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Why This Is China’s Year in Markets · Merryn Talks Money

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Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News. Welcome to Maren Talk
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Speaker 1: to Money, the podcast in which people who know the
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Speaker 1: markets explain the markets. I'm Meren sums Thatt Web. This
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Speaker 1: week I am speaking with Ed Cole, head of Multi
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Speaker 1: Strategy Equities within Solutions at Man Group. Complicated titl. Ed,
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Speaker 1: Thanks for joining us today.
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Speaker 2: Thank you for having me Mere in complicated title, but
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Speaker 2: a simple person.
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Speaker 1: Okay, and hopefully everything you're going to tell us is
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Speaker 1: also going to be really simple, straightforward and one hundred
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Speaker 1: percent accurate.
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Speaker 2: I won't make that promise, but let's see where we go.
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Speaker 1: What we want is correct forecasts on this show to
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Speaker 1: help us get through these difficult times. Listen, what I
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Speaker 1: really want to talk about is equity markets as a whole.
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Speaker 1: We've been writing a lot and talking a lot about
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Speaker 1: whether there is a great rebalancing going on from the
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Speaker 1: US equity market to effectively all of the rest of
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Speaker 1: the world. I don't know whether you would consider what
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Speaker 1: has been happening in the US market of the last
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Speaker 1: year or so well before January this year, whether they're
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Speaker 1: constituted a bubble or just a very expensive market. But
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Speaker 1: one way or another, possibly it's not that surprising to
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Speaker 1: see American exceptionalism begin to be questioned in the context
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Speaker 1: of the US equity market and for there to begin
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Speaker 1: to be flows into other markets, most obviously Europe at
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Speaker 1: the moment. But big question for our listeners, particularly as
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Speaker 1: we come up to the end of ice season, is
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Speaker 1: if they're investing now, should they say, Okay, do you
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Speaker 1: know what have made a lot of money in America
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Speaker 1: over the last decade, and maybe it's time to look elsewhere?
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Speaker 2: And if that is the case, where yeah, extac question
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Speaker 2: a question of course that preoccupies those thinking about their ISA,
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Speaker 2: but also those that are allocating large sovereign pools of
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Speaker 2: money as well. I'd start with a bit of kind
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Speaker 2: of common sense thinking, which is, whenever you hear terms
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Speaker 2: like exceptional or uninvestable, it pays to think through whether
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Speaker 2: there's another side to that, because typically those things you
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Speaker 2: use the word bubble, but ply those types of words
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Speaker 2: start to reverberate when consensuses are so strong that things
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Speaker 2: are priced to some degree to perfection. You could take
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Speaker 2: one side of the world today China allegedly uninvestable, where
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Speaker 2: that's priced for uninvestibility, and you take the other side
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Speaker 2: of the world, the US, which is exceptional, and in
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Speaker 2: some parts of that market price for exceptionalism. I mean,
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Speaker 2: I tend to think that it really does pay to
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Speaker 2: think about the other side on that typically because that's
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Speaker 2: normally a moment of complacency. And indeed, if you were
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Speaker 2: to do something like Google trend search the word US exceptionalism,
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Speaker 2: I suspect it would probably peak sometime after the US
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Speaker 2: election in the fourth quarter last year, which was around
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Speaker 2: the time the market peaked. Big picture, nothing's uninvestable and
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Speaker 2: nothing's exceptional. It really markets and assets have values, and
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Speaker 2: those values have to be connected to reality, and I
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Speaker 2: think we could we should be thinking about things in
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Speaker 2: those terms. I think that what the sort of extraordinary,
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Speaker 2: if not exceptional, thing about US equities is the level
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Speaker 2: of concentration. And of course you've had times in the
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Speaker 2: past where equities have been highly concentrated. In nifty to
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Speaker 2: fifty was in the sixties was a period where we
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Speaker 2: saw kind of concentration in a broader basket of stocks
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Speaker 2: them Today, though, and what's extraordinary about today is that
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Speaker 2: if you take the S and P. Five hundred, you
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Speaker 2: have one and a half percent of the constituents by
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Speaker 2: number that account for thirty five percent of the index weight.
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Speaker 1: And that's the Mega seven.
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Speaker 2: And that's that that type of group that's problematic because
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Speaker 2: it means you are not really investing in a broad index.
