Art as an Asset Class and the Dollar Smile

The Days Ahead:

• Fed meeting and earnings season moves into top gear

This Week:

• Art as an asset class
• Big problems with price transparency and costs
• And fashion and forgeries
• The dollar smile is back
• Higher interest payments to foreign holders of Treasury debt
• U.S. car production…looks like a permanent reduction in capacity
• Claims eased up again

Is Art an Asset Class?

No. I must doomscroll in the wrong places because I’ve started to see a lot of ads about how art is a non-correlated asset class and should be part of a modern, sophisticated portfolio. The ads even cite David Swensen, a pioneering investment manager and the Yale University endowment report, even though neither actually bought art for investment purposes.

Here are some quick thoughts about art as an asset class.

First up, we have to define what art we’re talking about. Sure, we can all dream of finding a Leonardo da Vinci up in the attic bought by some enlightened relation but those things don’t really happen. You’re better off with a lottery ticket. And speaking of lost Leonardos, the record price of $450 million paid for the “Salvator Mundi” in 2017, was for a work which is almost certainly not authentic,  badly restored and damaged. It now sits in a yacht somewhere and would perhaps fetch a middleish seven figure sum if it came up for auction. If anyone claims a new lost Leonardo again, they’re likely to be given very short shrift.

In most cases, “art as investment” is probably 80% contemporary and 20% from the 20^th century. Old Master art is obviously valuable but there’s not much inventory, meaning the good stuff is in museums or collections. Countries are increasingly strict about granting export licenses even if you can lay your hands on one.

So, let’s go though some of the steps of investing in art.

Finding the art. If you’re looking for contemporary art you face enormous risks. Some artists are popular for a while, then fall out of fashion. A Damien Hirst sculpture went for around $70 million in 2007 but it was later found out that the buyer was a consortium, one of whose members was Damien Hirst. If you tried ramping up a stock by creating a buying syndicate, you would be on the other end of a very unpleasant call from the SEC. But it was art so it was ok. Meanwhile, you can pick up a new Damien Hirst for around $8,000. He’s not cool any more.

Other contemporary artists like Ed Ruscha and Sol LeWitt are much favored by art funds but prices are all over the place, ranging from $2,500 to $800,000 for items of similar quality. You also have to ask yourself, is this a fashion? If Leonardo Di Caprio buys a Ruscha (he did) does that justify an increase in all works by Ruscha? It shouldn’t but it did. And you probably have to ask yourself, will it last? The contemporary wings of major art galleries change frequently. Artists go in and out of style and prices tend to fall when the artist dies (it’s complicated) and then rise again much later or forever remain in the bargain basement.

Is it a forgery? There are famous stories about very skillful forgers. One, Han van Meegeren, used old paints to recreate masterpieces and got away with it for years. Some Vermeers and Rembrandts he made in the 1940s were not discovered as forgeries until 40 years after his death. One of his works was donated to the National Galley in Washington in 1937 by Andrew Mellon, a distinguished collector, and hung for years as a pair to Vermeer’s famous “Girl With a Pearl Earring”. It’s a fake but was only discovered as such in 1995.

The market in forgeries is a well-guarded secret among curators, collectors and galleries. Some modern art is extremely easy to forge. A couple paid $8 million for a Rothko but which was done by a student in Queens. The Jackson Pollock and Warhol foundations decline all requests to authenticate a work.

No one wants to admit the work may not be what it claims to be. One artist, Norval Morrisseau, found himself going around to museums and galleries explaining that he was not the author of the works they had purchased. Many pushed back saying, “Of course it’s original, you just don’t remember painting it.” Fun stuff, if you’re an investor trying to sell.

Can artists forge their own work? Yes. Take the case of Giorgio de Chirico. Here was an artist painting around 1910-1920 who founded the Metaphysical movement which was then coopted by the Surrealists. He showed dream landscapes, often with mannequins, broken architecture and empty streets. As if the world was an illusion, distorted and enigmatic. And so, it must have been for the generation hurling themselves into the World War One trenches for a purpose that was confusing then and now. Here’s one of his masterpieces from 1917 called “Disquieting Muses.”

And here’s a good description of it. It’s in all the art history books and if you could buy it, it would set you back a lot. As in tens of millions. Critics and public beat a path to his door. He was “in.” De Chirico completed a number of works in this style. Later on, in the 1920s, he painted stuff like this and this, which were not so good and no critic beat a path to his door. In fact, they were quite rude about him and saw him as a has-been.

Around 1924, a wealthy client wanted to buy the above work but the then owner wasn’t selling. De Chirico, a little short of money, stepped forward, offered to paint something for him for one-fifth of the price and painted this:

The major difference is the signature and the buildings on the left. Later on, collectors really wanted De Chirico’s work. They were all in the art history books after all. But they wanted the stuff from 1910-1920 not the later stuff. So, he painted at least five more identical versions of “Disquieting Muses.” Same subject, colors, lines, size….everything. And he also back dated them to 1918. Because, you know, people wanted his works from his “in” period not the later stuff.

