May 26, 2023 • 48 mins
Famed contrarian investor Rob Arnott, co-founder of Research Affiliates, has said since the autumn of 2020 that UK shares are a great bargain—in particular so-called value stocks. In a conversation with Merryn Somerset Webb on this week’s Merryn Talks Money, he contends that’s still the case. The 2020s may be the “the decade for diversifiers,” he says—those prepared to move out of mainstream stocks and bonds and into assets that haven’t been talked about.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
John, I'm going to read you a quote, and then
I want you to guess who feels this way about themselves.
This is a group who feels that they should get
credit for being agile in changing conditions and being fast
to adjust projections.
Speaker 2 (00:18):
Is the IMF.
Speaker 3 (00:20):
Yes, yes, if they would like you to give it that,
they'd like you to ignore the fact that they're always completely,
absolutely totally wrong about everything and give them credit for
the fact that after stuff has changed, they change their productions.
Speaker 1 (00:38):
Good work, guys, I mean.
Speaker 2 (00:40):
If to be a fit, I think changing your prediction
in GDP from negative point three percent to plus point
four percent, which is a swinger point of seven percentage points.
In our minds, that's pretty, I jail. It's quite stupid,
but it's quite It's pretty, I jail.
Speaker 1 (00:56):
It's agile, it's fast, it recognizes changing conditions, and you know,
I'm going to give them recognizing changing conditions because I
don't know. If you watch the poor old Chief Examinment
keep the Poortry of economists at the Bank of England
yesterday talking for the Treasury Committee, well, he was explaining
that the reason that they get everything wrong is because
(01:18):
their model cannot react to changing conditions. It's worth watching.
I put the link in, I put the link on Twitter,
I put the link somewhere else. I'll put it at
the end of the blog. I put it somewhere. Go
and watch it, and it's absolutely fascinating to watch a
man who's way cleverer than me and dare said, John
probably way cleverer than you talking, I know, talking about
a model that he has that is an extrapolation machine.
Speaker 2 (01:45):
I think Marty King has always said this about the
model law, which is what I'll find slightly we are doing.
A guy who actually used to run the Bank of
England and not that long ago, keeps saying the problem
with the Inflation podcast model is that it assumes that
the bank will definitely get inflation back to two percent,
so everything they put and ends up coming back to
(02:06):
two percent. I mean, like Meevin himself has said, that's
how how can the chiefic coandom is not already be
aware that this is a potential flaw in the model.
Speaker 1 (02:17):
I know he needs he needs to be more agile,
but his point was that in the last thirty years
everything's being kind of the same, so is a bit
difficult to build a model that doesn't assume that everything's
going to be kind of the same. It's not really
design for stuff that changes.
Speaker 4 (02:36):
And you think, well, okay, that's that's nonsense, but it's
kind of clausible nonsense.
Speaker 1 (02:42):
And then you think, I want to take care. There's
been a lot of change, a lot of just pretty
big stuff has happened. And why did a lot of
that big stuff happen? A lot of that big stuff
happened because the Bank.
Speaker 4 (02:55):
Of England has been running one of the biggest monetary
experiments of all time. Is it possible that some of
the change has come from Bank of England policy? And
if that might be the case, how could their model
not be ready for the effects of stuff they did?
Speaker 1 (03:11):
I mean, I don't mean to be down on the
Bank of England, as I say, John, like cleverer than us.
I was going to say, demonstrably clever enough, But that's
not actually true, is it.
Speaker 4 (03:19):
We just assume, we assume and be cleverer than us,
and here we are, here we are.
Speaker 2 (03:26):
I mean, you know, it uses a long time. I mean,
I mean, I mean, that's like pretty much two thoughts
of the time I've been alive. And as we all know,
the coined me didn't really start doing anything until on eighteen,
and so realistically I can see why you would only
go back thirty years ago, because that obviously is the
(03:47):
only reliable history that we've got.
Speaker 1 (03:49):
I love the way you think macroeconomic policy and macroeconomics
is correlated to your eighteenth birthday, buddy. It must have
been a humdigger.
Speaker 2 (03:59):
I mean, I may not intelligent as kind of like
the buying England by I'm feeling ourcissistic, So I think
that qualifies me to comment on these things.
Speaker 1 (04:10):
Yeah, and you know, one thing I do want to
say is that the reason why models don't work ever,
is because modeling is incredibly difficult. And if it were
possible to model the future, then you know, that would
be really great because then we would know what was
going to happen. But it's not possible. We can't ever
know what's going to happen.
Speaker 5 (04:30):
So we can't actually ever expect a model to work.
It's inconceivable that the model could work. So the problem
here is not so much the model doesn't work, it's
kind of a given. The problem is that.
Speaker 1 (04:44):
Forecasters be at the IMF, be at the Bank of England,
be at some of them. Many other forecasts that you
and I talked to somehow seem to believe, or seem
to believe that other people should believe that their forecasts
are valid. Now that's the problem that they're not saying,
this is my best guess, but you know it's really
unlikely to be correct. They're saying, here's my forecast, it's valid,
(05:05):
base your behavior on it, and that's why we run
into trouble.
Speaker 2 (05:10):
Yeah, I mean, but part of the problem there is
that they do tend to try to have their cake
and eat it. Because you know if you said that,
I can guarantee if you said that to any of
the guys in front of the Treasury Select Committee yesterday,
they would have said, well, it's just a model, and
we do have a fine chart which shows that, you know,
the connect because if you look at this thing, particularly
in the moment, the outliers froy still not still not
(05:32):
wide enough, but you know they are, they are quite wide.
So they would say, oh, but yet, we all know
the forecasts don't actually predict the future, but they only
really say that whenever they haven't predicted the future. And
I think the other point that you would then make
is well, look, why do you make these forecasts? I mean,
(05:52):
by the Bank England, I can see because they've got
themselves tied up and not sway you know, forward guide
and all that sort of stuff. There is a case
whereby they need to sort of justify the path that
they're on. But imf, I mean, it's kind of why
do you come up with this stuff in the first place. Whenever.
(06:13):
On the one hand, if you're challenge this to why
you get it wrong all the time, you say, well,
you're not meant to take it seriously, And it's kind
of like, well, okay, we'll stop stop bombarding is with it,
you know, and stop blaming the newspapers for putting it
in headlines. Whenever you've said something headline grabbing. No clever
person says that the UK will endure it its worst
recession and living memory is a headline. It's a news story.
(06:35):
You know, you might not agree with it, it might
be based on fundamentally flawed data, but you know you
can't blame newspapers for reporting it in that way. So
I mean, I think if they all backed off from
making the forecast in the first place, then that would
probably help a lot, because it would make people kind
of have to think and look at the data themselves.
(06:57):
Apart from that and else.
Speaker 1 (06:58):
Okay, So our message this week then is this sort
of down with the I ms.
Speaker 2 (07:04):
Yes, smash the thing takes or whatever, even as I
don't know, but I think that yeah, I think actually yeah,
been more a bit more humility on the part of
you know, policy makers in general a mess and a.
Speaker 1 (07:23):
Bit more group think. I mean, people have been accusing
the Bank of England of group think for a long
time now, and I think that they're going to have
to start addressing this. It's time to bring some new
thinking into the Bank of England. And you know, John,
I know you're there for them, aren't you? Just cool? Guys?
Just cool?
Speaker 2 (07:39):
I mean a dB index linked pension. Yes, but I
see you went wrong there, Merton. You should have said
I'm there for it.
Speaker 1 (07:49):
You've just reminded me. And it's harpy I linked as well,
isn't it. Hey, Everyone around the Bank of England get
a little diversity of thought in I am for you.
Speaker 2 (08:00):
So I think the Bank England's ever had a female
Central Bank governor.
Speaker 1 (08:05):
Oh, now I'm really here for you.
Speaker 4 (08:07):
Yeah.
Speaker 2 (08:08):
I think I think we've We've solved a number of
problems with this one certainly.
Speaker 1 (08:13):
Have because they're interested in diversities, so they keep saying.
Speaker 2 (08:17):
Right, actually, just on this topic. Very quickly, you tweeted
something today about the Wall Street Channel had published an
opinion column based on this, this finding from two top
economists that the pandemic and the fiscal stimulus, the magic
(08:39):
combination of these two things had actually caused the inflation
that we're all seeing now, something that that in itself
was funny enough.
Speaker 5 (08:49):
Who pay these people?
Speaker 1 (08:51):
I'm here for you too. Whoever pays these people are
here for you too.
Speaker 2 (08:56):
But do you know who the two guys were, Ben
ber Nanke and Olivia Blanchard, so like so so not
just like two top obscure like you know, but noble
prize when in whatever economists or a couple of academics
like sitting somewhere in an ivory towel saying, oh, this
(09:17):
is how the inflation happened. It's the guy that used
to run the FED for ages and ages and ages
and then and also a guy who used to be
a chief economists that the IMF.
Speaker 1 (09:27):
Well, you know, Billy, he did say yesterday, we've got
a lot to learn about inflation. Do you know what
Andrew we have or you have transit where you look
at it? Anyway, John and I are available for any
job that involved a RP I linked dB. Just call us.
You know where we are. Welcome to Marren Talks Money,
(09:54):
the podcast in which people who know the markets explain
the markets and Maren sumset Web. This week, our guest
is Rob Arnott, founder and Chairman of the Board of
Asset Allocations Specialist Research Affiliates. Rob, thank you so much
for joining us today. We really appreciate it.
Speaker 6 (10:09):
It's a privilege.
Speaker 1 (10:11):
I think it's more a privilege for me. Actually we'll
find out the next half and out. Now, I want
to start by talking about in fact, we may talk
about this for twenty five minutes. I don't know the
most important thing out there, the only thing out there
that is going to make the difference to how our
assets behave over the next decade or so inflation. And
you've written about this extremely well, and everyone should go
in and you should read Rob's work on inflation because
(10:32):
it is fascinating and it's not encouraging either, is it.