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Speaker 2: You're investing in a kind of group of stocks. I
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Speaker 2: think that we are huge believers in everything that we
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Speaker 2: do in institutional portfolios at this company in diversification. And
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Speaker 2: where you end up today thinking investing in an SMP
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Speaker 2: tracker is I think you are in something that is
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Speaker 2: pretty undiversified, both in terms of number of stocks, but also,
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Speaker 2: and this is critical, in terms of the commonality of
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Speaker 2: the drivers of those stocks. Call them the mag seven
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Speaker 2: for example, are all broadly in a group technology, long
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Speaker 2: duration cash flows, as in like big growthy type companies,
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Speaker 2: high quality balance sheets. They've all got a certain type
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Speaker 2: of attribute and those attributes respond to macroeconomic conditions in
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Speaker 2: a very similar way. So if you're clustered into an
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Speaker 2: investment that is overweight one type of style, you have
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Speaker 2: to be prepared for the type to go out in
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Speaker 2: that type of style. That's a long intro to your question,
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Speaker 2: but in my mind, thinking about the medium term, let's
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Speaker 2: say the sort of five year plus time horizon, we
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Speaker 2: absolutely have to be thinking about diversifying holdings. It seems
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Speaker 2: unlikely to me that at the level of valuation that
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Speaker 2: US equities as a whole are to day and the
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Speaker 2: concentration of that group of stocks is at in particular,
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Speaker 2: that you're going to get super normal returns on a
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Speaker 2: multi year time horizon looking forward.
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Speaker 1: But does that interrupt you briefly? Is that even the
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Speaker 1: case if these companies were to meet their long term
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Speaker 1: earnings forecasts. So if you look at some of the
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Speaker 1: forecasts for earnings for those huge companies there, I mean,
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Speaker 1: they're extraordinary, expecting earnings to grow twenty twenty five percent
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Speaker 1: five years out, et cetera. Look at that kind of thing,
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Speaker 1: and you say, well, if that was true, maybe these
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Speaker 1: valuations are justified. I wouldn't, by the way, but other
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Speaker 1: people mind.
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Speaker 2: I would probably say, you need them to beat those
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Speaker 2: numbers to do well. So the bar's set high. That's
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Speaker 2: one thing. The bar is already set high. And that's
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Speaker 2: back to that point really about when you start getting
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Speaker 2: language like exceptionalism, it tells you that people are bought in.
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Speaker 2: There's a thematic or a narrative that starts to explain
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Speaker 2: things that you have to be a little bit skeptical
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Speaker 2: of the other side of it, though, quite simply, is
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Speaker 2: not the company earnings, which of course matter enormously for
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Speaker 2: the discrete stock if you buy that stock, but it's
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Speaker 2: also about the macroeconomic environment, and there are enormous cross
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Speaker 2: currents today in the global economy. I want to get
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Speaker 2: to inflation in a moment, but because it's critically important
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Speaker 2: and I think we're in a world today that's not
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Speaker 2: like one that any of us have really experienced in
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Speaker 2: our professional lifetimes. You could even just start with Europe
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Speaker 2: and what Europe today is intending to do with its
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Speaker 2: plan to rearm itself. Europe has been the big European
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Speaker 2: economies have been moribund for a long time, very stagnant,
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Speaker 2: very much lacking industrial policy in any form at all,
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Speaker 2: saddled with a lot of debt, low productivity growth. And
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Speaker 2: what you're talking about today, particularly coming out of Germany,
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Speaker 2: which she was an economy with plenty of fiscal room,
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Speaker 2: is something that I think dramatically changes the nominal growth
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Speaker 2: profile of that country, and in doing so, dramatically changes
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Speaker 2: the earnings growth potential of the companies in that country.
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Speaker 2: On a multi year view. Some estimates this is a
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Speaker 2: bigger stimulus for Germany than reunification for those who can
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Speaker 2: remember it, which was a big deal. So let's without
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Speaker 2: even necessarily having to wonder whether that group of exceptional
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Speaker 2: quote unquote exceptional US are going to beat their earnings,
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Speaker 2: you can start to think about the fact that there
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Speaker 2: are things moving in other parts of the world that
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Speaker 2: are probably not particularly well understood.
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Speaker 1: The key thing to say is that they are alternatives
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Speaker 1: that until very recently, most equity investors will look around
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Speaker 1: the world and say, well, it's looking a little pricey,
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Speaker 1: But the truth is there isn't any alternative. And they
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Speaker 1: would also have believed, until relatively recently that all the
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Speaker 1: big gains in technology in AI and space and evs, etcetera, etcetera,
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Speaker 1: are all going to come from the US, not from China.
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Speaker 1: And maybe deepsek with the catalyst to say, do you
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Speaker 1: know what, Actually there's quite a lot going on in
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Speaker 1: AA and China. Maybe it's not uninvestable, maybe it is
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Speaker 1: an alternative. So Germany and China are two sides of
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Speaker 1: this beginning of an idea that there is an alternative.
