More on Short-Duration Tangible Assets and the 2021 Outlook

By John Banks

What are some solid ways to make a lot of money in 2021? Where will the major trading and investing gains be made? What will the themes be that potentially drive large profits?

In answering these questions, a phrase to remember could be “short-duration tangible assets.” We’ll explain what that means in a moment.

First, to quickly look back on 2020, the TradeSmith Decoder got a number of big things right. For the Decoder model portfolio — on which subscribers receive updates every trading day, including live buy and sell recommendations — we did the following:

  • Bought a round of pandemic put options shortly before the March 2020 crash, including United Airlines puts within 72 hours of the meltdown.
  • Took very large positions in Bitcoin and silver within days of the March 2020 lows (and still hold the core of those positions today).
  • Took a large position in call options on GDX (the bellwether gold miner ETF) for triple-digit gains on the rebound off the March 2020 lows.
  • Added size in the right places, leading to large gains in Bitcoin and multiple Bitcoin-related equities (very much still ongoing), (still ongoing), various gold and silver miners, a major copper producer, and more.

The main thing we got wrong in 2020 was underestimating, at first, the power of the tech bubble and the Robinhood-driven mania.

That error of judgment led to a handful of summer-vintage put option positions we closed at a loss as soon as we comprehended the awesome, and unprecedented, direct-spending power of trillion-dollar fiscal intervention coupled with a “bored in lockdown” trading craze — think millions of Americans with no pressing need for their $1,200 stimulus check deciding to buy tech stocks.

Now, in the final weeks of 2020, the year is closing strong with our Bitcoin-related holdings taking on a vertical posture (two of the equity plays we hold were up roughly 16% and 13% on Thursday alone).

But the operative question here is, what else looks good for 2021? What are the areas to focus on for the big, bold trading gains that will come outside the Bitcoin space?

As we consider the shape of the landscape, we see:

  • Growing regulatory pain for the tech juggernauts (Google and Facebook are facing a legal and regulatory assault — and Amazon’s day is probably coming).
  • A renewed emphasis on vaccine-powered global growth (the world bouncing back aggressively as corporations get back to business and emerging markets shine).
  • A world in which the bottom half of the U.S. economy continues to struggle mightily, with the government attempting to help, and added stimulus meant to help the bottom 50% flowing into Wall Street’s pocket and enabling the top half of the economy to throw a post-pandemic party.
  • A renewed emphasis on inflation concerns and inflation protection plays as demand-driven and cost-driven inflation pressures start to heat up, with central banks keeping monetary policy loose so as not to bruise the recovery.
  • High odds of a localized bubble burst, and a series of extreme price declines, in the shares of wildly over-valued tech names (stuff like Tesla, Snowflake, DoorDash, and much of the electric vehicle space). 
  • An investor shift away from long-duration intangible assets (tech stocks, basically) and into short-duration tangible assets (think energy, materials, health care, and emerging markets).

So, let’s break down what the phrase “long-duration intangible assets” means.

The term “long duration,” in our use of it here, refers to companies whose cash flow payoff is expected to be far off in the future. Long-duration payoffs are a hallmark of super-speculative technology plays.

To give a hypothetical example, let’s say there is an electric vehicle battery technology play you are super-excited about. The company is losing money hand over fist at the moment — plowing all their funds into research and development — and their technology will take years to fully develop. But they have a shot at making big profits by, say, the year 2030 or so.

These long-duration speculative tech ideas tend to draw in lots of attention, and capital, in environments where funding is cheap and interest rates are close to zero.

Think about what the world looks like when capital is plentiful and interest rates are super-low. That is typically a low-growth environment, with lots of cheap capital in the system because respectable businesses have no need to borrow it.

In such an environment, investors can choose to fund projects with a payoff far, far in the future. The lower the interest rate, the longer you can wait to see a return on investment and still justify putting money into something. If your cost of capital was zero, you could theoretically justify project payoffs that are infinitely far into the future.

This type of environment allows investors to engage in extreme, George Jetson-style, techno-fantasy projections that leave all rational assessments of profit behind, because they can start to live so far into the future that present-day balance sheets don’t matter.

If you can justify investing in Tesla because, say, they will be doing self-driving trips on Mars in the year 2035, who cares if the valuation makes zero sense in the here and now?

Nor is it just speculative technology. The basic idea is that the lower the interest rate goes, the farther the time horizon investors can justify for all kinds of speculative projects, be they tech-related or not. This can be an especially attractive mindset when there are few other things to invest in because, say, the real economy is in a slump.