Speaker 6 (10:36):
It's not encouraging, but it's also not discouraging in that
even bad news can be a source of insights into
how to invest. So the good news is that the
widely accepted narrative that this inflation is transitory, that it
will dissipate in reasonably short order over the next two
(10:59):
or three years, is entirely possible. It can happen, It
has happened. It is also the benign end of the
spectrum of a much wider spectrum. The reality is not
that it's benign and will dissipate. The reality is anything
can happen. And where this gets interesting is the causes
(11:23):
of the inflation. We did a study in which we
looked at all fourteen countries that the OECD calls developed
economies today and called develop economies in nineteen seventy. So
that's our that's our peer group, and so it leaves
out current so called developed economies like Turkey, but countries
(11:47):
that have been developed for the last fifty years. You've
got fourteen countries fifty three.
Speaker 1 (11:50):
Years later in itself, before we even start on the
rest the fact that globally there were only fourteen countries
in nineteen seventy that counted as developed and still do.
Speaker 6 (11:59):
Yeah, the ones that did still do so. Becoming a
developed economy is a good path towards remaining a developed economy.
But be that as it may. UK has had inflation
surge past eight percent three times in the last fifty
years US twice in the last fifty years. Around the world,
(12:24):
that's too few data points you can't draw any conclusions.
But around the fourteen countries it's twenty nine times an
average of two per country. That's enough to draw some conclusions.
So what did we find. We found that when you
cross four percent inflation, half the time it goes higher
and can last longer. Half the time it rolls over,
(12:44):
and you don't go higher. When it rolls over, on average,
it dissipates back down below two percent within two years. Okay, great,
that's transitory inflation. Now, when you get to six percent inflation,
and especially when you get to eight and higher, it
is a consequence not of an exogenous shock that can
(13:05):
dissipate and with it allow the inflation to dissipate. It's
a result of conscious policy choices that are bad and
unless the policy choices change, the inflation pressures remain. Back
to the topic of four percent inflation, there have been
(13:26):
sixty seven episodes. Of those, almost five per country, Half
of those dissipated quickly, half of them didn't. The ones
that didn't almost in all cases went higher and lasted
an average of fourteen years.
Speaker 1 (13:42):
Okay, that is quite a long time.
Speaker 6 (13:44):
Right, eight percent, But we've.
Speaker 1 (13:47):
Already way past four percent. We're in we're in the
other world now.
Speaker 6 (13:51):
Correct above eight percent. What we found was twenty nine examples,
two per country. What we found was that two of
those dissipated fast within two years. So there are two
cases of transitory eight percent inflation. Those who anchor on
the notion that this will dissipate in the coming two
three years have historical precedent to point to to say, yes,
(14:14):
it can happen. Of the rest, a dozen of them
are still in progress. You're left with sixteen that have
been resolved, and so you can gauge the amount of time,
and other than those two that were transitory, the rest
averaged fourteen years. Okay, So this is bad news in
(14:37):
the sense that inflation is rarely transitory and doesn't dissipate
until the policy choices that led to the inflation are reversed.
There are those who say that Powell's hero is Paul Vulkar,
and that he's channeling his inner Volcar. Think about that
(15:00):
for a moment. Paul Vulker inherited an economy with serious inflation.
He inherited a political backdrop where citizens were so horrified
by how inflation was destroying their plans, destroying their retirement plans,
destroying their portfolios, that they basically said, do whatever it takes.
(15:25):
Vulkar did that. When inflation crested at fourteen point seven
percent in March of nineteen eighty, the Fed funds rate
was already nineteen point nine percent. It was five percent
above inflation. When inflation crested year and a half later,
it was twenty two percent. Now that is that is
(15:47):
using a relentless force to deal with inflation, the inflation
that we have here, and I'm speaking from the US perspective,
and Europe rhymes with us in terms of the way
the inflation looks, it's a bit worse here in the US.
(16:09):
Powell declared the inflation to be transitory in March of
twenty twenty one. What did inflation look like then? It
had just crossed four percent, And I've already said four
percent inflation half the time it's transitory. So it sounds
like it would ring true except for one thing. Half
of that four percent had happened in the prior three months,
(16:30):
So you had four percent inflation that was accelerating. Nine
months later, in November of twenty one, he declared that
the word transitory was not appropriate. Good news on that
to recognize that, and so slowly but surely, the FED
(16:52):
began to take inflation seriously. Inflation crested in the summer
of twenty twenty two at nine point one percent for
US above ten for you guys. Nine point one percent inflation?
Was he channeling his inner Volkar? Did he have the
FED funds rate at fourteen five percent higher? No, he
had the FED funds rate at one point two one
(17:14):
point two. It was eight percent under inflation.
Speaker 1 (17:18):
Yeah, I mean this is new, isn't it when it
comes to fighting inflation. To have the interest rates so
far behind that is relatively new.
Speaker 6 (17:27):
It's been tried in lots of countries. It'll tried it.
Speaker 1 (17:30):
Not in the developed countries that we've Italy.
Speaker 6 (17:33):
Did, Italy UK lots of times tried.
Speaker 1 (17:36):
K In the nineteen seventies, generally interest rates were okay,
not high enough, but higher than inflation most of the time,
if she most of.
Speaker 6 (17:44):
The time, but in the early surges of inflation. No,
And that's the difference with Vulcar. Now, I like to
join the joke that central bankers, instead of trying to
channel their Innervolcar, should channel their inner Powell. I don't mean,
I mean Colin Powell. Colin Powell said, if you're going
(18:05):
to commit to war, one, you have to have a
very specific goal, regime change whatever. Two you have to
have strong conviction that you can win. Three you have
to have an exit strategy. And four you have to
be willing to use overwhelming force to bring it to
(18:26):
a conclusion quickly, because that's the humane answer. It minimizes
damage to you and your adversary to end it fast.
So Vulkar used overwhelming force. He had a specific goal
get inflation under control. He was willing to use an
overwhelming force. He had an exit strategy, don't lower interest
(18:51):
rates until inflation is moderating fast. And the consequence was
it was brought under control. It took six.
Speaker 1 (19:00):
Years, still took six years.
Speaker 6 (19:02):
It was six years from that peak in inflation until
inflation briefly dipped below two. That's daunting. Now. Instead of
channeling his inner Vulcar, if he was channeling his inner Powell,
he would be saying, well, our goal is to bring
(19:23):
inflation under control. Our specific plan is to raise interest rates.
Crush demand. I mean, inflation is just supply and demand.
You have supply chain disruptions. You have people paid to
stay home and not work. You have people pretending to
work from home. You have a whole host of pressures
(19:47):
at work that hold down the supply of goods and services.
On the other side, your cost of living goes down
if you're working from home, so you have more money
to spend. You have stimulus checks being and so demand
goes up, supply goes down, bingo inflation. Well, how do
(20:09):
you equalize that? The Fed, the central bankers around the
world look at this and say, I can't do anything
about supply, but I can crush demand. Okay, let's crush demand.
I'm reminded of the colonel in Vietnam who was quoted
as saying, we had to destroy the village in order
to save it. Central banker's answer to inflation is we
have to destroy the economy in order to save it
(20:30):
from inflation. Does it work. Yes, it's a very painful, which.
Speaker 1 (20:37):
Of course is why they're not doing it properly. At
the moment, we could get rid of inflation in a
matter of weeks if okay, maybe not weeks, but you
kill it pretty quickly. You could kill it really slammed
up interest rates ahead of the rate of CBI by
a very significant amount. I mean, no one's ever going
to do that, but it's theoretically possible.
Speaker 6 (20:55):
And the government pushback on doing that is very straightforward.
The cost of the government debt. Now that the government
debt is in many developed economies triple or quadruple what
it was in the inflationary surge of late seventies and
early eighties, they're going to say, you're going to have
us spend our entire tax receipts on interest.
Speaker 1 (21:17):
Yeah, do say nothing of the welfare builds that come
with defrowing an economy correct temporarily correct.
Speaker 6 (21:22):
So my view on this is really extremely simple, and
that is that the way to bring inflation under control
is on the supply side, and that there is zero
political will in either party in the US or here
to do that. The way to boost supply is to
(21:44):
unshackle the private sector and let innovation lead to a
surge of productivity. I like to joke that the role
of government is to find out what the people are
up to and put a stop to it. If the
goal is to say, technologically, innovation is all well and good,
but these guys are too successful, their companies are too powerful,
(22:06):
let's put a stop to it. That's problematical.
Speaker 1 (22:09):
Well, the role of government to a degree these days
is to look for problems, to go out and seek
a problem and then try and solve it, to misdiagnose it,
and then come up with an incorrect policy to solve it.
Speaker 6 (22:19):
Which that's I think exactly right.
Speaker 1 (22:21):
Can't remember who's quoite that it, but it seems to
be exactly what what governments do at the moment in
the right, in the developed world at least, And that
tends to put a bit of a stopera on innovation
and creation, right. Creation.
Speaker 6 (22:32):
Now, one of the things that's just fascinating is inflation
is terrible for bonds. It's terrible temporarily for stocks, but
once the stocks reprice to a lower level, they do
participate in inflation, so you get back to a good
real return. The other impact that inflation has is it
(22:55):
rewards value? There's a narrative out there that value investing
wins in a higher interest rate environment because the long
term growth in the growth side of the market is
discounted at a higher rate, bringing the net present value
of that growth down. And that's less true of value stocks,
(23:17):
where the here and now profitability is the dominant factor
that resonates. It ignores the fact that growth rates and
the discount rate are linked. So they can cancel. But
what can't cancel is inflation. If inflation, there is no
(23:38):
such thing as elevated and stable inflation.
Speaker 1 (23:40):
This is the key point, isn't it. When people talk
about inflation staying higher and all, A lot of people
think themselves that means inflation running it a steady four
and a half or five percent for a reason long
amount of time, and that would be just fine. It
will be fine. We can live with that. It'll road
a lot of government debt, it a lot of private debt,
bit by bit. And if we could have a steady
four percent for a decade, boy, a lot of our
(24:01):
problems will be completely solved. But that does not how
inflation works.