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Speaker 2: I think you're so spot on China. I think the
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Speaker 2: markets have this kind of tendency to have a sort
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Speaker 2: of single narrative that they latch onto, and the single
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Speaker 2: narrative on China has been deflationary bust. This is a
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Speaker 2: deflationary bust economy. And actually what you can see with
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Speaker 2: the emergence of deep sea with the news this week
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Speaker 2: about BYD's ultra fast battery charging for the electric vehicles,
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Speaker 2: is that actually, during this period of attempted containment of
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Speaker 2: the Chinese economy over the last almost decade, that China
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Speaker 2: has really learned to do more with less. This has
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Speaker 2: been an innovative catalyst for China, not a headwind, and
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Speaker 2: so I think that's an excellent point. But it's also,
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Speaker 2: by the way, just one part of what's going on
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Speaker 2: in China. Conviction has been building for some time that
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Speaker 2: the Chinese authorities, the policymakers there are really starting to
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Speaker 2: understand how to fix their deflationary risk. That there are
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Speaker 2: several pillars to this. The technology and innovation part is
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Speaker 2: of course a key one, but actually the really important
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Speaker 2: thing here, and we think we're probably likely to see
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Speaker 2: some much more concrete announcements on this later this year.
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Speaker 2: If the US and China do some kind of trade deal.
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Speaker 2: Is that we think we're moving into an environment where
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Speaker 2: the Chinese, as you makers, are going to reform their
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Speaker 2: social security system quite materially, and that's incredibly important because
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Speaker 2: China has a massive savings rate. In essence, what happens
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Speaker 2: in China is if you're a migrant worker, your social
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Speaker 2: security benefits are payable in the place that you were born,
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Speaker 2: not the place that you live, and that requires you
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Speaker 2: to save, and that means that consumption is repressed by that.
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Speaker 2: And the plan that's taking shape, we think, is one
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Speaker 2: which will allow social security benefits to follow your domicile
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Speaker 2: or your residence and will allow people to save less
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Speaker 2: and spend more. Which sounds boring, it will be enormous
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Speaker 2: for the Chinese economy, and actually we think we're on That's.
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Speaker 1: Interesting because there's been talk for years about the Chinese
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Speaker 1: authorities understanding that they need to try and shift to
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Speaker 1: a more consumption based economy but finding it incredibly difficult
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Speaker 1: to do, not being able to find the route through
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Speaker 1: to make people start spending. But obviously this makes sense.
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Speaker 1: If you have a security net wherever you live, you're
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Speaker 1: much more likely to spend the money that you do have.
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Speaker 2: Yes, and it's a different flavor to China. Let's say,
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Speaker 2: the one that people have been used to from the
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Speaker 2: twenty tens onwards has been a sort of luxury obsessed
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Speaker 2: China conspicuous consumption. And let's not forget that g was very,
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Speaker 2: very vocal about common prosperity. And we think that probably
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Speaker 2: the way this takes place is actually mass consumption, that
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Speaker 2: the shape of consumption in China will have changed. All
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Speaker 2: of which is just to say there are really interesting
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Speaker 2: opportunities outside the US. That the US is a dynamic market,
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Speaker 2: it's a phenomenal economy, It innovates brilliantly. It has a
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Speaker 2: place in everyone's portfolio. But there are opportunities today to
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Speaker 2: think about proper allocations outside the US before, if I may,
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Speaker 2: before we come onto inflation, which is really important. One
10:39
Speaker 2: other thing, just so that I don't end up with
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Speaker 2: egg on my face. There is I think a real
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Speaker 2: possibility in the near term, call it the next few months,
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Speaker 2: that actually all this fear about the end of US
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Speaker 2: exceptionalism disappears. I think it's entirely possible. We've had this
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Speaker 2: big wobble in markets recently which has been very much
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Speaker 2: focused on the US, has been centered around unpredictable policy
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Speaker 2: around whether or not the economy will stay out of recession,
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Speaker 2: and it's I think reasonable to assume that actually, as
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Speaker 2: we get more clarity over policy, and it's entirely reasonable
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Speaker 2: for some of that risk premium to come back out again,
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Speaker 2: and we may well find ourselves in three months time
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Speaker 2: looking back at or near all time highs in US equities,
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Speaker 2: and people will think that's all over. It is not
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Speaker 2: to say that the earlier conversation about there being other
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Speaker 2: opportunities is wrong. It's just that actually these fears dissipate
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Speaker 2: quite quickly as prices change.
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Speaker 1: I agree with you that could well happen. But I
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Speaker 1: also think that the perlavas over the last few months
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Speaker 1: and the shifts in the other markets relative to the
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Speaker 1: US might mean just a little bit of the spell
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Speaker 1: is broken. A little bit of the spell is broken,
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Speaker 1: and pretty much any global allocator sitting down now or
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Speaker 1: in three months or in six months is going to
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Speaker 1: have in mind that the US is not the only
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Speaker 1: market in the world, and have in mind that perhaps
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Speaker 1: they were far too concentrated in that market in a
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Speaker 1: fragmenting world.
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Speaker 2: I don't disagree a soul.
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Speaker 1: All right, I'm going to let you lose on inflation.
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Speaker 1: I know that's where you really want to go.