The intangible assets concept goes hand-in-hand with long-duration assets.

Intangible assets are things like software code and intellectual property and business model advantages and brand value — stuff you can’t see or touch.

Investors love intangible assets because they scale up at minimal cost. One of the reasons the venture capital industry is heavily focused on software is because software code, as an intangible asset, is wildly scalable. With software, it doesn’t take much hardware to go from 1 million users to 100 million users. 

In a low-growth, low-inflation, low-interest-rate environment, long-duration intangible assets are the place to be. That is partly why the tech juggernauts have dominated the market for years upon end.

We’ve been living in a low-growth, low-inflation, low-interest-rate world where the cost of capital is cheap. That’s the perfect environment for investors to fund speculative tech ideas, and live far in the future, and get super excited about intangible assets (software code and future technologies).

Tech plays have also gotten a major boost from the pandemic itself. Think work-from-home, e-commerce, telecommuting, drone delivery, and all of the tech-related trends that were accelerated in their delivery by the realities of lockdowns and social distancing.

But here is the thing: When it comes to winning investment themes, investors are like Homer Simpson with donuts. They just keep gorging until they are full to bursting, at which point the valuations become so bloated it doesn’t take much to send them into reverse. Are companies like Zoom and DoorDash the future? Sure. Do they make sense at current valuations? Not on Earth, they don’t.

In 2021, that whole script could get flipped as genuine economic recovery takes hold.

  • With real recovery underway, sensible business models start making sense again. Companies doing profitable, bread-and-butter things in the present, versus pie-in-the-sky things in the future, start to see their year-on-year earnings comparisons look excellent as 2021 quarterly earnings and outlooks compare with much-depressed 2020 versions.
  • With consumer spending in recovery and companies working to rectify supply-chain shortages, investing in “stuff” starts to make sense again — think capital expenditure on things like factories and supply-chain infrastructure.
  • With inflation picking up as wage and labor costs rise, it becomes possible for interest rates to start rising, too. Central banks can be comfortable with rising interest rates as long as inflation itself is rising even faster — because that means real yields stay negative. If 10-year interest rates go to 2% but 10-year inflation is at 5%, they are still inflating away the debt (which is part of the deliberate plan).

So now we get to “short-duration tangible assets,” which are basically the opposite of tech stocks.

Short duration, in this case, means companies with profit-driven earnings potential in the here and now, and business models that can make money in the near-to-medium term as the economic outlook improves.

Think of, say, an international construction company that suddenly has a lot of business building new factories in emerging-market locales because investor capital is flooding the emerging market (EM) space and EM companies are expanding operations. A company like that won’t be promising to make money in five or 10 years. They will be banking profits here and now. That is a short-duration focus.

Or think of energy companies — in particular, beaten-up fossil-fuel plays — that see their earnings outlooks go from awful to awesome as the crude oil price climbs northward and energy demand roars back on both the oil and gas side (with green energy alternatives still years away from displacement).

Then, too, as soon as interest rates start to meaningfully rise — even if they only rise a modest amount — a lot of the wild financing math that relies on super-low rates no longer works.

The higher the interest rate, the more that profits and cash flow actually become relevant.

  • In a world of super-cheap funding, all kinds of speculative projects can get funded, even with payoff possibilities that are years away.
  • But in a world where financing has a meaningful cost hurdle — because interest rates have gone higher — you actually need incoming cash flow (profits in the near-term) to justify borrowing at the higher rates that are on offer.

The impact of rising rates — a natural corollary to growth-powered inflation — is another reason why the whole regime shifts away from overinflated tech to underappreciated short-duration tangible asset plays.

And the “tangible assets” reference here is basically the opposite of intangible assets — stuff that is material, stuff that is physical, stuff you can drop on your foot (like a commodity) or stuff you can lean against (like a factory or a refinery).

So that is more or less what we see for 2021: A regime change from long-duration intangible assets (primarily tech stocks with nosebleed valuations) to short-duration tangible assets (beaten-up boring businesses that will make money in the present, on the strength of inflationary recovery).

And what happens, by the way, if the recovery stalls out for whatever reason? If, say, the vaccine rollout stalls, or global growth runs into unforeseen snags? In that case, we will still be oriented toward tangible assets — again think physical “stuff” — but more in the inflation-protection vein, like precious metals stocks (which could in fact do well in either scenario).