Portfolios for a Shrinking World

I spend a lot of time thinking about climate change and its impact on investments. Lots of people are sounding the alarm on migration. More recently, you’re having a lot of people think about the implications of shrinking populations.

All three of these issues are tied together and have significant implications for the future of investing.

One of the more interesting ways of looking at the market was put up by Nicolas Rabener on Creating Anti-Fragile Portfolios. The thesis was that every investment is either long or short volatility with volatility defined as economic growth. His solution was to invest in tail-risk strategies that pay off bigly during Black Swan events. I don’t think I’d ever want to get a beer with Nassim Taleb, but I’m afraid his ego is only going to get bigger in the decades to come because the investment world has to navigate any number of major disruptions. I’d call them Black Swans, but they’re not really Black Swans: all of these problems have been known about for decades and it’s only because of greed and corruption, and the incentives provided to spread misinformation to delay action, that we will be forced to reckon with them whether we want to or not.

Future Possibilities

The path forward looks like the output of a Monte Carlo simulation our ingenuity, our persistence, and our ability to cling to hope will help us find a way. But looking at it through the lens of managing the financial system, there are two possible scenarios:

  1. Scenario 1 we have a shrinking population, aging demographics, the destruction of capital from climate change, and a Fed that commits to print enough money to keep inflation at 2 percent. However, given the amount of global capital that can now cross borders in search of returns, real yields on investments will likely be below the inflation rate.
  2. Scenario 2 we have a shrinking population, aging demographics, the destruction of capital from climate change, and a Fed that try as they might, cannot print enough money to stimulate any inflation and we end up in a deflationary environment.

The two scenarios do not lead to the easy wealth creation we saw in the 20th century in the US and into the 21st.

In the latter half of this century I think the market will bifurcate – there will be assets such as farmland and rental housing that provide steady cash flow (assuming you buy in places that aren’t beset by floods, fire, or drought) and then you’ll continue to see the creative destruction that we saw during the pandemic: they’ll be a few massive winners in the public markets while everything else struggles to stay afloat.

This assumption argues for owning small businesses at the local level in places that are desirable to live and that provides a needed service that can’t be delivered to your doorstep from a giant logistics apparatus. Scalability is a problem with this approach for big money, but it may prove a solid approach for individuals.

You also run the risk of the 2010s where a bunch of VCs subsidize businesses in order for them to achieve “scale” and ultimately dominate the marketplace. The issue is that it’ll suppress incumbents and they may end up in a price war that leaves both parties worse off.

I’ll also make the pitch that more active long/short strategies will come back in vogue, although their results will be decidedly mixed.

I realize this isn’t an optimistic post for the average investor. It’s sometimes hard to remember that finance is still a relatively young field. The first principles that form the bedrock of financial theory, namely perpetually increasing GDP and population growth, will need to change to deliver on its promises during the decades ahead.

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