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Speaker 2: I'm a child of the seventies in my blood, even
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Speaker 2: though I didn't know it. Inflation, yes, so inflation is
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Speaker 2: really important to markets. We have all through our professional
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Speaker 2: lives lived through this period that we call the Great Moderation,
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Speaker 2: which was really from the late eighties onwards. I think
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Speaker 2: the time was only coined in the early two thousands,
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Speaker 2: but it describes this environment that once central bankers in
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Speaker 2: the eighties and supply side reform in the US and
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Speaker 2: the UK and other countries had tamed inflation, we moved
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Speaker 2: to a much less volatile macroeconomic environment, and it was
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Speaker 2: a period in which asset prices obviously have done extraordinarily well,
12:45
Speaker 2: and the world has grown tremendously through that period. What
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Speaker 2: we see in that time is that central banks explicitly
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Speaker 2: targeted inflation. Inflation has been very well behaved in general.
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Speaker 2: In fact, it's tended that the risks have been to
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Speaker 2: the downside, not the upside. So you would go through
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Speaker 2: a period like the dot Com bust, or the Great
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Speaker 2: Financial Crisis, or the Eurozone debt crisis, and central bankers
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Speaker 2: were always primed to act to defend against deflation, not
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Speaker 2: worrying about inflation. And we talk in markets about the
13:17
Speaker 2: FED put this idea that the FED is there to
13:20
Speaker 2: protect you. That comes from the fact that the Federal
13:24
Speaker 2: Reserve the most important policy making central bank in the world,
13:28
Speaker 2: even for us here in the UK, that when they
13:31
Speaker 2: don't have to worry about inflation risks on the upside,
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Speaker 2: they can concentrate entirely on growth. So that's what that's
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Speaker 2: the world we've lived in. And what that's done for
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Speaker 2: markets and for savers is it's created this beautiful environment
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Speaker 2: where bond prices and stock prices are uncorrelated against each other.
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Speaker 2: And I'll explain a little bit what I mean by that.
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Speaker 2: It would mean that when you're in an environment like
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Speaker 2: the GFS either Great Financial Crisis twenty eight two thousand
13:59
Speaker 2: and nine, as your equity allocation sold off on fears
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Speaker 2: of recession and systemic crisis, your bond portfolio performed extremely
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Speaker 2: well because the world could have conviction that central bankers
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Speaker 2: had your back. Effectively, they would cut rates and stimulate
14:21
Speaker 2: policy sufficiently to rescue the economy, and in cutting rates
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Speaker 2: bonds would appreciate, bond values would go up on that.
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Speaker 2: So that was a world where to put some numbers
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Speaker 2: on it. In two thousand and eight or two thousand
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Speaker 2: and nine, by the trough of the Great Financial Crisis,
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Speaker 2: equities in the world had lost forty percent, but a
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Speaker 2: sixty to forty portfolio of bonds and equities had lost
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Speaker 2: about ten to twelve percent, really mitigated by having inverse
14:50
Speaker 2: correlations opposite behavior of these two asset classes. What happened
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Speaker 2: in twenty twenty two when inflation came back is that
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Speaker 2: the conviction that central banks would be able to protect
15:05
Speaker 2: you from disaster inequities dissipated. Suddenly, this policy goal that
15:13
Speaker 2: no one had worried about for thirty five years came back.
15:16
Speaker 2: So what we found was that actually, as equity prices
15:19
Speaker 2: came down, central bankers not only didn't have our back,
15:23
Speaker 2: they were making things worse by hiking interest rates, quote unquote,
15:26
Speaker 2: making things worse. They were dealing with an inflation problem.
15:29
Speaker 2: And what that did at that point in your portfolio
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Speaker 2: was it meant you lost money in both equities and bonds.
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Speaker 2: And that was a real shock, I think, to the industry,
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Speaker 2: and I guess what we worry about with inflation is
15:43
Speaker 2: that it's a little bit a case that once the
15:46
Speaker 2: genie's out of the bottle, it's quite hard to get
15:49
Speaker 2: it back in again. Inflation expectations get very sticky. We
15:52
Speaker 2: see this everywhere in the world. Japan, which has been
15:55
Speaker 2: a good equity market story for the last couple of years.
15:57
Speaker 2: In particular, Japan has had some central bank surveys on
16:01
Speaker 2: inflation and they show almost unprecedented expectations of inflation, both
16:05
Speaker 2: by households and businesses. In the UK here last week,
16:09
Speaker 2: I think it was we had wage data private sector
16:12
Speaker 2: earnings which are growing at about six percent. So you
16:15
Speaker 2: think about the fact that this economy is really not
16:17
Speaker 2: growing very much today at all, but there is an
16:19
Speaker 2: entrenched expectation of wage growth and there isn't very much
16:23
Speaker 2: productivity growth in the UK to support that. That's a
16:26
Speaker 2: problem because that's starting to demonstrate that actually inflation is
16:29
Speaker 2: becoming systemic to some extent, which is problematic. Now that
16:33
Speaker 2: doesn't mean we believe that you're going to experience inflation
16:37
Speaker 2: going back up to double digits again, as it did
16:39
Speaker 2: in twenty twenty one twenty twenty two, but what it
16:42
Speaker 2: may well mean is that we're in an environment where
16:46
Speaker 2: it's a bit above target for quite a long time,
16:49
Speaker 2: and if we find ourselves in a situation where growth
16:51
Speaker 2: starts to disappoint, central banks will be constrained on how
16:54
Speaker 2: much they can cut.
