“Self-reflection is the school of wisdom,” wrote Baltasar Gracian. As we finally get to turn the page on 2020, the Spanish philosopher prompts us to reflect deeply on the year that was.
In this annual review, as per tradition, we take a closer look at what we published and highlight what went right, where things went wrong, and what to expect for the coming year.
The Big Picture
We started the year with an unusual observation.
On January 12, Saturn and Pluto met in Capricorn for the first time since 1518. Astrologers refer to this planetary conjunction as a synod, which means “a traveling together.” The more slowly a synod moves, the more powerful its influence on human affairs.
Saturn and Pluto come together in a new synodic cycle every 33-37 years which impacts the world on a macro level, introducing change and sometimes upheaval. Who knew a celestial event will cause such monumental and globally felt shifts?
At Davos, Bridgewater’s co-CIO Bob Prince declared we have seen “the end of the boom-bust cycle” while Ray Dalio said “cash is trash.” Goldman economist Jan Hatzius called this period the “Great Moderation,” saying the economy is “structurally less recession-prone today.”
Wall Street strategists raised their bullish forecasts with expectations for a market melt-up. Barron’s magazine cover boldly stated, “Dow 30,000.” The editors asked, “How soon to 40,000?”
We examined a question few people were asking: “Could we be seeing a buying climax?” We warned investors that rather than a melt-up, “what comes next is an ominous churning pattern followed by a truly cleansing downside correction.” Stocks could revisit the lows from December 2018.
There was little support for this view at the time. But a visit to San Francisco in February and witnessing the ebullience during the Goldman Sachs Tech Conference strengthened our belief.
Clarity of perception is one thing and accuracy of response another. The mistake we made was that we viewed the rise of the radical left in US politics as the key event risk in 2020, which would be priced later in the year.
We downplayed the virus and incorrectly relied on equity market performance during past pandemic outbreaks to guide our forecasts.
Our analysis suggested the world is grossly exaggerating the threat to our lives from the coronavirus, and severely underestimating the potential human and economic toll due to our fear-driven response to it, which led to the most abrupt and widespread cessation of economic activity in history.
In 2008, we relied on economists’ shoddy models, then ridiculed them after they failed for considering economics a “science.” The lesson is not lost on us. Today, we rely on the false precision of epidemiologists’ models, which, of course, we can’t question because its science—and who is against saving lives?
On March 25, we wrote that we expect both new information and the changing interpretation of existing information about the coronavirus to inflect positively and support risk assets.
In China, no new local infections were reported for the first time since the outbreak began. Italy confirmed new cases have started to drop. First clinical trials for a vaccine were already under way. And Neil Ferguson, the epidemiologist who created the highly cited Imperial College coronavirus model, downgraded his estimates of deaths by more than 95 percent.
We turned to history to get acquainted to previous stock market crashes and found that what comes next is an explosive rise that recovers much of the steep drop. We expected many major markets to fully retrace March losses.
Rumi said as you start to walk on the way, the way appears. As events unfolded, we started laying considerable weight on the prospect of a new bull market. There were some obvious truths hidden in plain sight.
First, despite the worst economic contraction since the Great Recession, we may in fact see the fastest profits recovery ever. It took four years to get back to peak earnings after the Great Recession. During the Great Depression it took over a decade. We should return to pre-pandemic level of earnings by the end of 2022.
Second, while most investors were agitated by a rising stock market despite high unemployment and the dire economic outlook, we made the simple observation that the stock market is not reflective of the economy.
The top two sectors today (Tech and Health Care) make up half of the S&P 500’s market cap, but only around 20 percent of the economy. Earnings calculated have an upward bias because the S&P 500 index includes the largest companies by market value that are also benefiting the most from the pandemic’s disruption.
We also arrived at a new understanding: Our mistreatment of the environment and animals paved the way for Covid-19. This was karma.
The Earth had its hottest January in recorded history this year. The virus then triggered the largest ever annual fall in carbon dioxide (CO2) emissions, more than during any previous economic crisis or period of war. This could be the year that global emissions peak. We wrote the pandemic will accelerate the world’s transition to sustainable, decarbonized economies.
In May, we reviewed all the big declines in bond yields since the beginning of the secular downturn in interest rates in 1981. What we found was surprising: from each historic low, the 10-year Treasury yield retraced 50 to 61.8 percent of the drop over a span of 2 months to 14 months.
In our current cycle, the 10-year yield fell from a high of 3.2 percent in October 2018 to a low of 0.4 percent in March 2020. The 50 and 61.8 percent retracement of the decline comes in at 1.8 and 2.1 percent, respectively.
This seems inconceivable given the grim economic reality, but the historical pattern is clear. Something to keep an eye on for next year.
We turned our attention to an overwhelming topic over the summer: the history of American race relations. We wanted to cut through the noise and articulate something everyone’s thinking about, but no one is saying. Few people truly understood the racial schism separating white and black citizens.