Speaker 6 (24:05):
We've had thirty years of inflation steady in the two
to two and a half percent range, with an occasional
blip up to four or five and an occasional drop
to near zero. But eighty percent of the time the
rolling twelve month inflation was in the one and a
half to three range. So is today's eight percent inflation,
(24:29):
let's say, going to be in the seven to nine range. No,
it's going to be in the four to fourteen range.
Speaker 1 (24:38):
As you wished to go back a little bit and
talk about why it's what it is that will be
the drivers behind inflation from here that stop it from
being transient, because you still hear the argument that you know,
bit by bit that households are getting rid of the
savings that they accumulated during the policies around COVID, and
the supply chains are working themselves out, and China's back
on track, et cetera. So you still hear the transient argument.
(25:00):
So we should just talk briefly about what the dynamics
are that prevent it from being transient.
Speaker 6 (25:06):
Yeah, and by the way, a key point here is
not prevented from being transient, but make that improbable it
could happen. Think about the causes of inflation, demand stimulus
from people having more pocket money, from work from home,
and from massive stimulus air drops of cash into people's accounts.
(25:30):
Is that going to persist into the future. Well, hybrid
work is now the norm.
Speaker 1 (25:37):
Well, there's a lot of employers trying to change it
back to how it was.
Speaker 6 (25:40):
The millennials will resist that fiercely. In the US polls
suggests that required to work five days a week in
the office would for forty percent of millennials cause them
to quit. That's interesting, and it's particularly true in certain
segments of the skill sets that don't require office interactions.
(26:02):
It programming, marketing, marketing. People travel all the time anyway,
so what's the big deal? And so work from the
office tends to be resisted pretty fiercely. So part of
that added demand remains, and that's good. That's good. Demand
(26:22):
is a good thing, not a bad thing. Supply chain
disruptions deglobalization is with us for a good long time.
It's not going to reverse course fast. The China saber
rattling with regard to Taiwan means that even if the
China supply chains get fully back to normal, there will
(26:45):
be resistance to relying as heavily on them as in
the past, and as countries shift their production to be
more domestic and less based on the classic economic rule
of comparative advantage, where one country can produce x better
than another country, that that is not coming back fully.
(27:09):
So that'll be the with us for a long time.
So you're going to have work from home diminish but remain.
You're going to have people paid to be home and
not work diminish but remain. You're going to have supply
chain disruptions diminish but not go away. You're going to
(27:30):
have wage pressures because there is a mismatch between those
willing looking for work and work looking for employees. That
mismatch is not likely to disappear anytime soon. So none
of the core causes of the supply demand mismatch and
(27:52):
of the inflation are going away.
Speaker 1 (27:54):
They're all likely to make It seems like a particularly
big deal to us. And there used to be a
view that union power led to inflation, but of course
it's the other way around. Inflation leads to union power,
and once you get right.
Speaker 6 (28:10):
That's a really important point.
Speaker 1 (28:11):
Really, I think very misunderd so misunderstood. You know, the
unions for the last However, many decades in the UK
have been very weak because there's been no need for
them not to be and then demand from their members
because when inflation is running it one or two percent,
most people it's nothing. It doesn't mean anything to them,
so there's no particular need to demand pay rises. But
inflation has now been cripplingly high for people in the
(28:33):
UK and elsewhere for so long that everyone now understands
inflation and how it works and what it does to
their purchasing power. And even if inflation were to go
back to two or three percent next year, even if
it were, which it weren't, but if it were to,
I still think you'd see people saying, well, hang on,
I take care. I now understand that my real purchasing
power has been destroyed over a twenty year period, not
just a one year period, and I'd like that back.
(28:55):
So the echo of labor power this year would I
think continue for several years anyway, And we did have
our bank Fngland governor if they did say that, he
now sees that we are in a wage price viral. So,
like like all, central bank is a little behind the
rest of us, but we get there in the end.
Speaker 6 (29:11):
Now, one thing that I think is quite hilarious is
that we all wait with baited breath for the latest
prognostications of our central bankers about what the expectation is
for inflation, for unemployment, for GDP growth. A vast proportion
of United States economics PhDs work for the FAD. Yes,
(29:37):
they are all cut from a similar mold. They're all Neocainsians.
They range from mild Neokainsian to extreme MMT. And they
say that's diversity of views. No, no, it's not. And
there's a fellow named George Box who was co developer
of the Box Jenkins models, who famously said all models
(30:02):
are wrong, some models are useful. I love that, Don't
that great?
Speaker 1 (30:07):
True? If any people have said that at the beginning
of the pandemic, right.
Speaker 6 (30:12):
Right, It's true in medicine, just as it's true in economics.
And we have economists who say, the model says this
will happen. The model says the economy will do this
if we do that, And instead of saying, how can
our models work better by mimicking the way the economy behaves,
(30:35):
they argue with the economy and say the economy is wrong.
It should do this, So that's a good way to
get models that are not useful. The implication of all
of this is that the forecasting ability of us FED,
for instance, is slightly worse than useless, worse than useless,
(30:59):
meaning that they're or directional forecasts are worse than the
than the capital markets, and worse than a coin toss.
Why do we care what they have to say?
Speaker 1 (31:11):
Why do we keep listening? It's a really good question,
but we do. We do keep listening. We put it
on the front of our newspapers. Yes, every time one
of them comes out and speaks on the front of
the newspapers, everybody's listening, and everyone's using those words to
predict their own futures, even though we know that they're
almost always wrong.
Speaker 6 (31:27):
Yeah, and there's one good reason to listen to them,
and that's that their forecasts and their prognostications are driving
their decisions. So if you know that the consensus view
on inflation is it's going to dissipate reasonably quickly, and
if the FED says we've got this, we're getting it
(31:48):
under control, having some part of your portfolio that's betting,
well maybe not is a useful response. So it is
useful to know what they're projecting, but not from the
vantage point of believing it, Which brings me to what
do you do in this environment?
Speaker 1 (32:06):
Yeah, so when we say this environment, we're talking about
the environment we would expect inflation to be volatile between
you know, I don't know, say four and ten percent.
Speaker 6 (32:14):
Yeah, where you're expecting inflation to be elevated and volatile
for a decent span of times every fourteen years. Apparently
that's the history. That's I do not want to be
quoted as saying I'm expecting fourteen years of this. I'm
expecting longer.
Speaker 1 (32:31):
We'll put that in the headline good good.
Speaker 6 (32:34):
I'm saying, let's expect inflation to have higher odds of
being higher and longer than most people think. It could
settle back down, but it very likely won't. And in
that environment, bonds are troublesome. Stocks are troublesome until they're cheap.
(32:56):
In the UK they're cheap, So in the UK I'd
be fine with stock ownership. In the US, I wouldn't.
Speaker 1 (33:01):
Well, you did write and it didn't you go trade
of the decade? Yes, that UK, John, and I let that.
Speaker 6 (33:08):
Oh, I got so much pushback on that from britt
did you from BRIT's saying this guy's an idiot?
Speaker 1 (33:15):
Interesting? You know, foreigner investors in that buys at the moment,
domestic domestic investors still as sell us. Where is it
demivable law? Don't we? Well?
Speaker 6 (33:25):
Everybody is when performance has been disappointing, Yes, everyone. You
can't have a bargain without having created the bargain by
inflicting pain and losses. Yes, and yet human nature says,
you want me to buy more of this well.
Speaker 1 (33:39):
When Netflix repilated? Aren't we humans?
Speaker 5 (33:41):
Yeah?
Speaker 1 (33:41):
Yeah, so tell me your case.
Speaker 6 (33:44):
I think the way to invest in this environment is
very straightforward. Mainstream stocks and bonds represent vulnerable markets in
a period of rising inflation with a carve out, and
that carve out is markets that are cheap are fine.
Inflation helps value partly because inflation pushes up that discount rate,
(34:09):
and the important thing is the real discount rate. It
pushes the real discount rate up, and partly because a
period of heightened uncertainty is a time when investors want
the margin of safety associated with having a good base
of profits, of book value, of sales, of dividends, and buybacks.
(34:37):
For broad measures of the economic footprint, of a business.
For every hundred pounds or dollars or euros they invest,
they want a decent base of profits, sales, etc. And
that's value. The value side gives you that. The growth side,
you're paying for hopes and dreams which are nice, Which
(34:59):
are nice, and hopes and dreams have certainly prevailed this
year to day on the back of chat, GPT and
the narratives about AI. The thing about narratives is the
good news is they're usually at least partly true. The
bad news is they're already in the price.
Speaker 1 (35:17):
Yeah, it's not that they don't have value, it's just
that it's already they are predictive.
Speaker 6 (35:22):
They aren't predictive value. And that's the thing that people
just have trouble getting a handle on with narratives. Whatever's cheap,
there's always well what about this? What about that? Yeah,
it's in the price, that's why it's cheap.
Speaker 1 (35:34):
So when you look at the UK market, how are
you defining cheap?
Speaker 6 (35:38):
I love the Shiller pe ratio price relative to ten
year average earnings. It's a measure of how much profit
the company is likely capable of delivering on a long
term basis for every one hundred pounds you invest, and
the Shiller Pe ratio for the UK last I checked
was about fourteen times. For the US, it's about twice that.
(36:01):
The US doesn't have a margin for safety, mostly because
of the fang stocks. The value stocks in the US
are about sixteen eighteen times, but in the UK there's
a margin of safety. That's great. The other thing I
would say is diversifying away from the mainstream stocks and bonds.
(36:21):
Out of mainstream stocks and bonds, emerging market stocks and
bonds interesting. Merging markets bonds yield more than US junk
bonds do. Now, that's interesting.
Speaker 1 (36:31):
And emerging market equities are looking briefly cheap on almost
all measures, right, they're about it so reasonably as opposed
to vary.
Speaker 6 (36:37):
They're about the same as the UK. That's reasonably cheap,
and emerging markets value is very cheap. Merging markets values
trading at a Shiller Pe ratio a little under ten.