16:56
Speaker 1: Yeah. Well, there was an interesting survey that we talked
16:58
Speaker 1: about at the time. You may have seen when inflation
17:01
Speaker 1: was worth very high in the UK feedback that once
17:03
Speaker 1: inflation goes over eight percent, it's really hard to get
17:06
Speaker 1: it back to target. You know, it takes I think
17:08
Speaker 1: it was an average of fourteen years from that sebect.
17:10
Speaker 1: It doesn't mean that you get hyper inflation, doesn't mean
17:12
Speaker 1: it goes fifteen percent. Just means that once you go
17:14
Speaker 1: over eighty eight percent, people really notice. There's a new
17:18
Speaker 1: generational understanding that this can happen to prices, and people
17:21
Speaker 1: fight it. So it's hard to get it back down
17:23
Speaker 1: to two. Maybe you can get it to four, and
17:25
Speaker 1: maybe you can get it to three, two point eight,
17:27
Speaker 1: two point nine. Man to get it back down to
17:29
Speaker 1: two very hard.
17:30
Speaker 2: I think that's absolutely right. I think that's absolutely right.
17:32
Speaker 2: I think it just tying it back to your very
17:34
Speaker 2: first question, which is about US equity markets. The other
17:37
Speaker 2: thing in all of this is that the companies today
17:41
Speaker 2: that are the biggest, most successful, best performing companies in
17:45
Speaker 2: US equities over the last five to ten years are
17:49
Speaker 2: actually the ones that are most sensitive to inflation. We
17:52
Speaker 2: have this concept that we think about, which is a
17:56
Speaker 2: bit technical, but the duration of cash flows. And what
17:59
Speaker 2: we mean by that is if you're a really growthy company,
18:02
Speaker 2: if you're an AI company that's got a runway of
18:06
Speaker 2: growth for the next twenty years, the market will award
18:11
Speaker 2: you a really high multiple. Your valuation will be high
18:14
Speaker 2: on the expectation of that incredibly long runway for growth.
18:18
Speaker 2: In contrast, if you're a company that has a bunch
18:21
Speaker 2: of factories that make ball bearings, and you know exactly
18:25
Speaker 2: how many ball bearings are coming out every year and
18:26
Speaker 2: what the price of those ball bearings will be, you've
18:28
Speaker 2: got what we think of its short duration cash flows.
18:32
Speaker 2: The latter is not very sensitive to interest rates because
18:35
Speaker 2: it's very predictable and short in nature, so when you
18:37
Speaker 2: discount it, the impact is not very much the former.
18:41
Speaker 2: When you put interest rates up into your model on
18:44
Speaker 2: how you value that incredibly long stream of earnings and
18:47
Speaker 2: cash flows, it has a much much bigger impact and
18:49
Speaker 2: so guess what, no surprise. In twenty twenty two, when
18:53
Speaker 2: this inflation thing really bit, one of the worst performing
18:56
Speaker 2: equity markets was the US relative terms of the UK,
19:00
Speaker 2: which is a value market, did really well.
19:02
Speaker 1: Right.
19:02
Speaker 2: So there's two big implications for this. I think one
19:05
Speaker 2: is your first question, which is we've got to think about,
19:07
Speaker 2: if inflation is sticky, how we allocate in the world.
19:11
Speaker 2: And the other is in thinking about multi asset portfolios,
19:15
Speaker 2: which is a really sensible way to save, particularly depending
19:18
Speaker 2: on where you are in your time of life, but
19:21
Speaker 2: that multi asset portfolios may well not give you the
19:23
Speaker 2: protection today that they have done for such a long
19:26
Speaker 2: period of time in the past.
19:28
Speaker 1: Let's be the first bit of that. First, in a
19:30
Speaker 1: global inflationary environment, in an equity sense, which markets look
19:35
Speaker 1: the most attractive.
19:37
Speaker 2: Cheap ones?
19:38
Speaker 1: Yeah, cheap one one for the UK.
19:42
Speaker 2: Yeah, Look, there's certainly a case for it. I think
19:45
Speaker 2: we have a lot of high quality assets in the
19:47
Speaker 2: UK that trade it discounts. And I think there's also
19:49
Speaker 2: this extraordinary thing that we've seen both of the UK
19:52
Speaker 2: and continental Europe, which is what we think of as
19:54
Speaker 2: the postcode phenomenon, which is you can have a business
19:58
Speaker 2: that's domiciled in Europe or the UK, that trades at
20:03
Speaker 2: a material discount to a US peer, even if it
20:07
Speaker 2: has a large proportion of its assets or earnings coming
20:12
Speaker 2: from the US, And that just speaks to the way
20:15
Speaker 2: that capital is allocated, that it's been moving perhaps passively or.
