attractive market from a risk/return point of view, and obviously safer would be if asset valuations were cheap. For example, in the early-1980s, we had interest rates already being very high and likely to come down, and the economy was capable of producing very good growth. It wasn’t requiring great deals of government support. You weren’t overly leveraged with huge amounts of debt. That’d be a much safer market to invest in that what we’re in today. 

Today, we’re in a market where we’ve overstimulated the market, to be frank. We’ve got huge amounts of debt, and we can’t really pay back these debts under normal circumstances, requiring the government to help us out massively. Huge amounts of stimulation are required to keep the market up. As soon as we hit any sort of meaningful catalyst, the market falls apart completely. 

And further, it’s never safe to be investing in a market that depends upon only one thing, and I think it's quite clear the one thing the market as a whole really does depend upon is government largesse to keep up here. We’ve learned over time that central bankers globally, aren’t reliable parties, we don’t know what they’re going to do next or when they’re going to decide to change their tune.

We also see a huge number of risk factors out there that could cause massive problems for the markets such as geopolitical disturbances. We could also see inflation coming back in the next few years in a big way. 

There are all sorts of things that could be massive negative catalysts for these markets. I’m personally expecting markets to be rolling through a series of repeated crises. Frankly, we are living in ‘La La Land’.

Alan Kohler: How does that affect your investment strategy? I mean, in particular, does it lead you to be quite short? I mean, how much of your portfolio is short?

I think it’s dangerous to be net short. I don’t believe personally, despite your view of the market you should then say, “Right, we’re going to be shorting the whole market.” Because we don’t know exactly when things are going to fall over. But what it does lend me to do is actually have a low market exposure and to depend instead upon returns from other factors such as idiosyncratic returns, more active management and other things which clearly have a much better chance of being protective or going up if things are adverse, such as gold. 

One thing that’s great about this sort of environment is that these repeated crises and all this volatility provides great opportunities for active managers. We’re entering a period which is very different from where we’ve been in the last 10 or 20 years. We’re entering into a very exciting investment environment, whereby great active management will be rewarded. And so, I want the returns to depend very much upon that great active management, not upon markets remaining inflated by government largesse, if you like. 

Some fund managers fell over completely in February and March. If it weren’t for the government largesse they wouldn’t be here, probably. We saw that in the GFC and we’ve seen that many times before and I think we’ll continue to see that. Over a multi-year basis, investors eventually will work out, hang on a second, the fund manager I’m investing in really isn’t offering anything and without the markets going up, they’re not able to make me a return. 

That’s not what investors want. Investors actually want you to make them a return. They’re not interested in gambling whether the stock market goes up or down or any of that sort of stuff. They actually want you to make them a return. We’ve built this strategy to make an investor a return pretty much no matter what happens. It’s an all-weather fund. 

The multiple strategies we use underlying the fund are designed to complement each other and were designed to defend and protect capital in the subsequent big drawdowns we’ll see going forward, I think. But if the market goes up and everyone makes money, that’s great, we will too. But what if it doesn’t, what if it’s flat? In those circumstances, this is where we’re really going to look very, very strong relatively".

Hear the discussion with Alan in full

Market bubbles were just one thing we touched on in this 33-minute podcast with Alan. We also discussed the outlook for the rest of 2020, some of the risks ahead, my process for picking fund managers, and some information on the fund itself. You can access the podcast here: (VIEW LINK)

Important Notice This has been prepared by Lucerne Australia Pty Ltd ACN 609 346 581 a Corporate Authorised Representative of AFSL number 481 217 and issued by The Trust Company (RE Services) Limited ACN 003 278 831 as responsible entity and the issuer of units in the Lucerne Alternative Investments Fund. It is general information only and is not intended to provide you with financial advice and has been prepared without taking into account your objectives, financial situation or needs. You should consider the product disclosure statement, available by calling 03 8560 1440 or visiting our website (VIEW LINK), prior to making any investment decisions. If you require financial advice that takes into account your personal objectives, financial situation or needs, you should consult your licensed or authorised financial adviser. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. No company in the Perpetual Group (Perpetual Limited ABN 86 000 431 827 and its subsidiaries) guarantees the performance of any fund or the return of an investor’s capital.

Jerome Lander
Chief Investment Officer

Dr Jerome Lander is a highly experienced, proven Portfolio Manager and a specialist in outcome-based and absolute return investing, which is a client centric approach aligned with many peoples' preferences - and one which is well suited to today's...

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