And Fundamental Index, which we invented eighteen years ago, which
has a stark value tilt and increases your allocation as
(36:58):
a stock gets cheaper instead of as stock gets more expensive.
Fundamental Index on emerging markets is currently priced at eight
times earnings and has a dividend yield of just under.
Speaker 1 (37:10):
Five Okay, I mean that's that does sound like that's
pretty cool.
Speaker 6 (37:13):
Yeah, But it means shedding your desire to have results
similar to your neighbors, because if it zags when your
neighbor's portfolio zigs up, your patience will be tested. So
don't don't put more in it than you're comfortable.
Speaker 1 (37:32):
Oh, you don't look at your portfolio very often.
Speaker 6 (37:34):
Another option, that's a beautiful option. I do that with
my own personal portfolio client portfolios. I don't have the
luxury of just saying call me in three years and
let me know how it's going.
Speaker 1 (37:48):
Yeah, yeah, what about Japan? Where does that come?
Speaker 6 (37:51):
When your valuations actually relatively cheap?
Speaker 1 (37:53):
And it's been quite interesting, right, John and I we've
been long term bulls of Japan, possibly rather too long
at this point, but you know, finally we seem to
be getting some momentum there and we're at thirty o
DA highs and more jun calls are oural friend Jonathan
Allen used to call the iron coffin lid on on
top of Japanese equities appears who've been lifted, and they
(38:14):
do look readily cheap.
Speaker 6 (38:15):
But they're about eighteen times that's not bad. They do
have a demographic challenge. The population is shrinking, the working
population is shrinking.
Speaker 1 (38:24):
Faster, but that just means they're a little ahead of
the rest of US. So they're getting on top that.
Speaker 6 (38:29):
Right well in US are UK is in better shape
demographically than cotton el Europe by a big margin, and
US is better than most of the developed world by
a big margin. In the case of both, immigration is
a big part of that, and in the case of
the US, the fertility rates have not fallen to the
(38:51):
extent they have in much of the developed world. China
has the demographic wall of China coming big time.
Speaker 1 (39:00):
And well, they always said about China, didn't they old
before rich?
Speaker 6 (39:04):
Right, So, in twenty twenty, the ratio of working age
Chinese to senior citizen Chinese was the same as it
was in the US in nineteen fifty, beautiful benign circumstance
for rapid economic growth. The view was get rid of
the one child policy and women will start having more
(39:27):
kids too late. It's too late. Besides which, the invention
of birth control in nineteen sixty means women can choose
if women split equally between those who want no kids,
those who want one kid, and those who want two
or more kids. The fertility is going to be in
the one one and a half range. That's where it stuck,
(39:48):
and in China it fell during the pandemic to about
one point two. That demographic challenge means that they go
from being where we were in ninety teen fifty too,
by the year twenty forty five, they'll have a higher
support ratio than the US, and by twenty sixty higher
(40:09):
than Europe. As bad as it is, it will be
in Europe by then. So I view China's saber rattling
as a very big geopolitical concern right now. If we
can get to twenty forty without them acting on the
saber rattling, they won't be able to raise an army
big enough to matter.
Speaker 1 (40:26):
But I did see you're reminding me of a piece
of research I saw a couple of years ago that
drew the most fascinating correlation perfly al, which when you
think about it, between wars and the percentage of a
country that is male between sixteen and twenty nine. I
as you must have seen that bit of research somewhere.
Speaker 6 (40:48):
If we had time, I was going to go to
almost exactly those statistics. Yeah, testosterone filled young men, especially
in a country where there's not enough women, eighty million
missing women of China. Hey yea yai.
Speaker 1 (41:04):
Then we can get get through the next few decades
and we'll be at the other end of that bump, right.
Speaker 6 (41:10):
And so I view China as the biggest geopolitical source
of a risk of instability in the world today. And
I view them as I don't know, is this broadcast
in China a paper tiger years to take the risk?
(41:30):
I would view them as a paper tiger twenty years
from now.
Speaker 1 (41:32):
Okay, So you know Chinese equities right now then not
so much.
Speaker 6 (41:36):
They're actually reasonably fully priced by emerging market standards. The
reason that emerging markets value is so astonishingly cheap is
that emerging market's growth is dominated by the Chinese version
of the Fang stocks, the batstocks by Dula, Baba and
ten Cent. Those three stocks comprised fifteen percent of the
emerging markets at their peak, three stocks, and today they
(42:01):
comprise about eight or ten percent. Three stocks. They're all
on the growth side. So what you're left with is
value is very, very cheap and is mostly non China.
Speaker 1 (42:11):
Yeah, okay, right now we're doing well. Yeah, we're getting
a lot of interesting things for listeners to go away.
I look at we've told them that the UK is
traded the decade. I know you don't believe us, but
I think it could be true.
Speaker 6 (42:22):
Well, so far, so good. Yeah, I know, I know
relative to the rest of the world, UK stocks have
done beautifully.
Speaker 1 (42:30):
Yeah. Yeah. What about the commodity sector? Commodity so we
don't want anyone rushing off directly into commodities. We almost
made that mistake in our last podcast when we talked
about investigating commodities and suddenly had to remind everybody we
didn't mean actual commodities. We mentor commodity acrities.
Speaker 6 (42:45):
I think if people buy live cattle for their backyard,
they can get rid of the lawnmower and they have
a commodities investment. But more seriously, but you're not advising
that more seriously, commodities are relatively fully priced right now.
(43:06):
Commodities should fall in real prices on a long term basis,
and they do one to two percent a year because
of rising productivity. It gets back to the issue of inflation.
The answer to inflation is rising productivity.
Speaker 1 (43:23):
Although people do say people do say, but in this
market at the moment, in the quantities market, particularly metals
mining and fossil fuels, rising prices are not necessarily the
cure for rising prices as they have been in the past,
because the environmental concerns mean that it's very hard to
get permissions for the expiration and production you might have
done in the past, or you know, digging in new
mind somewhere is not as easy as going on and
(43:45):
digging in new mine. So the dynamic has changed, so
you could argue that that one to two percent for
the year is not necessarily in play like it was.
Speaker 6 (43:54):
It depends in part on the country of mining for
copper in Chile under a hard left new regime is
going to be difficult. Mining for earth metals and other
exotic metals in China is not a problem. So one
(44:14):
of the things that I think would be useful is
to do cost benefit analysis on do we want to
restrict this or do we want to lightly discourage it.
Speaker 1 (44:25):
Yeah, and that makes a difference for the long term.
I'm still not kind of picking up whether you're saying
it a good idea to be in the commodity sector
or not.
Speaker 6 (44:34):
I think commodities are terrific long term play, just not
so much right now. And it's a terrific long term
play from two perspectives. Firstly, you're going to earn the collateral,
so elevated interest rates, Okay, you're earning that. That's your
protection against current inflation. You also get protection against inflation
(44:56):
shocks because commodities magnify inflation or does inflation shocks by
about five to ten to one. In the US, inflation
expectations on a ten year basis are two and a quarter.
Why do I say that tenure bond is at three
and a half ten your linkers are at one and
a quarter. The difference is too and a quarter. So
if inflation is two and a quarter, and then both
(45:19):
bonds have the same return, all right. So that's all
well and good. But our work suggests that a better
estimate of inflation on a ten year basis is at
about three and a half because inflation dissipates slowly, and
if we're right, then that represents a positive inflation shock,
and commodities magnet fly inflation shocks by about a percent.
(45:43):
So that's one and a quarter percent above that would
mean that when inflation expectations rise to three and a
half that commodities will have risen about ten twelve percent.
So that's a nice expected return.
Speaker 1 (45:58):
Okay, two quick questions. It's like the quickfire round.
Speaker 6 (46:03):
Let's go for it.
Speaker 1 (46:04):
If if inflation did tend to be transient, it was
down at two percent by next year, if that was
the scenario we expected, how would we invest? Now?
Speaker 6 (46:14):
This is why I think you want to think of
things probabilistically rather than in terms of black and white.
This is why I resist the idea of Arnat says
inflation will be higher and longer. No, inflation is likely
to be higher and longer than most people expect. So
you wind up with a diversified portfolio with more than
(46:38):
your historic.
Speaker 1 (46:39):
Norms in the more probable area.
Speaker 6 (46:41):
In diversifications away from mainstream stocks and bonds, and in value.
And the beauty is right now, value is very cheap.
It's in the cheapest quintile relative to growth in history.
In the summer of twenty twenty, it was in the
cheapest percentile in history, and you could not persuade anyone
(47:03):
to buy value. Well, it has snapped back beautifully, but
there's still plenty of juice left in that orange. So
if value is cheap, that's a reason to overweight it.
If you think inflation is likely to surprise to the upside,
that's a reason to overweight value. So today, like I said,
I think the twenty twenties will be a decade for
(47:26):
diverse fires outside of mainstream stocks and bonds, and for
value in the stock market.
Speaker 1 (47:30):
Okay, now the final question, no probabilities about it. No,
maybe it's no diversifications. You've got to come down on
one side or the other. But I promise you I
won't make it the headline. Okay, you can make it
the headline bitcoin or gold.
Speaker 6 (47:46):
Gold.
Speaker 1 (47:47):
Perfect. That's my favorite answer because then I don't have
to argue with you.
Speaker 6 (47:51):
Yeah.
Speaker 1 (47:52):
Well, thank you so much for joining us Stox hugueally
appreciate it. We'll talk again soon and see how it
panned out.
Speaker 6 (47:57):
This was great fun.
Speaker 1 (48:05):
Thank you for listening to this week's Marin Talks Money.
We will be back next week. In the meantime. If
you like us, show, rate, review, and subscribe wherever you
listen to podcasts. They have noticed, by the way that
we do have one bad review. Someone who does not
approve of Value Investing. If you do review us, please
try and make it positive. We prefer those. This episode
was hosted by me Maren Sunset Web. It was produced
(48:27):
by Someasadi Moses and and Mohammed Faruk. Additional editing by
Blake Maple's special thanks of course to Rob Arnott and
to John Steppeck and of course our weekly reminder to
do please sign up to John's Sally newsletter Money Distilled.