20:19
Speaker 1: Yeah, I was going to say, it's a function of
20:21
Speaker 1: passive investment. Right, People invest with an allocation into the
20:24
Speaker 1: US and a very small allocation to the UK. So
20:26
Speaker 1: the automatic result is that American companies will be more
20:29
Speaker 1: highly valued than UK companies, regardless of what it is
20:32
Speaker 1: that they do. A should be a great opportunity for
20:34
Speaker 1: the stock pick or the individual investor, just hasn't worked
20:36
Speaker 1: out that way recently.
20:37
Speaker 2: If you have a long enough time horizon, or even
20:40
Speaker 2: a medium term time horizon, I think there is now
20:43
Speaker 2: There are now tailwinds for that valuation gap to close
20:46
Speaker 2: that there probably haven't been before.
20:48
Speaker 1: You say, cheap we said the UK, China, Japan, certain
20:52
Speaker 1: emerging markets.
20:54
Speaker 2: Yeah, all of those.
20:55
Speaker 1: Basically everywhere except for America.
20:57
Speaker 2: And within the US, there are plenty of good companies
21:01
Speaker 2: that also by virtue of size or style or sector,
21:06
Speaker 2: are overlooked. So I think there is I think it's
21:08
Speaker 2: a world in which active management probably guess what the
21:12
Speaker 2: active manager says, as a world in which active management
21:14
Speaker 2: couldn't work well. But actually there's a world.
21:16
Speaker 1: I think how many active managers we have who tell
21:18
Speaker 1: us that the age of actor is back?
21:21
Speaker 2: It would be a shame if we didn't. But I
21:23
Speaker 2: do think there is a lot of value to identify
21:25
Speaker 2: in markets today, and there are a lot of different
21:27
Speaker 2: macroeconomic impulses that are making those catalysts become a bit
21:30
Speaker 2: more real versus where they were ten years ago.
21:32
Speaker 1: Perhaps the politics of America will probably mean because another
21:36
Speaker 1: layer of inflation, doesn't it that there are new tariffs
21:38
Speaker 1: and produced globally. Trade wars are expensive.
21:42
Speaker 2: It's such an interesting question. Actually, we've done an awful
21:44
Speaker 2: lot of discussion of this. I work with it. For
21:47
Speaker 2: those of your listeners who'd like to read, I work
21:49
Speaker 2: with an extremely talented macroanalyst called Henry Neville, who writes
21:53
Speaker 2: prodigiously and publishes on our website and anyone can read it,
21:56
Speaker 2: and he writes on very interesting macro topics. But he
22:00
Speaker 2: and I spent a great deal of time trying to
22:03
Speaker 2: discussing the impact of tariffs on inflation because it is
22:06
Speaker 2: it seems to be the case that all analysis we
22:09
Speaker 2: see of it focuses on the mechanical impact of a
22:13
Speaker 2: price increase for the consumer, which is, of course, in
22:17
Speaker 2: the moment that it happens, inflationary. But actually, if you
22:20
Speaker 2: look back over history, if you look at the nineteen thirties,
22:24
Speaker 2: which had some obvious specific context of its own in
22:28
Speaker 2: terms of the Great Depression that had preceded it, but
22:32
Speaker 2: actually tariffs during that period were actually very disinflationary or deflationary.
22:36
Speaker 2: And you can also think about a tariff in some
22:40
Speaker 2: way like a sales tax, and we have a more
22:42
Speaker 2: recent experience in the last decade of Japan implementing sales
22:45
Speaker 2: taxes where when you look at the experience of inflation,
22:49
Speaker 2: you have a bump that reflects the imposition of the
22:52
Speaker 2: sales tax, and then as that comes out of the
22:55
Speaker 2: year on year comparison, things just normalize again. So it
22:58
Speaker 2: isn't obvious to me after tariffs what the inflationary consequences
23:03
Speaker 2: of tariffs are. I think, what is I mean? It
23:06
Speaker 2: is obvious that you will have a step change in
23:08
Speaker 2: inflation to reflect tariffs. It's also the case that probably
23:14
Speaker 2: a less globalized world with more fragmented supply chains is
23:17
Speaker 2: something that will have a tendency to be more inflation.
23:22
Speaker 1: Okay, let's go to your second part. Then, how in
23:25
Speaker 1: environment like this, if you can't use your old sixty
23:28
Speaker 1: to forty portfolio to protect you anymore, what do you
23:32
Speaker 1: put in your multi asset portfolio? And we've had various
23:34
Speaker 1: suggestions on the podcast over the last few months, and
23:36
Speaker 1: it mostly end up coming down on global equities with
23:40
Speaker 1: a lot more balanced than you have at the moment,
23:42
Speaker 1: for sixty percent cash for forty percent, gold for forty
23:45
Speaker 1: percent gold, or bitcoin for the other forty percent, etc.
