Asset Allocation for the Future

EATHERBIE CAPITAL

COMMENTARY 2/4

EATHERBIE CAPITAL

While no one knows howmuch debt issuance and quantitative easing bond investors will tolerate before beginning to demand higher interest rates, we believe it seems likely that they will revolt at some point .

With this kind of intervention combined with large debt levels and slow economic growth, we believe interest rates are unlikely to move materially higher in the short term. It may be that as negative interest rates roll through the world, the amazing desire to pay to lend will wash up on U.S. shores, transported from Japan and Europe by the global capital seas. While no one knows howmuch debt issuance and quantitative easing bond investors will tolerate before beginning to demand higher interest rates, we believe it seems likely that they will revolt at some point. The demand for higher interest rates and ultimately society’s desire to mitigate the mountains of debt that have been built up may ultimately manifest in higher inflation and interest rates (see Figure 2). But that moment could be a long way off because ultra-low rates allow the government and other entities to service their debt. Only the market can provide the answer on timing. Cash, Bonds and Inflation In our view, the role that cash and bonds play in traditional asset allocations may become diminished and potentially lose relevance to assets such as gold or bitcoin in an environment characterized by deflation at first and then possibly inflation. In deflationary times, gold or bitcoin may be more efficient stores of value. In periods of higher inflation, they may be more likely to better preserve their value while cash is exposed to the corrosive effects of inflation and the value of bonds is hurt by higher interest rates. Under either scenario, we think it is hard to make a case for bonds as a durable component of a portfolio. The Appeal of Equities Over time, we believe equities will continue to be a popular choice among investors. Equities have provided a handsome 6.9% annualized real return over the past 150 years, unmatched by any other asset class in magnitude and longevity. Small capitalization stocks, in particular, have historically produced strong returns (see Figure 3). During deflation, their long duration may potentially help them outperform. In higher inflation, they may potentially grow their businesses even faster than inflation while bond cash flows are stuck in neutral. EATHERBIE CAPITAL

EATH

Figure 2: Growth of Global Debt

% of GDP

Trillions

$250

250%

Global Debt Debt/GDP

$200

230%

210%

$150

190%

$100

170%

$50

150%

$0

4Q01

4Q03

4Q05

4Q07

4Q09

4Q11

4Q13

4Q15

4Q17

4Q19

Source: Bank for International Settlements