2021 Portfolio Thoughts (Part 1 – Themes)

As the year comes to a close, I wanted to pen down some thoughts to guide myself towards positioning for the first half of the next year, at least.

Broadly, I would like to take a deductive approach of starting from hypothesis of what could go right and wrong, and then use that as the guidance towards constructing the portfolio for the first quarter of the next year.

I will write this in two parts, with the first part dealing with the key hypothesis and the second part then arriving at the asset allocation that supports these themes.

As we stand here, there are few macro themes that I am considering, as I build the portfolio:

  1. Continued Fiscal and Monetary stimulus which may drive USD currency debasement: Lot has been written around potential for currency debasement due to money printing. It it correlated with the higher inflation assumption. However, value of currency is relative to the other currencies and the US Fed has been the most dovish. There have been some signals (let’s say DXY trend over the past 6 months) around it and this hypothesis is currently supported by a vast majority of investment practitioners.
  2. Vaccine “stimulus”: Its been a technological marvel to get to a vaccine in 6 months when previously it took many years to get a vaccine made and distributed. Assuming this vaccine will sort out the Covid issue (even the new strains), this distribution of vaccine could turn out to be a material stimulus for the sectors that have been repressed in the economy including Travel and Hospitality
  3. Continued liquidity injections: Liquidity injections by the Fed will continue. Its expected that they may even increase under Biden’s administration These liquidity injections have been coming through bond buys, direct payments to families and individuals as well as other monetary and fiscal stimulus
  4. Continued passive flows into indexes through retirement (and education, etc.) accounts: As I have mentioned in my previous blogs passive flows have continued in the retirement accounts. These don’t focus on the price of the assets but just focus on the quantity. This argument has been primarily forwarded by Mike Green of Logica. The underlying argument here is that younger generations are investing in passive funds either through 401K or even through retail brokerage accounts.
  5. Inflation assumptions: As mentioned in my previous blogs there are a few factors that might drive the reflation in the next 6 months. The background behind that may be driven by increased money supply, especially driven by credit guarantees from government over bank lending as well as localization of supply chains which may drive the cost of goods higher. However, given the current slack in labor supply its unlikely that we will see any inflation in the next 6 months. As vaccine leads to a broader economic recovery and economy gets back on its feet, we may start to see signals for reflation and inflation. These might even lead to stabilization and (possible) increase of longer term rates as jobs and reflation/inflation signals start to build
  6. High equity valuations: By any standard valuation metric, the current US stock market recovery has overheated. But as I explained that may still not mean an equity price correction although as Charlie Munger has recently explained that the forward looking expected equity returns are expected to be lower in the future.
  7. Continuing rise of China: As indicated in Ray Dalio’s Changing World Order and as indicated by Harvard’s Kennedy School Thucydides Trap, China continues to lead the world forward. As an investment professional this is not something that I can ignore and need to consider investment approaches
  8. Segmented Recovery: Across the equity spectrum, and worldwide, there has been a differentiated recovery. Tech has recovered strongly driven by low interest rates while other sectors have not. The companies have different level of leverage, earnings (P/E, earnings growth), current ratio, Cash to OpEx and Price to Book Value, etc. The forward looking outlook is expected to be different, similarly.
  9. New Technologies: There are a number on new technological trends on the horizon – some closer than other. These include (1) Blockchain, (2) AI (as a service), (3) Cryptocurrencies, (4) 5G and IoT, (5) Autonomous driving, (6) Genomics (with AI) as evidenced by recent mRNA vaccine, (7) AR/VR. These technologies can change the existing dynamics, start new use cases and industries and need to be looked at as one seeks growth.
  10. There are other smaller macro themes which could be used to drive the portfolio construction:
    • Probability of wealth shift from savers and wealthy populous through taxation increase (higher probability in Biden’s Term) and Inflation (already discussed above).
    • Brexit has prevented the rebound of UK and pound
    • ESG is a strong macro trend that most investors are aligning to

In the next part of this blog, we will look at what these themes imply in terms of right portfolio construction.

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