The link as ever is in the show notes.
John, I'm going to read you a quote, and then
I want you to guess who feels this way about themselves.
This is a group who feels that they should get
credit for being agile in changing conditions and being fast
to adjust projections.
Speaker 2 (00:18):
Is the IMF.
Speaker 3 (00:20):
Yes, yes, if they would like you to give it that,
they'd like you to ignore the fact that they're always completely,
absolutely totally wrong about everything and give them credit for
the fact that after stuff has changed, they change their productions.
Speaker 1 (00:38):
Good work, guys, I mean.
Speaker 2 (00:40):
If to be a fit, I think changing your prediction
in GDP from negative point three percent to plus point
four percent, which is a swinger point of seven percentage points.
In our minds, that's pretty, I jail. It's quite stupid,
but it's quite It's pretty, I jail.
Speaker 1 (00:56):
It's agile, it's fast, it recognizes changing conditions, and you know,
I'm going to give them recognizing changing conditions because I
don't know. If you watch the poor old Chief Examinment
keep the Poortry of economists at the Bank of England
yesterday talking for the Treasury Committee, well, he was explaining
that the reason that they get everything wrong is because
(01:18):
their model cannot react to changing conditions. It's worth watching.
I put the link in, I put the link on Twitter,
I put the link somewhere else. I'll put it at
the end of the blog. I put it somewhere. Go
and watch it, and it's absolutely fascinating to watch a
man who's way cleverer than me and dare said, John
probably way cleverer than you talking, I know, talking about
a model that he has that is an extrapolation machine.
Speaker 2 (01:45):
I think Marty King has always said this about the
model law, which is what I'll find slightly we are doing.
A guy who actually used to run the Bank of
England and not that long ago, keeps saying the problem
with the Inflation podcast model is that it assumes that
the bank will definitely get inflation back to two percent,
so everything they put and ends up coming back to
(02:06):
two percent. I mean, like Meevin himself has said, that's
how how can the chiefic coandom is not already be
aware that this is a potential flaw in the model.
Speaker 1 (02:17):
I know he needs he needs to be more agile,
but his point was that in the last thirty years
everything's being kind of the same, so is a bit
difficult to build a model that doesn't assume that everything's
going to be kind of the same. It's not really
design for stuff that changes.
Speaker 4 (02:36):
And you think, well, okay, that's that's nonsense, but it's
kind of clausible nonsense.
Speaker 1 (02:42):
And then you think, I want to take care. There's
been a lot of change, a lot of just pretty
big stuff has happened. And why did a lot of
that big stuff happen? A lot of that big stuff
happened because the Bank.
Speaker 4 (02:55):
Of England has been running one of the biggest monetary
experiments of all time. Is it possible that some of
the change has come from Bank of England policy? And
if that might be the case, how could their model
not be ready for the effects of stuff they did?
Speaker 1 (03:11):
I mean, I don't mean to be down on the
Bank of England, as I say, John, like cleverer than us.
I was going to say, demonstrably clever enough, But that's
not actually true, is it.
Speaker 4 (03:19):
We just assume, we assume and be cleverer than us,
and here we are, here we are.
Speaker 2 (03:26):
I mean, you know, it uses a long time. I mean,
I mean, I mean, that's like pretty much two thoughts
of the time I've been alive. And as we all know,
the coined me didn't really start doing anything until on eighteen,
and so realistically I can see why you would only
go back thirty years ago, because that obviously is the
(03:47):
only reliable history that we've got.
Speaker 1 (03:49):
I love the way you think macroeconomic policy and macroeconomics
is correlated to your eighteenth birthday, buddy. It must have
been a humdigger.
Speaker 2 (03:59):
I mean, I may not intelligent as kind of like
the buying England by I'm feeling ourcissistic, So I think
that qualifies me to comment on these things.
Speaker 1 (04:10):
Yeah, and you know, one thing I do want to
say is that the reason why models don't work ever,
is because modeling is incredibly difficult. And if it were
possible to model the future, then you know, that would
be really great because then we would know what was
going to happen. But it's not possible. We can't ever
know what's going to happen.
Speaker 5 (04:30):
So we can't actually ever expect a model to work.
It's inconceivable that the model could work. So the problem
here is not so much the model doesn't work, it's
kind of a given. The problem is that.
Speaker 1 (04:44):
Forecasters be at the IMF, be at the Bank of England,
be at some of them. Many other forecasts that you
and I talked to somehow seem to believe, or seem
to believe that other people should believe that their forecasts
are valid. Now that's the problem that they're not saying,
this is my best guess, but you know it's really
unlikely to be correct. They're saying, here's my forecast, it's valid,
(05:05):
base your behavior on it, and that's why we run
into trouble.
Speaker 2 (05:10):
Yeah, I mean, but part of the problem there is
that they do tend to try to have their cake
and eat it. Because you know if you said that,
I can guarantee if you said that to any of
the guys in front of the Treasury Select Committee yesterday,
they would have said, well, it's just a model, and
we do have a fine chart which shows that, you know,
the connect because if you look at this thing, particularly
in the moment, the outliers froy still not still not
(05:32):
wide enough, but you know they are, they are quite wide.
So they would say, oh, but yet, we all know
the forecasts don't actually predict the future, but they only
really say that whenever they haven't predicted the future. And
I think the other point that you would then make
is well, look, why do you make these forecasts? I mean,
(05:52):
by the Bank England, I can see because they've got
themselves tied up and not sway you know, forward guide
and all that sort of stuff. There is a case
whereby they need to sort of justify the path that
they're on. But imf, I mean, it's kind of why
do you come up with this stuff in the first place. Whenever.
(06:13):
On the one hand, if you're challenge this to why
you get it wrong all the time, you say, well,
you're not meant to take it seriously, And it's kind
of like, well, okay, we'll stop stop bombarding is with it,
you know, and stop blaming the newspapers for putting it
in headlines. Whenever you've said something headline grabbing. No clever
person says that the UK will endure it its worst
recession and living memory is a headline. It's a news story.
(06:35):
You know, you might not agree with it, it might
be based on fundamentally flawed data, but you know you
can't blame newspapers for reporting it in that way. So
I mean, I think if they all backed off from
making the forecast in the first place, then that would
probably help a lot, because it would make people kind
of have to think and look at the data themselves.
(06:57):
Apart from that and else.
Speaker 1 (06:58):
Okay, So our message this week then is this sort
of down with the I ms.
Speaker 2 (07:04):
Yes, smash the thing takes or whatever, even as I
don't know, but I think that yeah, I think actually yeah,
been more a bit more humility on the part of
you know, policy makers in general a mess and a.
Speaker 1 (07:23):
Bit more group think. I mean, people have been accusing
the Bank of England of group think for a long
time now, and I think that they're going to have
to start addressing this. It's time to bring some new
thinking into the Bank of England. And you know, John,
I know you're there for them, aren't you? Just cool? Guys?
Just cool?
Speaker 2 (07:39):
I mean a dB index linked pension. Yes, but I
see you went wrong there, Merton. You should have said
I'm there for it.
Speaker 1 (07:49):
You've just reminded me. And it's harpy I linked as well,
isn't it. Hey, Everyone around the Bank of England get
a little diversity of thought in I am for you.
Speaker 2 (08:00):
So I think the Bank England's ever had a female
Central Bank governor.
Speaker 1 (08:05):
Oh, now I'm really here for you.
Speaker 4 (08:07):
Yeah.
Speaker 2 (08:08):
I think I think we've We've solved a number of
problems with this one certainly.
Speaker 1 (08:13):
Have because they're interested in diversities, so they keep saying.
Speaker 2 (08:17):
Right, actually, just on this topic. Very quickly, you tweeted
something today about the Wall Street Channel had published an
opinion column based on this, this finding from two top
economists that the pandemic and the fiscal stimulus, the magic
(08:39):
combination of these two things had actually caused the inflation
that we're all seeing now, something that that in itself
was funny enough.
Speaker 5 (08:49):
Who pay these people?
Speaker 1 (08:51):
I'm here for you too. Whoever pays these people are
here for you too.
Speaker 2 (08:56):
But do you know who the two guys were, Ben
ber Nanke and Olivia Blanchard, so like so so not
just like two top obscure like you know, but noble
prize when in whatever economists or a couple of academics
like sitting somewhere in an ivory towel saying, oh, this
(09:17):
is how the inflation happened. It's the guy that used
to run the FED for ages and ages and ages
and then and also a guy who used to be
a chief economists that the IMF.
Speaker 1 (09:27):
Well, you know, Billy, he did say yesterday, we've got
a lot to learn about inflation. Do you know what
Andrew we have or you have transit where you look
at it? Anyway, John and I are available for any
job that involved a RP I linked dB. Just call us.
You know where we are. Welcome to Marren Talks Money,
(09:54):
the podcast in which people who know the markets explain
the markets and Maren sumset Web. This week, our guest
is Rob Arnott, founder and Chairman of the Board of
Asset Allocations Specialist Research Affiliates. Rob, thank you so much
for joining us today. We really appreciate it.
Speaker 6 (10:09):
It's a privilege.
Speaker 1 (10:11):
I think it's more a privilege for me. Actually we'll
find out the next half and out. Now, I want
to start by talking about in fact, we may talk
about this for twenty five minutes. I don't know the
most important thing out there, the only thing out there
that is going to make the difference to how our
assets behave over the next decade or so inflation. And
you've written about this extremely well, and everyone should go
in and you should read Rob's work on inflation because
(10:32):
it is fascinating and it's not encouraging either, is it.
