Dear Friends,
We created Dorot Partners as a vehicle to manage our family assets and help our friends in managing theirs. We believe pairing Liran’s public and Itzik’s private market experiences with longer investment horizons will lead to better long-term returns. Our main goal in writing this letter is to generate a dialogue with market participents. Please, reach out to discuss your perspectives with us.
Macro Outlook
As the world starts looking past the Covid-19 investment climate, we believe it is valuable to pause and look at investment cycles over the last 50 years (since the global onset of fiat currency). We believe during this period the economy operated in one of two key states:
1. Low asset inflation / high goods inflation: Commodities, and commodity-producing countries do well and real estate outperforms stocks (1970’s, 2000’s)
2. High asset inflation / low goods inflation – best performers are growth companies; real estate underperforms equities. Commodities and commodity producers do poorly (1980’s, 1990’s and 2010’s)
We believe the post Covid-19 global political dynamic will lead to increased direct transfer payments to lower income families, higher minimum wages, and a sustained increase in government spending. These conditions combined with a lack of investment in resource production will lead to an investment environment characterized by lower asset inflation and higher goods inflation (especially essential goods).
Currency Outlook – The End of Reserves?
Currency markets from 2000-2010 were a dynamic asset. Investors could find interesting macro expressions of growth differential between countries, expectations of monetary policy, etc. The current environment is beset with low volatility G10 currencies and a grinding devaluation of EM currencies that undermines any superficially appealing interest rate differential. With global interest rates hoovering near the 0% “bound”, there has been a lot of interest and resources in the investment community directed toward exploiting future currency moves. While we share the hope of interesting currency markets, we do not believe low interest rate will be the likely cause. If anything, we would argue that rates pinned to zero would, over time, drive currency volatility towards zero too. However, in the coming years we expect the end of currency reserve regimes. This should lead to a volatile and interesting currency market with ample opportunities to express fruitful macro views. More precisely, we believe the next 12-24 months will see countries move to abandon their reserve accumulation strategy and with some reducing existing holdings. While this trend has not started, we anticipate the most important currency cross to watch as we move into this regime is USD/JPY. Currencies to go long have attractive valuations and currently hold significant currency reserves.
Commodity Outlook
Investing in commodities over the last decade was a recipe for underperformance. $10,000 invested in the Bloomberg commodity index at the beginning of 2010 is worth $6,000 today. As expected, depressed commodity prices have led to significant reductions in production and exploration across all commodity sectors. As we emerge from the Covid-19 crisis, governments across the world will focus on stimulating their economies in any way imagined and unimagined, including infrastructure spending (good for hard commodities) and transfer payments (good for soft commodities). We expect a pickup in commodity demand after a decade of declining supply – this is a classic set-up for a multi-year bull market and we believe commodities and commodity-producing countries will outperform in the coming decade.
Volatility Outlook
Volatility tends to trade in multi-year regimes. In early 2018, we exited a low vol regime and entered a high vol regime. We anticipate this extending through the equity bull market and into the early stages of the next bear market. One interesting aspect about the current high vol regime is that it has been concentrated in equity markets almost exclusively. While the low volatility in rates may be easily explained by central banks intervention, we believe FX and commodities will follow into a higher volatility regime. We expect crowded positioning to be squeezed and FX to move towards our longer-term valuations. In the current environment, VIX near or under 20 should be unsustainable and FX and commodity vol will emerge. We are running our options book with a long vol bias whenever VIX approaches 20.
Global Equities Outlook
Over the last few years, we have seen an acceleration of the transition to ETFs as the preferred investment vehicle. We used to be strong believers in ETFs as an efficient way to express a country view, but excessive inflows and the change in composition has made these ETFs less attractive. Most of our readers are aware of the entry of TSLA into the S&P 500, which forced every holder of an S&P index fund to sell 2% of assets to buy TSLA. Furthermore, our suspicion is that few EPOL holder (a Polish Equities ETF) knew they sold 10% of their assets to replace them with Allegro (an e-commerce company). We expect this dynamic to accelerate and believe the correct approach to global equity investing will increasingly move to the pre-ETF dynamic: build your own diversified portfolio of global companies that represent your macro view. Companies we believe will benefit under our long-term macro-outlook: commodity producers, financials in commodity heavy countries, consumer products companies (especially non-discretionary), and industrials with exposure to infrastructure spending.
Fixed Income Outlook
In contrast to the last half century, we do not expect interest rates to be a key driver in the next few years. While we do believe we are heading into a goods’ inflationary environment, we do not expect a rapid increase in interest rates in the early stages. A rapid increase in rates, prior to a significant reduction in overall debt burden, would lead to a recession and quickly self-correct. On the other hand, we think that we’ve seen the low in global rates and have entered a multi-year move higher. To us, the rates environment today looks similar to EMFX 10 years ago. While in general EMFX today is much weaker than it was 10 years ago (due to cost of carry and other effects) it was not an attractive investment from either the long or the short side. Therefore, we maintain a low exposure to Fixed Income with a focus on markets where we expect to have a currency tailwind.
Private Early-Stage Tech Outlook
First, congratulations to the team at Talkspace on their going public announcement via SPAC at a valuation of $1.4B. Talkspace was one of our first early-stage tech investments back in 2013 (this effort has been led by Itzik). Early-stage tech is a very different asset than the others we discuss in this letter. These investments tend to be entirely driven by Micro rather than Macro considerations. Investment in early-stage startups relies on many aspects including: the teams’ potential, their ability to execute, and the product’s market opportunity. While we view some bigger tech companies to be overvalued, we think there is, and always will be, tremendous opportunity in seed and series A investments. We regularly discuss our early-stage tech investing with our public markets partners and invite them to join us whenever possible.
We want to thank you for your ongoing support. The past year has been one of the most eventful and challenging years in all of our lives, but we hope and believe in a better future ahead. We welcome your discussion on the views in this letter and look forward to hearing from you.
All the best,
Liran Blum Itzik Ben Bassat
Chief Investment Officer President