America was on edge. Investors worried about the election and were still haunted by their memories, waiting for the crash to reappear. They looked with skepticism at the new, younger players in this market. We instead saw this as a bullish sign. The sudden Covid-19 shock was getting more people looking to save and buy stocks.
We explained why the equity culture is ascendant again, and that trying to resist the present moment is futile and will only cause more pain. As Alan Watts puts it, “The only way to make sense out of change is to plunge into it, move with it, and join the dance.”
In August, we asked, “What if the stock market crash this year was an intervening cyclical top within a contrasting secular trend?” Looking at a similar occurrence in 1962 and 1987, we argued the bull market has years to run. “The path is likely to be messier and confusing, but we think the S&P 500 could easily rally to 5,000.”
We outlined a timely cautious tactical stance in September. Stocks fell 10 percent. But we reiterated our bullishness next month. The boom in day trading, the birth of rolling funds, and the rise of blank-check companies (SPACs) all still pointed to one thing: the greed tide is beginning.
We introduced a new multi-year theme: Death by Fintech. The pandemic has accelerated the adoption of digital financial services across all age groups and entire industries. Over the next several years, we believe Square, Shopify, and PayPal be worth more than the ten largest US banks combined. This is one of our highest-conviction views.
As the US election drew near, we evoked Seneca who entreated us to spare a little time each day to think of everything that could go wrong: “Reckon on everything, expect everything. Nothing ought to be unexpected by us.”
We couldn’t seem to get comfortable with the consensus around the Blue Wave.
Our analysis suggested the election will be much closer than people think. But we concluded stocks should do well no matter who wins. In the end, Trump lost the election by less than 150,000 votes across the key battleground states.
While the world still balks at America’s failed response to a pandemic and the election rancor, we explained in December how their economic management may yet prove to be superior. America bounced back from a historic contraction in both GDP and employment more quickly than anyone imagined.
The days of American exceptionalism are not over. The US equity market will likely maintain its global leadership and the dollar may find some relief.
“The global recovery is advancing at different speeds, shaped by the pandemic and the effectiveness of policy support. These uneven recoveries—with America leading, Europe lagging, China slowing, and emerging economies suffering—worsen the prospects of global reflation next year.”
We also presented evidence the rotation from value to growth is the start of a secular trend that will persist over many decades. This is a key contrarian insight. As long as the global economy becomes more knowledge-based and increasingly reliant on new technologies, growth indices will continue outperforming because of an overweight in the dominant industries of our time.
Lastly, we shared a new framework to analyze the dramatic changes taking place in society, the economy, and markets. Covid-19 is not just the defining global health and economic crisis of our time. The pandemic is a major displacement.
The collapse of the Bretton Woods system was a displacement that led to the 1970s gold mania. In the 1990s it was an information-technology revolution leading to the dot-com bubble. China’s entry into the World Trade Organization in 2001 was another displacement, which led to the bubble in commodities.
The displacement changes investment horizons, expectations and behavior—the full extent of which remains unclear at first. But once price movements confirm the dominant narrative, an emotionally driven process takes over until it evolves into a state of euphoria. This takes time.
It’s easy to say we’re in a bubble today. But the insight from financial history is that we’ve endured the “displacement” and are only now entering the “boom.” The “mania” phase lies well ahead.
Our salon series summons the best ideas from our community of hedge fund CIOs and portfolio managers across the globe. We kicked off the year in London with an intimate dinner.
One of the members who is an experienced credit investor told us that the “signal” from credit markets does not support a “melt-up” in equity markets. He recommended buying credit protection through credit default swap positions in the European iTraxx Crossover index. This helped his fund make over 50 percent returns in March.
At the end of our evening, he also shared a wonderful perspective on life and markets. Of all the dinners we have hosted around the world, this moment was our all-time favorite.
“Ego is a very expensive suit that we wear. It worries about external perception and validation and hence takes you away from the path of truth... The way to learn is to shed your ego. This means be open to defeat.”
Another member shared the bullish case for Tesla and Nio, which are up 4x and 10x this year, respectively. “EV companies are the next FANGs,” he said. “The market is still underestimating the value of these brands.”
We traveled to San Francisco in February, where one of our members hosted us in his Atherton mansion.
Over dinner, we learned that Reed’s law will enable powerful network effects.
The value of networks that allow the formation of groups can scale exponentially with the of the network. There is a large economic opportunity for startups working on verticals or groups with similar interests—in gaming, remote work, and crypto—with an ability to be winner-take-all. A member proposed Slack as the best example of the Reed’s law in action.
We also discussed how the pandemic will likely accelerate innovation in remote working. Companies that benefit from work being more decentralized stand to benefit. Zoom was pitched as a no-brainer long.
One of the members also suggested how the total market cap of bitcoin could attain a trillion-dollar valuation.
There was no way of knowing this would be our last in-person event. But we ended the evening on a touching note. Everyone reflected on Professor Clayton Christensen’s final advice after he was diagnosed with cancer: “Think about the metric by which your life will be judged and make a resolution to live every day so that in the end, your life will be judged a success.”