23:48
Speaker 1: And then we had the abliity as well, a big
23:50
Speaker 1: part of private equity, which we wouldn't necessarily feel would
23:53
Speaker 1: be the answer. What's your answer?
23:56
Speaker 2: I would frame it in a couple of ways. I
23:59
Speaker 2: think that the multi asset portfolio has definitely still got
24:04
Speaker 2: a real use. I think it's a really good way
24:06
Speaker 2: for individual investors to get a diversified portfolio. But I
24:12
Speaker 2: think if you're cognizant of the risk that I've mentioned,
24:15
Speaker 2: that perhaps the bomb part of it doesn't protect you
24:17
Speaker 2: when you need it. Now you need to think about
24:21
Speaker 2: implementations of multi asset portfolios that then think about managing
24:25
Speaker 2: risk a bit more dynamically. One way to think about
24:28
Speaker 2: that is portfolios that can identify where correlations between different
24:35
Speaker 2: asset classes are changing and dynamically shift the allocation or
24:39
Speaker 2: reduce the allocation to one of those asset classes. So
24:42
Speaker 2: that's something that we can do systematically, but it's a
24:46
Speaker 2: way of ensuring that you can stay in a really
24:49
Speaker 2: efficient multi asset portfolio but avoid some of the kind
24:53
Speaker 2: of some of the extremes of equity volatility, particularly if
24:55
Speaker 2: you don't believe you're going to get rescued by the
24:58
Speaker 2: bomb market. The other thing that we think makes a
25:03
Speaker 2: great deal of sense, and the conversations that we have
25:05
Speaker 2: with big allocators, I think reflect this is the introduction
25:08
Speaker 2: of liquid alternatives into your portfolio. And that's just a
25:12
Speaker 2: bit of terminology that really requires some explanation.
25:15
Speaker 1: It does because when we think about alternatives, probably most
25:18
Speaker 1: of our listeners, when they think about alternatives, they're mainly
25:20
Speaker 1: thinking about things which are very I liquid, right, So
25:22
Speaker 1: they're thinking, they're thinking about private equity, they're thinking about property,
25:26
Speaker 1: they're thinking about forestry. Maybe they're thinking about a physical
25:29
Speaker 1: portfolio of metals, etc. They're not thinking about anything that
25:33
Speaker 1: is particularly liquid. So this is new for us.
25:36
Speaker 2: That way merin b dragons, we think, because the liquid
25:41
Speaker 2: part's really critical if you think about what I've described
25:44
Speaker 2: about the relationship between So let's say you have your
25:46
Speaker 2: core exposure, your core portfolio that gives you some exposure
25:49
Speaker 2: to bonds, which is a pretty good thing today. They
25:51
Speaker 2: yield something nice. You get an income out of bonds
25:54
Speaker 2: that you haven't had for many years. So you want
25:56
Speaker 2: some bonds and you want some equities because they're a
25:58
Speaker 2: good long term growth asset. If you have a year
26:00
Speaker 2: like twenty twenty two and both of them draw down
26:03
Speaker 2: at the same period of time, and you're not able
26:07
Speaker 2: to tap your alternatives, which are by definition designed to diversify,
26:13
Speaker 2: then in our mind, they've failed to do their job.
26:16
Speaker 2: The problem that I think, the thing we worry about
26:21
Speaker 2: with private equity is twofold. The first is that what
26:25
Speaker 2: you're actually investing in is a portfolio of smaller companies
26:30
Speaker 2: that are subject to the same macroeconomic and micro forces
26:36
Speaker 2: that public equities are. So they are companies that have
26:40
Speaker 2: to earn cash flows and deliver earnings and pay dividends
26:44
Speaker 2: and pay off debt and do all the things that
26:46
Speaker 2: public companies have to do, but you're doing it in
26:49
Speaker 2: a liquid form. So the first question is it actually
26:52
Speaker 2: an alternative? Is it a diversifier? People think it's a
26:55
Speaker 2: diversifier because it doesn't price very regularly, but actually is
26:58
Speaker 2: the inherent volatility and cash flow profile of that investment
27:02
Speaker 2: different from what you have in public equities. So that's
27:05
Speaker 2: question number one. But then question number two is even
27:07
Speaker 2: if it is that, the value of a liquid diversifying
27:12
Speaker 2: alternative is that you can tap it when you need it,
27:16
Speaker 2: and if you can't tap it for seven or eight years,
27:19
Speaker 2: then the question is it actually diversifying for you? And
27:22
Speaker 2: does it have a function that allows you to opportunistically
27:25
Speaker 2: add exposure when you need it. I'll give you an example,
27:29
Speaker 2: a really recent example in the UK, which is twenty
27:32
Speaker 2: twenty two September the LDI crisis. So that was a
27:36
Speaker 2: period where the UK sixty forty portfolio lost about eight
27:41
Speaker 2: percent in two weeks, which is a lot, right. This
27:45
Speaker 2: is a balanced portfolio that many pension schemes are exposed to,
27:49
Speaker 2: and it lost eight percent in two weeks. Over the
27:51
Speaker 2: same period, a diversified portfolio of what we call liquid alternatives,
27:57
Speaker 2: so things that perhaps incorporate equity market neutral, non directional
28:02
Speaker 2: equities trend following multi asset investing, but in an alternative
28:08
Speaker 2: form over a similar period, it made about four percent
28:12
Speaker 2: now the liquidity of that portfolio. If you've got something
28:15
Speaker 2: that's moving in the opposite direction to your core portfolio
28:17
Speaker 2: and it's highly liquid, you can liquidate it and you
28:20
Speaker 2: can buy more of the traditional assets that are at
28:23
Speaker 2: that moment in time dislocated. And that's got a real value.
