Weekly Edition #58
In this edition:
We’ve written several times before about how things can change dramatically in an instant and we have to be prepared for whatever comes our way. We’ll recap a couple of the one’s which have happened recently:
In 2019, then President Mauricio Macri, was behind by 15.5% in an election primary. When markets opened on Monday, the Argentine peso dropped 30.3%, and the stock market dropped 31%. To put these numbers in perspective, in the 1987 US stock market crash, the S&P 500 dropped 20.46% (which has been the largest single day drop in US stock market history).
As is still ongoing, Russia invaded Ukraine, the Russian stock market dropped 32%, and has been closed since then (it should reopen Thursday), Russian and Ukrainian bonds were decimated, and sanctions have been getting stronger by the minute. The Russian economy is collapsing and who knows when and how this will end.
The US pulled out of Afghanistan and the Taliban took over the country in a matter of days. The former finance minister for Afghanistan is now an Uber driver in Washington DC. He went from overseeing a $6 billion budget to trying to complete 50 trips to receive a $95 bonus. And he was one of the lucky ones that was able to get out and get to the US, many are still trapped in Afghanistan, and many are dead.
If all this seems far away look at what’s happened recently close to home. Nicaragua jailed opposition members on bogus charges. Chile elected a leftist president. El Salvador is gambling their future with bitcoin bonds which might blow up and cost their taxpayers hundreds of millions. If you think it can’t happen where you live or if you think you will see it coming and be able to at accordingly, the reality is that you can’t and you won’t be able to. When events happen, markets react instantly. Therefore, unless you have a crystal ball you need to diversify. Diversify your investments by asset class (bonds, stocks, real estate), by issuer (buy many different stocks), and by geography (invest across the globe, reduce single country risk). In this day and age, it is extremely easy to have a globally diversified portfolio, there’s no excuse for not having one!
We’ve mentioned El Salvador’s experiments with Bitcoin a couple of times before. In their most recent experiment, they decided to issue a bond with a 6.5% coupon, which will be used to buy bitcoin (half of the proceeds) and to the rest used for infrastructure and bitcoin mining powered by geothermal energy. Apart from the fact that investing in this bond doesn’t make financial sense(because of the pricing of the bond, it would be better to buy an existing El Salvador bond and bitcoin directly). Now it seems El Salvador is trying to time the market by not issuing the bonds now due to the conflict in Ukraine.
Bitcoin dropped 23.67% in the first 3 weeks of the year only to rise 19.78% and is currently down 8.58% for the year. Investors in sovereign bonds are looking for a certain level of coupon and gauging whether a sovereign country will default or not. Introducing bitcoin in the mix sounds kind of ridiculous. If we were citizens of El Salvador, we would strongly oppose the president gambling the country’s future on the fate of bitcoin. Imagine if the price of bitcoin drops by half, or 70,80,90% (like it’s done several times before), then the country’s taxpayers would be on the hook to make bond investors whole. Emerging countries face many problems as is, adding bitcoin volatility to the mix doesn’t help.
We tend to view everything through a risk lens. By this we mean that instead of trying to predict (guess) what will happen and make a decision based off of that; we tend to look at the probable outcomes, what will happen in each scenario and base our decision off that. For example, let’s say you have to decide if you make a large business investment. You can either try and predict if the investment will be a success and decide based off that. Or you could think of two scenarios, what happens if it’s a success and what happens if it’s a failure. Under this framing your decision could be very different. Imagine if this investment has a 75% probability of working out. Under this framing you might want to take it on. However, if you think that in the event that it doesn’t work out your company will go bankrupt then you might reconsider. Even if the numbers are 90-10, the consequences of going bankrupt are so large that you might not want to take on that risk.
Maybe the above isn’t the best example. But we always think of what happens in each scenario and decide based on that. We generally don’t try and predict the future to make our decision. In investing it’s exactly the same thing. Don’t invest in something just because it offers a high return. Think about what can happen. If it’s El Salvador’s bitcoin bond we wrote about above, don’t think about the 6.5% coupon and the possibility that bitcoin increases in price. Also think about what happens if bitcoin falls to $1,000 and El Salvador defaults on that bond. Is a 6.5% coupon worth the risk of getting wiped out? We’ll let you decide for yourself, but you can be pretty sure what our answer is…
In the 1970s the US reached an agreement with Saudi Arabia to only sell oil in US dollars. In exchange the US would sell military equipment to the Kingdom and provide certain security guarantees. This is one of the reasons why the US dollar is still the world reserve currency. Up until a couple of years ago all oil sold was priced in dollars, and a vast majority (all?) of commodity sales have been priced in dollars. A large reason of why the USD is the reserve currency is also the US’ military might and their patrolling of the seas, but we digress.
A couple of years ago, China listed yuan-denominated oil futures. More recently Saudi Arabia is considering accepting yuan for its oil sales. Tensions between the Kingdom and the US have been rising and are getting worse. However, making a switch like this would not be easy. The riyal (Saudi currency) is pegged to the USD, and the yuan has limited use outside of China. As sanctions on Russia keep getting stronger, we’ll start seeing more news like this come out. Countries which aren’t closely allied to the US (China) have been looking for alternatives to the USD for some time now. The economic sanctions placed on Russia have only accelerated this trend.
Liquidity is a tricky concept. It’s often defined as the ability to sell something quickly. However, that’s not right. The issue is not with how easy it is to sell something, but rather selling something easily at a fair price. Anything can be sold in an instant at the right price. For example, Costa Rican real estate is fairly illiquid. However, if you want to sell your house and you list it at $1,000, we’ll but it immediately, doesn’t matter where it is. If something is cheap enough then someone will buy it. Therefore, the definition of a liquid asset is something that can be sold quickly at a fair price.
The other thing about liquidity is that it evaporates just when you need it most. It tends to be harder to sell assets when there are market crises. Therefore, we always try to invest in liquid assets. We’ve been in situations where clients were invested in funds, they needed to sell them to use the money to pay for an urgent expense and weren’t able to do so because they were very illiquid (the specific case we’re thinking about also included a broker filled with conflicts of interest). Investing in illiquid assets might generate higher returns, but at the expense of much higher risk. Portfolio management includes a balance of how much to invest in liquid vs. illiquid assets. This mix is crucial since if our portfolio is too illiquid we might face severe crash crunches in crisis situations, like Harvard’s endowment suffered in 2008.
Thanks for reading!
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