Of course, this drove dealers, collectors and museums bonkers. Did they own the first Disquieting Muse? Or the fifth? Or the sixth? Because they’re all signed, dated and original art works. You can probably guess that the earlier ones are far more valuable than the later ones but spotting the early ones is hard. And people who have what they think is an early one, are not going to want to find out that in fact it’s a later version, and worth a fraction of what they paid for it.

How can you tell a fashionable artist from a great one? You can’t, except perhaps over time. Pietro Annigoni was hugely popular artist in the 1950s, here and here, commanding commissions of over $100,000. Today you can pick up his work for less than $5,000. One of the ads I saw showed a Banksy, who’s an unidentified street artist and does most of his work in stencil. That means his work is very easily copied. Again, hugely fashionable now but unlikely to stand the test of time, especially as his best work self-destructs or has to be pried off a brick wall.

Is art a good inflation hedge? This gets difficult. We do know that a Picasso’s Women of Algiers sold for $32 million in 1997 and again for $179 million in 2015 for a return of 10%. That’s not bad. But a Warhol self-portrait sold for $17 million in 1986 and for $40 million in 2011. That’s only a 1.5% return and the S&P 500 would have turned that $27 million into $101 million, excluding dividends. There’s even some question as to whether the sale was real.

The old maxim among dealers on art is “Your money back in five years, double it in 10 and add multiples thereafter.” Aside from the inconvenience of sitting on dead money for five years, that’s not a great return. The S&P 500 index has done that for years.

The one big experiment in using art as an investment was the British Rail Pension Fund (BRPF) which started a collection in the 1970s and wound it up in 1996. Its total return was about the same as government bonds. The fund had access to the best galleries in the world but found, to its cost, that quality doesn’t just matter, it really matters. It’s not enough to have a good Renoir, you need an “exceptional” one to make good money, and there just aren’t enough of those around.

One good study showed that:

Between 1900 and 1986, art returned 5.2% with a volatility of 37%, while the S&P 500 stock index generated an average of 5.7% with a volatility of 21%. Thus, art returned between… -70 %and +81% per annum about 95% of the time. Conversely, stocks returned -36% and +47%, within two-standard-deviation (i.e., 95% of the time) parameters. With a higher average annual return (5.7% versus 5.2%) and lower standard deviation (21% versus 37%), one may begin to comprehend the relative investment risks and benefits between art and equities: art appears to have a lower mean return and is more volatile.”

We’d agree.

They also experienced illiquidity. Buyers don’t always show up when you want to sell. Spending on art is a luxury and it’s tied to the economic cycle. Prices are volatile. The timing mismatch was one of the reasons, along with a dwindling supply of good art to buy, that BRPF sold its collection. As far as I know, no other major pension or sovereign wealth fund has tried it again.

Costs and insurance. Art costs money all the time. The average commission from a Sotheby’s or Christies is 20% for buyer and seller. That’s a 40% round trip. A major gallery usually charges at least that amount, and usually on both sides. If you want to keep your art at home, crating it up and sending it home would cost around $10,000 for a decent work. Insurance costs on a $1 million collection could cost as much as $10,000 a year, providing you have a state-of-the-art security system.

When the BRPF sold off its collection it found that the 10.4% return fell to 2.5% after accounting for storage, restorations, management, repairs and lost dividends.

Restoration is very expensive. Jackson Pollock famously dripped acrylic paints on to unprepared canvases and table cloths. Great. But the paint separates from the canvas and literally falls off and wastes away. A restorer’s time will be long and the bill very costly.

Art Funds. There have been plenty of art funds launched over the years. But the returns are usually unaudited and gross of fees. One fund we saw has a 5-year lock up, charges 3% to buy the art for the fund, another 3% to sell it, 2% in management fees, another 0.25% to prepare your K-1, and takes 15% of gains. Nice work if you can get it.

There is no pricing transparency. Even when an auctioneer cries, “Sold” down a telephone in a bid, you don’t know if that’s the real price (there could be discounts) or even if it was sold at all. If a work fails to reach its reserve price, the house does not say “Darn, that’s not high enough, the seller wants more” but it will say “Sold, to the gentleman on the red phone.” The work will then disappear into the basements for a few years.

So, art funds are particularly difficult to assess and when we see one, we tend to give it a wide berth. They don’t pay income, supply and demand is very cyclical and problems compound with forgeries and artists’ own production volumes. If you come across any funds that you’d really like to have, please give us a call. We’ll probably talk you out of it. As we often tell clients, if you like art, buy it. It may increase in value but at least you get to enjoy it…don’t outsource your own taste.

(p.s. technically a forgery is a work done in the “style of” and a fake is a copy of an existing work. But the terms are often interchangeable.)

Is the Dollar Smiling?

Financial markets like patterns and there’s one for the value of the U.S. dollar called, “The Dollar Smile”. This is what it looks like.

Please excuse the very badly drawn “smile” over the chart. The basic theory is that the dollar is strong (at the top of the graph) in two very different circumstances. First, when the U.S. economy is strong and there’s general optimism and second, when the global economy weakens and risk appetite falls.

