Ruffer LLP Q1 2025 Investment Review

There is a moment in David Lean’s Dr Zhivago (1965) when dishevelled Russian troops, retreating from the front line in the First World War, are confronted by an immaculate Russian officer, who brandishes a pistol and tells the men to go back to the battlefield.

He climbs onto a water barrel to elevate his harangue. In mid-peroration, the wooden struts at the top of the barrel give way, and he ends up head and shoulders sticking out of the water. Everybody laughs and jeers. Then a shot is fired off-screen, and he slumps lifeless in the barrel. It is a great scene, illustrating, theatrically, a time when everything changes – at that moment, there’s a regime change.

My colleague Matt Smith used more colourful language to describe today: “Everything has been smashed up” – the 1941 Atlantic Charter (progenitor of NATO), the Washington Consensus, the pax Americana. The world we have known is changed. And, like the giraffe I de-stuffed at the age of four, the stuffing is not going to be restored to its old order.

We sort of know that – but we don’t yet sense it. Sir Niall Ferguson, one of Britain’s great historians, made his name in the financial world by tracking stock markets from the assassination of Archduke Franz Ferdinand on 28 June 1914 to the start of the First World War – 1 August for Germany and Russia, 4 August for the British. He observed that it was not until the end of July that markets really perceived the existential threat to the world (and, ergo, the world economy). The implication he drew from that was that markets were pretty cloth-eared as to the risks which were on show. I rather think it should be exactly the other way around. Investors took comfort, throughout those weeks, that there was no market collapse, so the common knowledge was that these extraordinary events, plain for all to see, were ‘priced in’ to the market. And, as things quickly became worse, there grew to be a belief that the fundamentals of the economies of the world must be prodigiously strong to hold up in the face of this deterioration. This 1914 view was shared by the Bank of England, which granted ‘accepting house’ status to my family’s bank, A. Rüffer. So, the following week, when A. Rüffer (with all its assets in Germany and all its liabilities in London) went bust, His Majesty’s Government had to underwrite the losses of £1 million. (The National Debt was then £709 million – it was an expensive mistake.)

The same could well be happening today. The danger of a financialised marketplace is that risk is interlinked, so that trouble in one place is instantaneously trouble in a series of other places. If the sea level rises, one can anticipate obvious trouble in East Anglia and Venice. But, when great inland lakes appear, the sheer unexpectedness adds meaningfully to the sense of nervous uncertainty. A startling statistic was published a few months ago by the American Association of Individual Investors, which showed that 64% of American citizens owned US equities. It is a chilling echo of one of the features in 1929, when public engagement in the equity market (much lower in percentage terms, of course) was a contributing factor to the malaise of the depressionary 1930s.

That two-thirds of the American people have investments in the prosperity of their homeland is a sign of confidence – confidence which is the engine fuel of prosperity. Such optimism is, however, compromised by the overlay of intergenerational tensions in the Western world. My generation (I was born in 1951) bought houses at prices that were affordable; our children and grandchildren have no opportunity to do the same. With every year that passes, the ranks of those excluded from the property-owning classes grow. This social problem is a scandal, of course, and scandals have a habit of creating eructations in unlikely places. The mood I sense is that often the only hope of those disposed to make money is to play the markets while the sun is still shining: no time to be owning Colgate, the toothpaste manufacturer – better to take risks on high-growth businesses which, if successful, will generate high rewards.

When it comes to predicting future returns from an investment, I believe securing a margin of safety in the valuation that one pays for a company’s stock is a much more important factor than whether investors are correctly assessing the future growth prospects of the underlying business. Put another way: financial markets have a remarkable habit of turning good companies into bad investments. In my last Investment Review, I compared two previous manias – the Nifty Fifty and the dot.com bubble. The Nifty Fifty is an almost perfect example of this truth. The question, all those years ago, was: which are the best companies in the world? The answer Wall Street gave was pretty much spot-on – a generation later, those businesses were strikingly the ones which had continued to be world-beaters. The problem was that purchasers paid what was in retrospect the wrong prices for them.

