Mr Douglass said he expected to be widely attacked for his views on crypto, but did not care.
“I can’t tell you when that will happen by the way. It could happen shortly, it could happen quite some time into the future … I think when we look back in 20 years it will be the case study of the irrationality.”
Meme stocks such as Tesla were also specifically singled out by the fund manager as areas of reckless speculation where share prices have nothing to do with the underlying value of the business.
Electric vehicle maker Tesla is up 14-fold over the past five years at the same time as its founder Elon Musk acquired 58.3 million Twitter followers. Other meme stocks such as AMC, GameStop, and Nokia also soared after gaining viral attention on social media platforms like Twitter and Reddit as part of the retail investor phenomenon of 2020.
Uncertain outlook
Mr Douglass was not overly concerned about such asset price bubbles as far as Magellan’s investment performance was concerned, as it had zero exposure. However, he warned of a contagious hit to sentiment if cryptocurrencies’ ballooning popularity creates a systemic risk, where contagion in the event of a collapse hurts broader investor confidence and upends markets.
The fund manager also defended Magellan’s defensive portfolio positioning and investment underperformance over the past 12 months on the basis of mounting risks around a material correction in equities.
Magellan’s flagship global fund returned 10.8 per cent for the year to June 30, versus a 27.5 per cent return for its benchmark the MSCI All World Index.
“I guess it’s a little bit of a wake-up call in Australia with Sydney and Melbourne being back in a hard lockdown,” he said. “We all thought this was over. We were about to get vaccinated. The risk is we get an escaped mutant from this virus. One that evades the vaccines … This delta one’s frightening at the speed it can spread, but the vaccines still seem to be effective against death.”
Inflation and rates
The other great known unknown risk facing markets over the next 12 months and beyond is inflation, according to the fund manager.
Last week, US inflation data showed prices rising at their fastest pace in 13 years for June as the cost of a broad basket of consumer goods including housing, cars, trucks and petrol shot higher. “Our view is that the most likely outcome, and certainly not the only outcome, is these major inflationary pressures we’re seeing just at the moment will prove to be transitory,” he said.
If June’s inflation surge proves more than transitory, Mr Douglass warned the only outcome is market-shaking higher interest rates and recession. “And that would make it [inflation] very problematic for equity investors around the world.”
Rising risk-free rates as a symptom of inflation also threaten the balance sheets and solvency of many corporations which have taken on debt over the past three to five years, according to the fund manager.
“They’ve leveraged up their balance sheets, their credit ratings have gone down, and there’s been a huge resurgence of speculative-grade junk bond credits out there,” he said. “People have chased these types of credits because interest rates are at zero and people have been reaching for yield so these assets are enormous scale.”
The fund manager cautioned investors not to discount to zero the risk that yields on benchmark risk-free rates in the form of US 10-year Treasuries jump from 1.5 per cent to 3.5 per cent over the medium term.
As risk-free rates rise, investors demand more compensation for the risks around uncertain future cash flows from equities via lower valuations. “As Warren Buffett famously says, interest rates are the gravity of markets. You know higher rates, lower asset prices,” he said.
“And [with] lower interest rates, which we’ve all seen over the last decade, asset prices have soared.”