The coronavirus outbreak roiled our desert gathering in Abu Dhabi in March. Rather than feel bummed, we took the opportunity to think about how we can create a digital-first experience for all our members.
There were a few advantages. First, we could bring together members from all parts of the world. (Our first online salon in April had participants join us from London, Singapore, and New York.) And second, our members could now watch the discussion live rather than just read notes after.
There was still uncertainty and doubt about emerging trends in April. Our first virtual gathering opened our mind to the prospect of a weak dollar regime and the bullish case for tech with every component of FANG stronger because of the coronavirus pandemic.
In May, we believed it’s time to pay attention to commodities. To dig deeper, we gathered our community of commodity experts for a focused discussion.
“A decade long commodity bear market is causing supply destruction across the commoditycomplex. Meanwhile, the demand hit because of the pandemic is only going to be temporary,” one of the members said. “On the other side of this, industrial GDP will be higher given services has shrunk while commodity markets will be tighter. This is bullish.”
The CRB Commodities Index is up more than 25 percent. Copper is up 50 percent. Oil is up 60 Percent. One of the members expected natural gas prices to double by the end of the year (which happened in October).
The key insight from our next salon was that some of the largest pools of capital will be forced to go up the risk curve because “they’ll have no other choice” as unfunded liabilities explode. “All the levers of risk taking are going to get yanked by the collective pension funds of the world. There might be a melt-up as they chase stocks.”
In September, the salon discussion shifted to the displacements caused by the global pandemic. One member said this will lead to a home buying surge in America, built on Millennial demand.
Another member suggested that leading bricks and mortar retailers were the non-obvious winners in a post-Covid world. Not only are they going to come out of the pandemic stronger online, but they’re going to face a weaker set of competitors. Both liked Target, which is up 15 percent since then.
We discussed the fate of the American republic in October, a timely and riveting discussion ahead of the election. And in November, we sketched out the major themes that will underpin the “twenties”: balanced multipolarity, generational conflict, China’s introspection, atoms over bits, and climate change as an investment thesis.
For our final salon this year, we turned our attention to China to contemplate risks in 2021. While China weathered the Covid crisis better than anyone, the new year presents its own challenges: de-risking the financial system, supporting a domestic recovery, addressing a growing wealth gap, and fostering innovation. The way ahead will be more difficult, less predictable, and highly contingent on complex policy choices. We believe the risk of a policy error is high.
As always, we published a series of work to expand our knowledge beyond markets. Successful investing is only possible with knowledge of oneself.
The Guru How our decisions about allocating personal time, energy, and talent ultimately shape our life’s strategy. We have a propensity to over-invest in our careers and underinvest in our families, though intimate and loving relationships are the most powerful and enduring source of happiness.
Stress How to welcome stress by recognizing that it’s a response to something we care about, and then make use of the energy it gives us. Stress can activate strength and can be used as a signal to the body to help us rise to the challenge.
Woulda, coulda, shoulda Why we accumulate at least some regrets while investing. Regret is just an internal trigger telling us to take another look at our decisions. It can be a helpful emotion—not just a painful one.
Awareness Why the end object of investment should be serenity and how to achieve it.
Try not to try Understand this: our job is not to see the future; it’s to see the present very clearly. What makes us unable to invest with pure awareness is our warped relationship with time.
The Misbehavior of Contrarians Why more investment mistakes arise from a dogmatic mindset than from uncertainty and confusion.
Fasting How the challenge of spiritual life is discovering how to empty yourself to be filled. There’s hidden sweetness in the stomach’s emptiness. Fast and see the strength of the spirit reveal itself.
Learn to Breathe Why weakness of breath underpins weakness of mind and body. Strength in breathing carries strength to both. Know that breath must be exercised.
Striking Thoughts Wisdom from Bruce Lee: “To express oneself honestly—not lying to oneself—that, my friend, is very hard to do.”
Lachesism Why we love to feel the unique and terrible pleasure of doom. The pandemic is a chance to go through a cataclysmic event and come out of it with a larger appreciation for living.
This year taught us that our ability to cope with an increasingly complex world is limited. We comprehend only a small, unique fraction on our own. Our talents and minds are different, and experiences vary from one investor to the next.
That’s why community matters. When the membership puts its heads together, it’s just easier (and more fun) to make sense of things. The exchange of insights is what keeps us coming back for more.
From pre-pandemic dinners to monthly online salons and our invaluable Slack group, it’s all an excuse to foster deeper, more meaningful relationships. Rumi knew, after all: “Be with those who help your being.”
We are proud of the work we’ve done and look forward to serving you again next year. Your trust is something I’m grateful for. We take it seriously that we are relied upon for clarity, conviction, and a sense of calm.
I hope you are safe, healthy, and full of newfound wonder and gratitude. I wish I could hug you.