Speaker 6 (10:36):
It's not encouraging, but it's also not discouraging in that
even bad news can be a source of insights into
how to invest. So the good news is that the
widely accepted narrative that this inflation is transitory, that it
will dissipate in reasonably short order over the next two
(10:59):
or three years, is entirely possible. It can happen, It
has happened. It is also the benign end of the
spectrum of a much wider spectrum. The reality is not
that it's benign and will dissipate. The reality is anything
can happen. And where this gets interesting is the causes
(11:23):
of the inflation. We did a study in which we
looked at all fourteen countries that the OECD calls developed
economies today and called develop economies in nineteen seventy. So
that's our that's our peer group, and so it leaves
out current so called developed economies like Turkey, but countries
(11:47):
that have been developed for the last fifty years. You've
got fourteen countries fifty three.
Speaker 1 (11:50):
Years later in itself, before we even start on the
rest the fact that globally there were only fourteen countries
in nineteen seventy that counted as developed and still do.
Speaker 6 (11:59):
Yeah, the ones that did still do so. Becoming a
developed economy is a good path towards remaining a developed economy.
But be that as it may. UK has had inflation
surge past eight percent three times in the last fifty
years US twice in the last fifty years. Around the world,
(12:24):
that's too few data points you can't draw any conclusions.
But around the fourteen countries it's twenty nine times an
average of two per country. That's enough to draw some conclusions.
So what did we find. We found that when you
cross four percent inflation, half the time it goes higher
and can last longer. Half the time it rolls over,
(12:44):
and you don't go higher. When it rolls over, on average,
it dissipates back down below two percent within two years. Okay, great,
that's transitory inflation. Now, when you get to six percent inflation,
and especially when you get to eight and higher, it
is a consequence not of an exogenous shock that can
(13:05):
dissipate and with it allow the inflation to dissipate. It's
a result of conscious policy choices that are bad and
unless the policy choices change, the inflation pressures remain. Back
to the topic of four percent inflation, there have been
(13:26):
sixty seven episodes. Of those, almost five per country, Half
of those dissipated quickly, half of them didn't. The ones
that didn't almost in all cases went higher and lasted
an average of fourteen years.
Speaker 1 (13:42):
Okay, that is quite a long time.
Speaker 6 (13:44):
Right, eight percent, But we've.
Speaker 1 (13:47):
Already way past four percent. We're in we're in the
other world now.
Speaker 6 (13:51):
Correct above eight percent. What we found was twenty nine examples,
two per country. What we found was that two of
those dissipated fast within two years. So there are two
cases of transitory eight percent inflation. Those who anchor on
the notion that this will dissipate in the coming two
three years have historical precedent to point to to say, yes,
(14:14):
it can happen. Of the rest, a dozen of them
are still in progress. You're left with sixteen that have
been resolved, and so you can gauge the amount of time,
and other than those two that were transitory, the rest
averaged fourteen years. Okay, So this is bad news in
(14:37):
the sense that inflation is rarely transitory and doesn't dissipate
until the policy choices that led to the inflation are reversed.
There are those who say that Powell's hero is Paul Vulkar,
and that he's channeling his inner Volcar. Think about that
(15:00):
for a moment. Paul Vulker inherited an economy with serious inflation.
He inherited a political backdrop where citizens were so horrified
by how inflation was destroying their plans, destroying their retirement plans,
destroying their portfolios, that they basically said, do whatever it takes.
(15:25):
Vulkar did that. When inflation crested at fourteen point seven
percent in March of nineteen eighty, the Fed funds rate
was already nineteen point nine percent. It was five percent
above inflation. When inflation crested year and a half later,
it was twenty two percent. Now that is that is
(15:47):
using a relentless force to deal with inflation, the inflation
that we have here, and I'm speaking from the US perspective,
and Europe rhymes with us in terms of the way
the inflation looks, it's a bit worse here in the US.
(16:09):
Powell declared the inflation to be transitory in March of
twenty twenty one. What did inflation look like then? It
had just crossed four percent, And I've already said four
percent inflation half the time it's transitory. So it sounds
like it would ring true except for one thing. Half
of that four percent had happened in the prior three months,
(16:30):
So you had four percent inflation that was accelerating. Nine
months later, in November of twenty one, he declared that
the word transitory was not appropriate. Good news on that
to recognize that, and so slowly but surely, the FED
(16:52):
began to take inflation seriously. Inflation crested in the summer
of twenty twenty two at nine point one percent for
US above ten for you guys. Nine point one percent inflation?
Was he channeling his inner Volkar? Did he have the
FED funds rate at fourteen five percent higher? No, he
had the FED funds rate at one point two one
(17:14):
point two. It was eight percent under inflation.
Speaker 1 (17:18):
Yeah, I mean this is new, isn't it when it
comes to fighting inflation. To have the interest rates so
far behind that is relatively new.
Speaker 6 (17:27):
It's been tried in lots of countries. It'll tried it.
Speaker 1 (17:30):
Not in the developed countries that we've Italy.
Speaker 6 (17:33):
Did, Italy UK lots of times tried.
Speaker 1 (17:36):
K In the nineteen seventies, generally interest rates were okay,
not high enough, but higher than inflation most of the time,
if she most of.
Speaker 6 (17:44):
The time, but in the early surges of inflation. No,
And that's the difference with Vulcar. Now, I like to
join the joke that central bankers, instead of trying to
channel their Innervolcar, should channel their inner Powell. I don't mean,
I mean Colin Powell. Colin Powell said, if you're going
(18:05):
to commit to war, one, you have to have a
very specific goal, regime change whatever. Two you have to
have strong conviction that you can win. Three you have
to have an exit strategy. And four you have to
be willing to use overwhelming force to bring it to
(18:26):
a conclusion quickly, because that's the humane answer. It minimizes
damage to you and your adversary to end it fast.
So Vulkar used overwhelming force. He had a specific goal
get inflation under control. He was willing to use an
overwhelming force. He had an exit strategy, don't lower interest
(18:51):
rates until inflation is moderating fast. And the consequence was
it was brought under control. It took six.
Speaker 1 (19:00):
Years, still took six years.
Speaker 6 (19:02):
It was six years from that peak in inflation until
inflation briefly dipped below two. That's daunting. Now. Instead of
channeling his inner Vulcar, if he was channeling his inner Powell,
he would be saying, well, our goal is to bring
(19:23):
inflation under control. Our specific plan is to raise interest rates.
Crush demand. I mean, inflation is just supply and demand.
You have supply chain disruptions. You have people paid to
stay home and not work. You have people pretending to
work from home. You have a whole host of pressures
(19:47):
at work that hold down the supply of goods and services.
On the other side, your cost of living goes down
if you're working from home, so you have more money
to spend. You have stimulus checks being and so demand
goes up, supply goes down, bingo inflation. Well, how do
(20:09):
you equalize that? The Fed, the central bankers around the
world look at this and say, I can't do anything
about supply, but I can crush demand. Okay, let's crush demand.
I'm reminded of the colonel in Vietnam who was quoted
as saying, we had to destroy the village in order
to save it. Central banker's answer to inflation is we
have to destroy the economy in order to save it
(20:30):
from inflation. Does it work. Yes, it's a very painful, which.
Speaker 1 (20:37):
Of course is why they're not doing it properly. At
the moment, we could get rid of inflation in a
matter of weeks if okay, maybe not weeks, but you
kill it pretty quickly. You could kill it really slammed
up interest rates ahead of the rate of CBI by
a very significant amount. I mean, no one's ever going
to do that, but it's theoretically possible.
Speaker 6 (20:55):
And the government pushback on doing that is very straightforward.
The cost of the government debt. Now that the government
debt is in many developed economies triple or quadruple what
it was in the inflationary surge of late seventies and
early eighties, they're going to say, you're going to have
us spend our entire tax receipts on interest.
Speaker 1 (21:17):
Yeah, do say nothing of the welfare builds that come
with defrowing an economy correct temporarily correct.
Speaker 6 (21:22):
So my view on this is really extremely simple, and
that is that the way to bring inflation under control
is on the supply side, and that there is zero
political will in either party in the US or here
to do that. The way to boost supply is to
(21:44):
unshackle the private sector and let innovation lead to a
surge of productivity. I like to joke that the role
of government is to find out what the people are
up to and put a stop to it. If the
goal is to say, technologically, innovation is all well and good,
but these guys are too successful, their companies are too powerful,
(22:06):
let's put a stop to it. That's problematical.
Speaker 1 (22:09):
Well, the role of government to a degree these days
is to look for problems, to go out and seek
a problem and then try and solve it, to misdiagnose it,
and then come up with an incorrect policy to solve it.
Speaker 6 (22:19):
Which that's I think exactly right.
Speaker 1 (22:21):
Can't remember who's quoite that it, but it seems to
be exactly what what governments do at the moment in
the right, in the developed world at least, And that
tends to put a bit of a stopera on innovation
and creation, right. Creation.
Speaker 6 (22:32):
Now, one of the things that's just fascinating is inflation
is terrible for bonds. It's terrible temporarily for stocks, but
once the stocks reprice to a lower level, they do
participate in inflation, so you get back to a good
real return. The other impact that inflation has is it
(22:55):
rewards value? There's a narrative out there that value investing
wins in a higher interest rate environment because the long
term growth in the growth side of the market is
discounted at a higher rate, bringing the net present value
of that growth down. And that's less true of value stocks,
(23:17):
where the here and now profitability is the dominant factor
that resonates. It ignores the fact that growth rates and
the discount rate are linked. So they can cancel. But
what can't cancel is inflation. If inflation, there is no
(23:38):
such thing as elevated and stable inflation.
Speaker 1 (23:40):
This is the key point, isn't it. When people talk
about inflation staying higher and all, A lot of people
think themselves that means inflation running it a steady four
and a half or five percent for a reason long
amount of time, and that would be just fine. It
will be fine. We can live with that. It'll road
a lot of government debt, it a lot of private debt,
bit by bit. And if we could have a steady
four percent for a decade, boy, a lot of our
(24:01):
problems will be completely solved. But that does not how
inflation works.
Speaker 6 (24:05):
We've had thirty years of inflation steady in the two
to two and a half percent range, with an occasional
blip up to four or five and an occasional drop
to near zero. But eighty percent of the time the
rolling twelve month inflation was in the one and a
half to three range. So is today's eight percent inflation,
(24:29):
let's say, going to be in the seven to nine range. No,
it's going to be in the four to fourteen range.