Behind the idea is that in the first case, investors flock to U.S. assets, like equities, and drive up the dollar. In the second case, they do the same, except they buy assets like Treasuries, when things look risky and need safety. In both cases, the dollar strengthens.

At other times, the dollar will weaken as capital looks for other and better investment opportunities.

You can see this in the chart. In the run-up to the dotcom mania in the 1990s, where the U.S. was the place to be and the dollar strengthened. The dollar then entered the “gutter” of the smile as other economies worked. From 2001 to 2007, Emerging Markets rose by over 380%, and the Euro had just come into circulation. Investors were willing to sell U.S. dollars to be part of the rapid growth in Asia and the replacement to the deutschemark, franc, guilder and half a dozen other European currencies. The dollar fell by 40%.

By 2007, the banking crisis was in full swing, risk appetite vanished and the investors bought as many Treasuries as they could. The 10-year Treasury yield fell from 5% to 2% and the dollar gained 20% overall and 24% against the euro.

Then there are few more smaller “smiles” and a pause for a few years while the world grew slowly under a zero-rate policy. Then in 2021 it took off as U.S. markets rallied all the way through to the end of 2022. Since then, the dollar has fallen around 12%.

A quick summary, therefore, is the more the U.S. economy lags or leads the rest of the world, the stronger the dollar.

That’s fine but like many financial rules, it only goes back to the period of free-floating exchange rates, which was from the mid-1970s and it can take many years to work.

So, are we about to see some change?

It seems so. In the last two weeks, the dollar has depreciated by nearly 5% against the Swiss Franc and over 3% against the euro and yen. That’s despite the dollar having a three-month yield advantage of 2% against the Euro, 3.6% against the Swiss Franc and 5.4% against the Yen.

What happened? The quick answer is that the U.S. seems only one more rate hike away from finishing where as other central banks have more to do. That at least means rates will rise more overseas. While their economies may not grow faster than the US, the differential between the two will narrow and that usually means a weaker U.S. dollar.

Another thought is the higher interest payments on U.S. debt. Monthly interest payments made by the U.S. Treasury on debt was about $122 billion in June compared to $77 billion in March. The Treasury estimated back in March that total interest payments for the year would be $767 billion. They now except it to be $900 billion and it will probably go up again given that Treasury bill rates have risen in the last few weeks.

Foreign buyers hold around $7.5 trillion of U.S. Treasuries or 30% of the total of all debt. That means around $270 billion is flowing out of the U.S. to foreign debt holders. Of course, not all those dollars will be converted back to their home currencies. But some of it will, and likely a lot more than in the last few years. That could come as headwind to the dollar.

Calling turns on foreign exchange is hard but the cycle of rate hikes and the higher payments flowing out of the U.S. means that the dollar may continue to come under pressure. At least until the smile returns.

U.S. Car Production

One debate that will run for a while is whether the drop in inflation was because of the Fed or because supply bottlenecks and disruptions ended. We tend to the latter. Most of the price increases in 2020 to 2021 were due to choked ports, car rental companies panic selling their fleets not enough staff, boats stuck in the Suez Canal, and big cuts in production that proved hard to restart.

It didn’t matter that unemployment was high. Even with all the positive thinking in the world, you can’t build cars with grounded pilots and furloughed construction workers. The car companies made a real hash of closing and opening. Monthly automotive production ran at an annual rate of around 10 million to 13 million in the five years up to Covid-19. It then fell to 2 million. There’s some recovery but monthly totals have never risen above 11.7 million. The cumulative volume looks like this.

The green line is cumulative auto production over the last five years and the blue line is what it would have been if pre-Covid-19 trends had continued. By this, admittedly simple, measure, we’re 70 million cars short from what we should be. Demand came back but there were and remain not enough cars to meet demand. No wonder used-car prices skyrocketed.

We don’t know if this capacity is gone for good or if auto companies took the closures as an opportunity to retool for electric vehicles. But slowly production is coming back and prices should stop rising. Again, that should help inflation in coming months. But it doesn’t have much to do with the Fed. (h/t Matt Klein).

The Bottom Line

Markets grappled with the “Is the economy weakening or not” question. Last week’s news on inflation was categorically positive. This week we saw continuing weak numbers on housing starts and home sales but new jobless claims of only 228,000 when they had been as high as 260,000 in early June. We think some of the seasonal adjustments on claims are out of whack from Covid-19 as the spreads between the seasonally and non-seasonally adjusted has widened a lot in recent years. The summer months are when the auto companies shut down production for retooling and they do it at different times every year.

Fixed income markets barely moved. They’re looking at the Fed meeting next week.

Stocks are in the midst of earnings season. The banks have come out of it mostly looking good, especially JP Morgan, Charles Schwab and Bank of America. Only Goldman Sachs disappointed but that’s because they’re unwinding (sorry pivoting away from) a very expensive move into retail banking. Next week we’ll have the big tech stocks reporting. So far some 80% of companies have beaten earnings. It’s early days but so far so good.

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Art: Petra Cortright