Anti-Fragile Investing, One Antidote to Inflation
March 9, 2022
Just a month ago we were reminiscing over how stretched were markets in 2021. The top four US tech stocks were worth four times the entire German stock market. Tesla was more valuable than all of the auto makers in the world. The handful of tech giants represented in the “FANG” index rose in price by nearly 13 times since January 2013, while the S&P 500 rose only 2.8 times. They earn only 0.7% of the S&P 500’s total revenue but accounted for 12.2% of its market capitalization. And finally, the Fed bought up $400 of the $550 billion TIPS market, so therefore, inflation protected treasury bonds yield whatever the Fed wants them to yield, which was -5%. Negative real interest rates are useful to the treasury because they increase the value of financial assets for taxing purposes, all while low income bank account savers pay for government spending and the resulting national debt balance. There are many ways to incite a bubble, but they all die from excess valuation.
Most individual investors rebalance their portfolios in January; if you procrastinated and left too much risk on you are in trouble. The world is a different place now. Wars are always inflationary, and a low inflation portfolio should look a lot different than a high inflation portfolio, so it’s important to know if this war temporary or persistent. The Fed has rendered itself useless and our energy policy is totally incoherent, so you are on your own. On the one hand, slowing or declining populations exert a strong deflationary force on the economy; on the other hand, inflation is becoming increasingly entrenched and may even be useful to the political class. Normally the central bank can raise interest rates aggressively to stem rising prices, but we are in a new bind now with a hot war and an impending energy fueled recession. Meanwhile, the US balance sheet has reached a milestone of sorts in that our debt is now larger than our national income (GDP) because of the shutdown and ensuing $5 trillion of stimulus. It’s a conundrum that investors must contemplate since countries rarely climb back up that slippery debt slope. While we no longer pretend that we can ever repay our debt, servicing the debt does become an inconvenience if interest rates rise. Permanent financial suppression is the logical conclusion.
Why do countries slip into the debt trap, and what’s the solution? Political affiliations aside, it’s just plain hard to get re-elected or reappointed without providing some form of benefit payments to the voters. Free stuff requires social spending and suggests that the appetite for revenue is unquenchable. Deficit spending is not a growth or tax problem; it’s a political phenomenon. Maintaining political power at the expense of national solvency is a 5000-year-old, predictable, repeatable cycle; every regime has done it. If you are a ruler, the question is, where to find more money so you can wage war and provide bread and circus to the workforce? The sources are finite; you can raise taxes, hope a Spanish Galleon loaded with gold sails into the harbor, go to war with your neighbor and take stuff, change out the currency over the weekend, clip the corners off the gold and silver coins, or slowly devalue the currency. It turns out that the only way to avoid a rebellion and the long knives is to gradually increase the supply of money relative to the goods and services produced by the people (a.k.a inflation). It’s stealthy and very efficient; 7% annual inflation cuts the real national debt in half in 10 years. But you cannot mess it up or the common workers will quit the cities, move into the farmland and offer to work for food. Historically laborers have been quick to jump on the road to serfdom, it’s the feudal system reincarnated. Alternatively, our leaders could just give out food stamps; it’s less risky. Why is this relevant? Government benefits are indexed to inflation, your earnings and investment income are not. As a nation’s ratio of debt to GDP increases, so does its affinity toward systemic inflation. Consider this: when rebalancing your portfolio, inflation is not temporary.
Eventually astute investors figure out the con and reallocate assets out of cash, government debt and other assets correlated with interest rates and into stores of wealth like land, energy, rail car leasing, cash flowing real estate, entitled lots, farmland, roadside billboards, precious metals, ships, art, natural resources, companies that have assets and pricing power and foreign currency. This is commonly referred to as an anti-fragile portfolio. Ultimately, it becomes a chess match where governments first prevent capital from leaking offshore and later outlaw investments in precious metals, foreign currency, crypto currencies, and alternative stores of wealth. Their next step is to craft regulations limiting investment choices thereby forcing financial institutions and savers to purchase government debt through an array of restrictions like S&P quality thresholds, capital adequacy ratios, and financial reserve requirements. It’s an attempt to force capital into funding government debt and has traditionally been a third world tactic. (Did anyone noticed the proposal in the Build Back Better Act, to block IRA’s and other retirement vehicles from investing in private funds?) Enough about financial repression; let’s focus on intelligent investment strategies.
If you cannot or do not want to own a diverse portfolio of anti-fragile assets, perhaps a diversified portfolio of loans on these assets is the next best thing. Bay Point Advisor’s core investment strategy is lending on anti-fragile collateral, and while we usually do not own the collateral, we strive to build durable income based returns into our loans. Bay Point Advisors is always seeking to be an anti-fragile investment option for savers.
Bay Point Advisors
Chairman & Founding Partner
About Bay Point Advisors
Established in 2012, Bay Point Advisors LLC is a privately held firm based in Atlanta, Georgia specializing in customized, secured lending solutions across real estate and other industries, including entertainment, aviation, and natural resources. Since its inception, Bay Point Advisors has originated over $1 billion of privately negotiated loans.