Speaker 1 (24:38):
As you wished to go back a little bit and
talk about why it's what it is that will be
the drivers behind inflation from here that stop it from
being transient, because you still hear the argument that you know,
bit by bit that households are getting rid of the
savings that they accumulated during the policies around COVID, and
the supply chains are working themselves out, and China's back
on track, et cetera. So you still hear the transient argument.
(25:00):
So we should just talk briefly about what the dynamics
are that prevent it from being transient.
Speaker 6 (25:06):
Yeah, and by the way, a key point here is
not prevented from being transient, but make that improbable it
could happen. Think about the causes of inflation, demand stimulus
from people having more pocket money, from work from home,
and from massive stimulus air drops of cash into people's accounts.
(25:30):
Is that going to persist into the future. Well, hybrid
work is now the norm.
Speaker 1 (25:37):
Well, there's a lot of employers trying to change it
back to how it was.
Speaker 6 (25:40):
The millennials will resist that fiercely. In the US polls
suggests that required to work five days a week in
the office would for forty percent of millennials cause them
to quit. That's interesting, and it's particularly true in certain
segments of the skill sets that don't require office interactions.
(26:02):
It programming, marketing, marketing. People travel all the time anyway,
so what's the big deal? And so work from the
office tends to be resisted pretty fiercely. So part of
that added demand remains, and that's good. That's good. Demand
(26:22):
is a good thing, not a bad thing. Supply chain
disruptions deglobalization is with us for a good long time.
It's not going to reverse course fast. The China saber
rattling with regard to Taiwan means that even if the
China supply chains get fully back to normal, there will
(26:45):
be resistance to relying as heavily on them as in
the past, and as countries shift their production to be
more domestic and less based on the classic economic rule
of comparative advantage, where one country can produce x better
than another country, that that is not coming back fully.
(27:09):
So that'll be the with us for a long time.
So you're going to have work from home diminish but remain.
You're going to have people paid to be home and
not work diminish but remain. You're going to have supply
chain disruptions diminish but not go away. You're going to
(27:30):
have wage pressures because there is a mismatch between those
willing looking for work and work looking for employees. That
mismatch is not likely to disappear anytime soon. So none
of the core causes of the supply demand mismatch and
(27:52):
of the inflation are going away.
Speaker 1 (27:54):
They're all likely to make It seems like a particularly
big deal to us. And there used to be a
view that union power led to inflation, but of course
it's the other way around. Inflation leads to union power,
and once you get right.
Speaker 6 (28:10):
That's a really important point.
Speaker 1 (28:11):
Really, I think very misunderd so misunderstood. You know, the
unions for the last However, many decades in the UK
have been very weak because there's been no need for
them not to be and then demand from their members
because when inflation is running it one or two percent,
most people it's nothing. It doesn't mean anything to them,
so there's no particular need to demand pay rises. But
inflation has now been cripplingly high for people in the
(28:33):
UK and elsewhere for so long that everyone now understands
inflation and how it works and what it does to
their purchasing power. And even if inflation were to go
back to two or three percent next year, even if
it were, which it weren't, but if it were to,
I still think you'd see people saying, well, hang on,
I take care. I now understand that my real purchasing
power has been destroyed over a twenty year period, not
just a one year period, and I'd like that back.
(28:55):
So the echo of labor power this year would I
think continue for several years anyway, And we did have
our bank Fngland governor if they did say that, he
now sees that we are in a wage price viral. So,
like like all, central bank is a little behind the
rest of us, but we get there in the end.
Speaker 6 (29:11):
Now, one thing that I think is quite hilarious is
that we all wait with baited breath for the latest
prognostications of our central bankers about what the expectation is
for inflation, for unemployment, for GDP growth. A vast proportion
of United States economics PhDs work for the FAD. Yes,
(29:37):
they are all cut from a similar mold. They're all Neocainsians.
They range from mild Neokainsian to extreme MMT. And they
say that's diversity of views. No, no, it's not. And
there's a fellow named George Box who was co developer
of the Box Jenkins models, who famously said all models
(30:02):
are wrong, some models are useful. I love that, Don't
that great?
Speaker 1 (30:07):
True? If any people have said that at the beginning
of the pandemic, right.
Speaker 6 (30:12):
Right, It's true in medicine, just as it's true in economics.
And we have economists who say, the model says this
will happen. The model says the economy will do this
if we do that, And instead of saying, how can
our models work better by mimicking the way the economy behaves,
(30:35):
they argue with the economy and say the economy is wrong.
It should do this, So that's a good way to
get models that are not useful. The implication of all
of this is that the forecasting ability of us FED,
for instance, is slightly worse than useless, worse than useless,
(30:59):
meaning that they're or directional forecasts are worse than the
than the capital markets, and worse than a coin toss.
Why do we care what they have to say?
Speaker 1 (31:11):
Why do we keep listening? It's a really good question,
but we do. We do keep listening. We put it
on the front of our newspapers. Yes, every time one
of them comes out and speaks on the front of
the newspapers, everybody's listening, and everyone's using those words to
predict their own futures, even though we know that they're
almost always wrong.
Speaker 6 (31:27):
Yeah, and there's one good reason to listen to them,
and that's that their forecasts and their prognostications are driving
their decisions. So if you know that the consensus view
on inflation is it's going to dissipate reasonably quickly, and
if the FED says we've got this, we're getting it
(31:48):
under control, having some part of your portfolio that's betting,
well maybe not is a useful response. So it is
useful to know what they're projecting, but not from the
vantage point of believing it, Which brings me to what
do you do in this environment?
Speaker 1 (32:06):
Yeah, so when we say this environment, we're talking about
the environment we would expect inflation to be volatile between
you know, I don't know, say four and ten percent.
Speaker 6 (32:14):
Yeah, where you're expecting inflation to be elevated and volatile
for a decent span of times every fourteen years. Apparently
that's the history. That's I do not want to be
quoted as saying I'm expecting fourteen years of this. I'm
expecting longer.
Speaker 1 (32:31):
We'll put that in the headline good good.
Speaker 6 (32:34):
I'm saying, let's expect inflation to have higher odds of
being higher and longer than most people think. It could
settle back down, but it very likely won't. And in
that environment, bonds are troublesome. Stocks are troublesome until they're cheap.
(32:56):
In the UK they're cheap, So in the UK I'd
be fine with stock ownership. In the US, I wouldn't.
Speaker 1 (33:01):
Well, you did write and it didn't you go trade
of the decade? Yes, that UK, John, and I let that.
Speaker 6 (33:08):
Oh, I got so much pushback on that from britt
did you from BRIT's saying this guy's an idiot?
Speaker 1 (33:15):
Interesting? You know, foreigner investors in that buys at the moment,
domestic domestic investors still as sell us. Where is it
demivable law? Don't we? Well?
Speaker 6 (33:25):
Everybody is when performance has been disappointing, Yes, everyone. You
can't have a bargain without having created the bargain by
inflicting pain and losses. Yes, and yet human nature says,
you want me to buy more of this well.
Speaker 1 (33:39):
When Netflix repilated? Aren't we humans?
Speaker 5 (33:41):
Yeah?
Speaker 1 (33:41):
Yeah, so tell me your case.
Speaker 6 (33:44):
I think the way to invest in this environment is
very straightforward. Mainstream stocks and bonds represent vulnerable markets in
a period of rising inflation with a carve out, and
that carve out is markets that are cheap are fine.
Inflation helps value partly because inflation pushes up that discount rate,
(34:09):
and the important thing is the real discount rate. It
pushes the real discount rate up, and partly because a
period of heightened uncertainty is a time when investors want
the margin of safety associated with having a good base
of profits, of book value, of sales, of dividends, and buybacks.
(34:37):
For broad measures of the economic footprint, of a business.
For every hundred pounds or dollars or euros they invest,
they want a decent base of profits, sales, etc. And
that's value. The value side gives you that. The growth side,
you're paying for hopes and dreams which are nice, Which
(34:59):
are nice, and hopes and dreams have certainly prevailed this
year to day on the back of chat, GPT and
the narratives about AI. The thing about narratives is the
good news is they're usually at least partly true. The
bad news is they're already in the price.
Speaker 1 (35:17):
Yeah, it's not that they don't have value, it's just
that it's already they are predictive.
Speaker 6 (35:22):
They aren't predictive value. And that's the thing that people
just have trouble getting a handle on with narratives. Whatever's cheap,
there's always well what about this? What about that? Yeah,
it's in the price, that's why it's cheap.
Speaker 1 (35:34):
So when you look at the UK market, how are
you defining cheap?
Speaker 6 (35:38):
I love the Shiller pe ratio price relative to ten
year average earnings. It's a measure of how much profit
the company is likely capable of delivering on a long
term basis for every one hundred pounds you invest, and
the Shiller Pe ratio for the UK last I checked
was about fourteen times. For the US, it's about twice that.
(36:01):
The US doesn't have a margin for safety, mostly because
of the fang stocks. The value stocks in the US
are about sixteen eighteen times, but in the UK there's
a margin of safety. That's great. The other thing I
would say is diversifying away from the mainstream stocks and bonds.
(36:21):
Out of mainstream stocks and bonds, emerging market stocks and
bonds interesting. Merging markets bonds yield more than US junk
bonds do. Now, that's interesting.
Speaker 1 (36:31):
And emerging market equities are looking briefly cheap on almost
all measures, right, they're about it so reasonably as opposed
to vary.
Speaker 6 (36:37):
They're about the same as the UK. That's reasonably cheap,
and emerging markets value is very cheap. Merging markets values
trading at a Shiller Pe ratio a little under ten.
And Fundamental Index, which we invented eighteen years ago, which
has a stark value tilt and increases your allocation as
(36:58):
a stock gets cheaper instead of as stock gets more expensive.
