“I thought you chaps at Ruffer said that you’d never lose money for me – what’s gone wrong?”
The weakness in markets reflects the passing of an inflexion point of mood: from a sensation that we’ve been living through extremely benign investment conditions, and that now we have moved into a much harsher environment. We have been arguing that the new climate will see a market setback punctuated by a trinity of mischiefs: the broadness of the setback, the speed of the fall, and the extent of the decline. If this proves to be accurate, it will represent some of the most challenging conditions for a generation. In broad terms, our strategy has been – and still is – to have a limited exposure to equity risk, and to combine this with powerful protections. These barely protect at all against limited falls, but will build into a powerful carapace when gales become storms. It is hard to protect risk assets from ordinary setbacks – everybody knows these can happen routinely, and protection against them is prohibitively expensive. Our central belief is that there lies ahead of us market conditions which are capable of causing permanent damage to people’s wealth, and our absolute preoccupation is to prepare for this, while continuing to accept that the timing is uncertain. It would be reasonable for investors to feel that the events of December give credence to our view that bad things are, indeed, on the way, while at the same time they might question whether we have a handle on navigating it. This review, and the accompanying report by our Chief Investment Officer, Henry Maxey, are to provide reassurance on the navigation.
The two reports – this one and Henry’s – are designed to be complementary. His report is an analysis of the pressures on the market – it is technical, going into the plumbing of the system. I highlight it because it brings together a wide range of disparate threads to create a cogent single narrative. I will therefore use this review to concentrate on what we are doing in the portfolio; the key to why we are doing it is set out in Henry’s piece.
Let me turn first to our equities. These accounted about 40% of portfolios in 2018; last year they fell, on average, by 14% – around 6% of the whole portfolio value. In a world where 90% of asset classes (as tracked by Deutsche Bank) have had a down year in dollar terms, there has been little possibility of diversifying into ‘pockets of strength’, but, even allowing for this, there needs to be a further explanation for the extent of the equity fall. At the beginning of the year, equities could be categorised as: momentum (largely growth stocks), value (cyclicals, financials etc) or safe, ‘no surprise’ companies. The right place to be was in the latter. The first category, momentum, turned out to be the hare – a stellar first half, and ‘cow attempting the moon’ in the second half. The tortoise, which won the race, was found amongst the safe staples, concentrated into those companies which did not put, commercially, a foot wrong. While they might seem to have been an obvious place for Ruffer portfolios, they were, and are, dangerously expensive. Additionally, the purpose of our equities is to make money – we parade the virtue of safety and protection, but we would not be out–performing the equity indices over 25 years of existence if we had not made good money from the companies we invest in. Last year we favoured ‘value’ stocks, many of them somewhat troubled businesses – troubles which in our view were fully priced into their ratings. With every sign of a late–cycle boom in the economy, which benefits the earnings of cyclical companies, and accompanied by higher interest rates, which assists the financial industry, we concentrated on these. We were not wrong on the economic growth, nor the interest rate rises, but the market has savaged the value stocks. If you take risk, you get risk. As the markets declined, we took out some of the risk in financials and the retailing sector, as events there showed that profits can fall as fast as, if not faster than, share prices. Simultaneously, we added a little to our protective assets.
We have been pleased to see the gold price creeping up – again, we have increased our exposure there. The value at the moment is in gold stocks, rather than gold bullion. The mining companies’ share prices have been in long–term decline, and have reached that happy–hunting ground where the enemy of stock appreciation is not bearishness, but indifference. In a world where everything goes down, before everything rallies, and then everything… here is a genuine diversifier. Gold is an opaque and shadowy investment – many refuse to admit it is an investment at all – and so its early signal of a positive response to difficult markets generally is a hopeful sign.
I want to write – for the umpteenth time – about the inflation–linked bonds within the portfolios: we have held them in the UK for a long time, and they have been reinforced by TIPS in the United States.
How can it be that we are worried about inflation while simultaneously preoccupied by market conditions which will be horribly consistent with a powerful – possibly overwhelming – deflation? A dislocative fall in markets would almost certainly create a deep economic contraction, as it did in 2008 – some of the early figures a decade ago showed catastrophic falls in national outputs. These are seemingly the exact opposite conditions of the inflation needed to make these critters crit. We do not see it like that.