28:27
Speaker 2: It's got a real value to institutional scale asset allocators,
28:31
Speaker 2: and it's got a real value to retail investors as well.
28:35
Speaker 1: Okay, I'm going to put links in the show notes
28:37
Speaker 1: to your very interesting sounding economist, was it Henry Neville?
28:41
Speaker 2: Henry Neville?
28:42
Speaker 1: Henry Neville, And I'm going to put a link if
28:44
Speaker 1: you don't mind. The report that you wrote on this
28:46
Speaker 1: type of diversification. Very good, so that we just going
28:48
Speaker 1: to look at it more carefully because is super interesting.
28:51
Speaker 1: Can I ask you one or two other quick questions?
28:54
Speaker 2: Please?
28:55
Speaker 1: China up a lot this year so far. I'm still
28:58
Speaker 1: happy with that.
28:58
Speaker 2: For the rest of the year, yeah, I think it
29:00
Speaker 2: will take a pause I think we've gone from uninvestable
29:03
Speaker 2: to investable. So where I started, which is beware of
29:06
Speaker 2: narratives and how they change in consensuses. Let me put
29:09
Speaker 2: it this way, I wouldn't be surprised. I think I
29:10
Speaker 2: said at the beginning of this year that a reasonable
29:12
Speaker 2: bingo kard would be China for the best performing market
29:15
Speaker 2: in the US to give you pretty much nothing, and
29:17
Speaker 2: I still think that's probably recent.
29:19
Speaker 1: Okay, what are you reading at the moment?
29:21
Speaker 2: That's an excellent question. I'm reading a book of ts
29:24
Speaker 2: Eliot's poetry, because I'm woefully poorly read when it comes
29:29
Speaker 2: to T. S. Eliot. I have to say, actually that
29:31
Speaker 2: if your readers are looking for advice on finance books,
29:34
Speaker 2: I'm the wrong person because I'm trying to spend my
29:36
Speaker 2: time learning more about the human condition and less about
29:39
Speaker 2: financial markets.
29:41
Speaker 1: Some people would say those were the same things. Final
29:45
Speaker 1: question bitcoin on gold, gold.
29:48
Speaker 2: I would It's not to say that I don't think
29:50
Speaker 2: there's a regulatory tailwind that supports crypto, but I think
29:54
Speaker 2: gold has an established use as a store of value
30:00
Speaker 2: over millennia. We know that we've done some really interesting work.
30:04
Speaker 2: We did a paper, an academic paper called the best
30:06
Speaker 2: strategies for the worst times, in which we look at
30:08
Speaker 2: different ways to protect wealth in the worst part of
30:12
Speaker 2: equity drawdowns, and actually generally in bad times, gold gives
30:16
Speaker 2: you a positive excess return or positive real returns. I
30:19
Speaker 2: tend to think that for the long term, you want
30:21
Speaker 2: to be in something that has a proven store of value.
30:23
Speaker 1: That's why we like it too. Thanks Ed, it's been
30:26
Speaker 1: really good having you on Great pleasure, Maren.
30:28
Speaker 2: Thank you very much.
30:33
Speaker 1: Thanks for listening to this week's Maren Talk to Your Money.
30:36
Speaker 1: If you like us, share rate, review, and subscribe wherever
30:38
Speaker 1: you listen to the podcasts and keep sending questions or
30:40
Speaker 1: comments to Merror Money at Bloomberg dot net. You can
30:43
Speaker 1: also follow me and John on Twitter or x I'm
30:45
Speaker 1: at Meren sw and John is John Underscore stepek Eddie
30:49
Speaker 1: on Twitter. I am not I had a feeling you
30:52
Speaker 1: were going to say that, but you know, if you're
30:53
Speaker 1: interested in the human condition, it's all out there.
30:55
Speaker 2: I was once and then I found that it was
30:57
Speaker 2: possibly a facet of the human condition I didn't like
31:00
Speaker 2: too much.
31:00
Speaker 1: Fair enough, fair Enough. This episode was hosted by me
31:03
Speaker 1: Maren zamzet Web. It was produced by Someersadi production and
31:06
Speaker 1: support by Moses and especial thanks of course to ed
31:09
Speaker 1: Cole