Fundamental Index on emerging markets is currently priced at eight
times earnings and has a dividend yield of just under.
Speaker 1 (37:10):
Five Okay, I mean that's that does sound like that's
pretty cool.
Speaker 6 (37:13):
Yeah, But it means shedding your desire to have results
similar to your neighbors, because if it zags when your
neighbor's portfolio zigs up, your patience will be tested. So
don't don't put more in it than you're comfortable.
Speaker 1 (37:32):
Oh, you don't look at your portfolio very often.
Speaker 6 (37:34):
Another option, that's a beautiful option. I do that with
my own personal portfolio client portfolios. I don't have the
luxury of just saying call me in three years and
let me know how it's going.
Speaker 1 (37:48):
Yeah, yeah, what about Japan? Where does that come?
Speaker 6 (37:51):
When your valuations actually relatively cheap?
Speaker 1 (37:53):
And it's been quite interesting, right, John and I we've
been long term bulls of Japan, possibly rather too long
at this point, but you know, finally we seem to
be getting some momentum there and we're at thirty o
DA highs and more jun calls are oural friend Jonathan
Allen used to call the iron coffin lid on on
top of Japanese equities appears who've been lifted, and they
(38:14):
do look readily cheap.
Speaker 6 (38:15):
But they're about eighteen times that's not bad. They do
have a demographic challenge. The population is shrinking, the working
population is shrinking.
Speaker 1 (38:24):
Faster, but that just means they're a little ahead of
the rest of US. So they're getting on top that.
Speaker 6 (38:29):
Right well in US are UK is in better shape
demographically than cotton el Europe by a big margin, and
US is better than most of the developed world by
a big margin. In the case of both, immigration is
a big part of that, and in the case of
the US, the fertility rates have not fallen to the
(38:51):
extent they have in much of the developed world. China
has the demographic wall of China coming big time.
Speaker 1 (39:00):
And well, they always said about China, didn't they old
before rich?
Speaker 6 (39:04):
Right, So, in twenty twenty, the ratio of working age
Chinese to senior citizen Chinese was the same as it
was in the US in nineteen fifty, beautiful benign circumstance
for rapid economic growth. The view was get rid of
the one child policy and women will start having more
(39:27):
kids too late. It's too late. Besides which, the invention
of birth control in nineteen sixty means women can choose
if women split equally between those who want no kids,
those who want one kid, and those who want two
or more kids. The fertility is going to be in
the one one and a half range. That's where it stuck,
(39:48):
and in China it fell during the pandemic to about
one point two. That demographic challenge means that they go
from being where we were in ninety teen fifty too,
by the year twenty forty five, they'll have a higher
support ratio than the US, and by twenty sixty higher
(40:09):
than Europe. As bad as it is, it will be
in Europe by then. So I view China's saber rattling
as a very big geopolitical concern right now. If we
can get to twenty forty without them acting on the
saber rattling, they won't be able to raise an army
big enough to matter.
Speaker 1 (40:26):
But I did see you're reminding me of a piece
of research I saw a couple of years ago that
drew the most fascinating correlation perfly al, which when you
think about it, between wars and the percentage of a
country that is male between sixteen and twenty nine. I
as you must have seen that bit of research somewhere.
Speaker 6 (40:48):
If we had time, I was going to go to
almost exactly those statistics. Yeah, testosterone filled young men, especially
in a country where there's not enough women, eighty million
missing women of China. Hey yea yai.
Speaker 1 (41:04):
Then we can get get through the next few decades
and we'll be at the other end of that bump, right.
Speaker 6 (41:10):
And so I view China as the biggest geopolitical source
of a risk of instability in the world today. And
I view them as I don't know, is this broadcast
in China a paper tiger years to take the risk?
(41:30):
I would view them as a paper tiger twenty years
from now.
Speaker 1 (41:32):
Okay, So you know Chinese equities right now then not
so much.
Speaker 6 (41:36):
They're actually reasonably fully priced by emerging market standards. The
reason that emerging markets value is so astonishingly cheap is
that emerging market's growth is dominated by the Chinese version
of the Fang stocks, the batstocks by Dula, Baba and
ten Cent. Those three stocks comprised fifteen percent of the
emerging markets at their peak, three stocks, and today they
(42:01):
comprise about eight or ten percent. Three stocks. They're all
on the growth side. So what you're left with is
value is very, very cheap and is mostly non China.
Speaker 1 (42:11):
Yeah, okay, right now we're doing well. Yeah, we're getting
a lot of interesting things for listeners to go away.
I look at we've told them that the UK is
traded the decade. I know you don't believe us, but
I think it could be true.
Speaker 6 (42:22):
Well, so far, so good. Yeah, I know, I know
relative to the rest of the world, UK stocks have
done beautifully.
Speaker 1 (42:30):
Yeah. Yeah. What about the commodity sector? Commodity so we
don't want anyone rushing off directly into commodities. We almost
made that mistake in our last podcast when we talked
about investigating commodities and suddenly had to remind everybody we
didn't mean actual commodities. We mentor commodity acrities.
Speaker 6 (42:45):
I think if people buy live cattle for their backyard,
they can get rid of the lawnmower and they have
a commodities investment. But more seriously, but you're not advising
that more seriously, commodities are relatively fully priced right now.
(43:06):
Commodities should fall in real prices on a long term basis,
and they do one to two percent a year because
of rising productivity. It gets back to the issue of inflation.
The answer to inflation is rising productivity.
Speaker 1 (43:23):
Although people do say people do say, but in this
market at the moment, in the quantities market, particularly metals
mining and fossil fuels, rising prices are not necessarily the
cure for rising prices as they have been in the past,
because the environmental concerns mean that it's very hard to
get permissions for the expiration and production you might have
done in the past, or you know, digging in new
mind somewhere is not as easy as going on and
(43:45):
digging in new mine. So the dynamic has changed, so
you could argue that that one to two percent for
the year is not necessarily in play like it was.
Speaker 6 (43:54):
It depends in part on the country of mining for
copper in Chile under a hard left new regime is
going to be difficult. Mining for earth metals and other
exotic metals in China is not a problem. So one
(44:14):
of the things that I think would be useful is
to do cost benefit analysis on do we want to
restrict this or do we want to lightly discourage it.
Speaker 1 (44:25):
Yeah, and that makes a difference for the long term.
I'm still not kind of picking up whether you're saying
it a good idea to be in the commodity sector
or not.
Speaker 6 (44:34):
I think commodities are terrific long term play, just not
so much right now. And it's a terrific long term
play from two perspectives. Firstly, you're going to earn the collateral,
so elevated interest rates, Okay, you're earning that. That's your
protection against current inflation. You also get protection against inflation
(44:56):
shocks because commodities magnify inflation or does inflation shocks by
about five to ten to one. In the US, inflation
expectations on a ten year basis are two and a quarter.
Why do I say that tenure bond is at three
and a half ten your linkers are at one and
a quarter. The difference is too and a quarter. So
if inflation is two and a quarter, and then both
(45:19):
bonds have the same return, all right. So that's all
well and good. But our work suggests that a better
estimate of inflation on a ten year basis is at
about three and a half because inflation dissipates slowly, and
if we're right, then that represents a positive inflation shock,
and commodities magnet fly inflation shocks by about a percent.
(45:43):
So that's one and a quarter percent above that would
mean that when inflation expectations rise to three and a
half that commodities will have risen about ten twelve percent.
So that's a nice expected return.
Speaker 1 (45:58):
Okay, two quick questions. It's like the quickfire round.
Speaker 6 (46:03):
Let's go for it.
Speaker 1 (46:04):
If if inflation did tend to be transient, it was
down at two percent by next year, if that was
the scenario we expected, how would we invest? Now?
Speaker 6 (46:14):
This is why I think you want to think of
things probabilistically rather than in terms of black and white.
This is why I resist the idea of Arnat says
inflation will be higher and longer. No, inflation is likely
to be higher and longer than most people expect. So
you wind up with a diversified portfolio with more than
(46:38):
your historic.
Speaker 1 (46:39):
Norms in the more probable area.
Speaker 6 (46:41):
In diversifications away from mainstream stocks and bonds, and in value.
And the beauty is right now, value is very cheap.
It's in the cheapest quintile relative to growth in history.
In the summer of twenty twenty, it was in the
cheapest percentile in history, and you could not persuade anyone
(47:03):
to buy value. Well, it has snapped back beautifully, but
there's still plenty of juice left in that orange. So
if value is cheap, that's a reason to overweight it.
If you think inflation is likely to surprise to the upside,
that's a reason to overweight value. So today, like I said,
I think the twenty twenties will be a decade for
(47:26):
diverse fires outside of mainstream stocks and bonds, and for
value in the stock market.
Speaker 1 (47:30):
Okay, now the final question, no probabilities about it. No,
maybe it's no diversifications. You've got to come down on
one side or the other. But I promise you I
won't make it the headline. Okay, you can make it
the headline bitcoin or gold.
Speaker 6 (47:46):
Gold.
Speaker 1 (47:47):
Perfect. That's my favorite answer because then I don't have
to argue with you.
Speaker 6 (47:51):
Yeah.
Speaker 1 (47:52):
Well, thank you so much for joining us Stox hugueally
appreciate it. We'll talk again soon and see how it
panned out.
Speaker 6 (47:57):
This was great fun.
Speaker 1 (48:05):
Thank you for listening to this week's Marin Talks Money.
We will be back next week. In the meantime. If
you like us, show, rate, review, and subscribe wherever you
listen to podcasts. They have noticed, by the way that
we do have one bad review. Someone who does not
approve of Value Investing. If you do review us, please
try and make it positive. We prefer those. This episode
was hosted by me Maren Sunset Web. It was produced
(48:27):
by Someasadi Moses and and Mohammed Faruk. Additional editing by
Blake Maple's special thanks of course to Rob Arnott and
to John Steppeck and of course our weekly reminder to
do please sign up to John's Sally newsletter Money Distilled.
The link as ever is in the show notes.
Host
Merryn Somerset Webb
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