On Friday, August 20, 2010, I posted a link to a lecture given by Niall Ferguson, a Harvard historian who also teaches at the Harvard Business School, entitled “Fiscal Crises and Imperial Collapses: Historical Perspectives on Current Predicaments”. I chose to write about the lecture because during the Q&A, a questioner asked Ferguson what, “History tells us about how one invests their money in this kind of situation?” Before I get to Ferguson’s answer, I want to offer some brief perspective.
Those who follow value investing know that value investors are famous for not spending a lot of time on macroeconomics. The general view among value investors – at least going into the current crisis – is that the performance of the economy cannot be predicted with a useful level of certainty. Ample evidence exists to bolster this claim.
Investing is, after all, about predicting what will happen in the future. It makes sense to limit oneself to those few areas where it can actually be done.
One such area, which is generally focused on by Buffett in the Berkshire era, is to only invest in companies with clear durable competitive advantages, which lend themselves to long-range forecasting. The most obvious example of this approach is Buffett’s investment in Coke.
Another strategy is to invest in situations where predicting the future is unnecessary because the assets in which you invest are so compellingly valued that you are (nearly) assured of making money regardless of what happens in the future.
What is striking about Ferguson’s analysis about the current macroeconomic predicament is his conclusion about the seeming inevitability of the outcome. Picking up the argument, based on historical precedence, Ferguson argues that there are six ways out of the debt crisis facing the United States.
- Grow your way out.
- Lower interest rates on your borrowing.
- Get bailed out.
- Fiscal pain: Increase taxes and cut spending
- Print money (inflate your way out)
Ferguson quickly rules out the first three options. He is skeptical the U.S. can grow fast enough given its current burdens. Rates are already low and borrowing costs could spike if the market begins to focus on the growing risks of U.S. debt. No one is in a position to bail out the U.S.
Then, based on the lessons of history, he concludes that option 4 is highly unlikely (he could find only one example where it was successfully done) which leaves printing money and default. I recommend reading the lecture in its entirety to better follow Ferguson’s argument.
Now back to the investing question. As I previously indicated, Ferguson was asked how he would invest given his assessment.
He likes countries that are fiscally sound as evidenced by moderate debt-to-GDP ratios. He cited Canada and Norway as specific examples of countries where he would be long.
He is bullish on the future growth of both China and India, but he favors India given its rule of law, representative government and free speech. He is concerned about the sustainability of innovation and entrepreneurship in a controlled economy.
He is also concerned about the rising risks of holding paper currencies and said he should perhaps be valuing his portfolio in terms of barrels of oil or ounces of gold. He did not offer any specific recommendations for going long oil or gold.
Many hedge funds have been taking material positions in gold over the past year. See the blog marketfolly.com for excellent coverage of these investments. Interestingly, the FPA Capital Fund, whose investment officer Bob Rodriguez is a highly regarded value investor with one of the best records over the past decade, has over a third of its capital in oil-related investments as of June 30, 2010 (24.38% Oil Field Services and 11.7% Oil & Gas Exploration).
Value investor Chuck Akre, whose 2nd Quarter 2010 letter I also posted on Friday and whose take on Ferguson’s analysis is worth reading, recommends investing in businesses with superior economics in light of possible U.S. debt crisis.
We do positively conclude therefore that the “best” safe place for the preservation and future enhancement of our accumulated capital is in operating businesses which have ‘pricing power.’ So we continue down that very path which we have been on for several decades, searching for the outstanding businesses that demonstrate high returns on capital, managed by folks with equal parts of skill and integrity, where the ‘reinvestment’ thinking and execution are way above average. It turns out that in 1975, and again in 2009, that those businesses which have these attributes continued to build real economic value throughout the market collapse, and recovered much of their “lost” value in a reasonable time frame. We continue to purchase such businesses while being disciplined about price. We’re also mindful that in the midst of a massive debt crisis, having some cash on hand for a rainy day really isn’t awful. If we’ve explained it properly, our hope is that this defensive approach will appeal to you, although it most certainly will cause our results to vary from the indices.