We live, of course, in a world where the best franchises can be compromised by technological change. It is a hallmark of all super-profitable companies that either innovation or competition will compromise those profits eventually. One must be aware of this – and look for opportunities amongst the new predators. But we are nervous of their valuations, and, anyway, hope is a tricky commodity to price. It is a hesitation which applies equally to traditional investments. Back in the 1970s, it could be assumed that technological breakthroughs would remain in the same corporate hands, as automobiles and electrical appliances largely did. Today it’s wiser, perhaps, to assume that one must be agnostic as to who the beneficiary will be. The market is full of future winners and losers, so I judge expensiveness less by the eye-popping valuations of the AI stocks than by the valuation of the market as a whole. I am particularly interested in the price to sales ratio of the market because the valuation of a corporation can’t be fudged; nor can the sales figure. A high price-to-sales ratio is justified by today’s investors as the natural state for companies with terrifically high margins, but in that margin assumption lies an equal amount of the danger. In the days of my innocent youth, a price-to-sales ratio of more than 1x was an amber light. Today’s US equity market briefly moved through 3x in late 2021 and again late last year. Who knows what colour of a light that is, but for our money it’s certainly not green.

If I return to the world that is broken, it is not always the case that nemesis follows swiftly. Did the Second World War start in September 1939? Or in May 1940, when Western Europe was overrun in six startling weeks? The gas masks which had been issued to the children of London at the outbreak of war did not face the bombers for another year – and, in the event, they turned out to be the wrong sort of protection.

Many investors hope for a setback, even a biggish one because they feel they have a secret weapon – ‘buy the dip’! The best investment strategy is, of course, one that is not shared by a large number of other people. But, that aside, there is another reason to think hard about a strategy which first worked in 1987 and has worked every single time since. The enemy to this way of thinking is not contrariness of thought; buy the dip is after all a mechanical exercise. The danger is that in every iteration more people do it, and eventually they forget what the reasoning was in the first place. Success breeds complacency: the strategy becomes obsolete simply from the dynamics within it. What’s the evidence? The world has become increasingly, excessively, leveraged. Governments have higher debt to GDP ratios than ever; Germany, a rare exception, has just given itself permission to join the party. Investors, too, are extended; the latest hedge fund data shows their gross exposure to be in the 100th percentile – in plain English, highly indebted. This compromises their ability to buy the dip; after all, what’s the use in spotting a gap in the enemy lines if you’ve already committed all of your troops elsewhere?

To top things off, there is in this cycle a crucial dynamic at play, one where falling markets create the recession. Conventional wisdom regards the stock markets as a leading indicator – predictive of future events. Markets are not always right, of course, as evidenced by the economist Paul Samuelson’s famous quip that the stock market has predicted nine out of the last five recessions. Forecasting requires of its analysts a series of predictions – often fan-shaped, to reflect a multitude of different outcomes, only one (at most!) of which will, in the event, occur. It is a flawed model: analysts know that surprises routinely upend their peacock tails. What is not properly considered is that the course of events in the real world are often determined by severe dislocations in the financial markets which have already occurred. This calls not for a gradient ‘fan’ of outcomes, but a binary model: the US economy can continue to grow at 2.5% if there is no dislocation; but it will contract, and sharply, if in a crisis the current high indebtedness compromises all its players. This is why the commentators who write about the Depression in the 1930s start with the story of the Wall Street Crash in 1929. There have been plenty of crises before and afterwards, but only the Panic of 1873 seems to have shared the 1929 characteristic of not only foretelling but actually being a major contributor to the hard times to come.

The world we are left with today is one that features equities at maximum valuations, investors at peak investedness and now a new feature: a perceived but not yet digested regime change. As markets begin to sense the impossibility of the first two co-existing with the third, they will fall, and where they go, the economy will follow.

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.