Paradoxical Investing

The irresistible force paradox is a thought experiment designed by physicists to ask what would happen if an immovable object met an unstoppable force. The origin goes back to a 3rd century B.C. story where a merchant is attempting to sell a spear and a shield. He claims the spear can pierce any shield, and the shield can stop all spear attacks. This logic presents a problem as both can’t be true at the same time. In the superhero universe, this is represented as Captain America’s shield and Thor’s hammer. When the two objects collided in the movie, both were left intact but reduced the surrounding area to rubble. I often think of this paradox when listening to my children argue and fight with each other. My daughter is the unstoppable force, and my son is the immovable object, and when they collide, chaos ensues. It takes my outside force to resolve the issue and rule in favor of one or the other. I can’t wait to see what their teenage years bring!

It seems like we are witnessing the same type of battle in the economy between inflation and deflation. The deflationary pressures have manifested in economic shutdowns in many parts of the country, and businesses and industries have suffered. Millions have found themselves in the unemployment ranks, as seen through the data since the pandemic started. Theme parks, restaurants, indoor activities have been running at half capacity, while the entertainment and cruise industries have shuttered completely. Hopes remain high that the vaccine rollout and push towards herd immunity will open up these industries¹. On the other side of the ledger, it seems that inflationary forces are showing up in the form of commodities like copper, timber, and other goods and services, all while the government is getting ready to enact another $1.9 Trillion stimulus package².

I’ve spent a considerable amount of time thinking about this situation and have read some compelling theories on both sides that make strong cases. The deflation side of the argument seems to hinge on an aging demographic of investors that will invest more conservatively over time and shift their portfolio allocations to favor bonds over stocks. The thesis goes that this natural shift will keep rates anchored lower and reduce the valuation of stocks. The inflation side posits that the government will continue to “print” more money to fix any problems along the way, like what we have seen with the fallout from the pandemic. Eventually, it will cause higher amounts of inflation.

So, what types of investments should investors be considering in this type of environment?

Ultimately, this type of question needs to be answered first by determining why you are investing in the first place. Sitting down and defining your goals will lead an investor into the optimal portfolio to achieve financial success while taking an appropriate amount of risk. Periods where returns are above average will happen, along with periods when they aren’t as great as we want. Both positive and negative scenarios and everything in between are modeled when building long-term financial plans for our clients.

Philosophically, we acknowledge that we can’t predict the future. We take this in our approach of globally diversifying our stock investments, not by favoring countries or segments that we think have the best potential for gains or chasing the recent winners, but by owning all of them. Bonds are held in the same manner, using a global approach that holds bonds of countries and companies worldwide. However, we do prefer a bond allocation with short and intermediate-term bonds along with inflation-protected bonds. Much like during the last rate hiking cycle, these bonds will likely perform better than long-term bonds if interest rates rise as the economy improves and inflation picks up. This belief isn’t based on where we think interest rates are going in the next few years, but based on the desire to protect more conservative portfolios from the impact of rising rates.

These types of intellectual exercises can be interesting and something we pay attention to for our clients. Given the complexity of the issue, it’s impossible to say which side will end up winning, and I have my thoughts about which will win in the end. But even with my opinion about what happens next, I haven’t changed my investments because I realized years ago that this is a marathon, not a sprint, and it will be decided based on how the next few decades go, and not what happens in the next eighteen months.

Nathan Smith is a Portfolio Manager with Rather & Kittrell.

¹ https://www.wsj.com/articles/well-have-herd-immunity-by-april-11613669731

² https://www.cnbc.com/2021/01/14/biden-stimulus-package-details-checks-unemployment-minimum-wage.html