Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway.
Speaker 2: And I'm Joe Wisenthal.
Speaker 1: Joe, you know, it's a hot topic at the moment. Uh,
Speaker 1: don't say AI.
Speaker 3: I mean it is, right, but I guess it is.
Speaker 1: Yeah, Okay, Hey, we're not talking about AI. We're talking
Speaker 1: about another hot button topic, which is corporate profits.
Speaker 3: Yes, but it might kind of be related valuations, stocked, booming,
Speaker 3: profits booming, et cetera.
Speaker 2: Like there might be some.
Speaker 1: Connection, right, Okay, that is fair. But one of the
Speaker 1: reasons everyone's talking about corporate profits at the moment is
Speaker 1: because obviously there is this new idea that maybe there
Speaker 1: is profit led inflation, companies raising their prices a little
Speaker 1: more than they have to given, you know, input costs
Speaker 1: and things like supplying to and that's boosting profits. So
Speaker 1: you see it everywhere now. And one of the things
Speaker 1: that you see is corporate profits have been very, very
Speaker 1: high in recent years. Although it's true they are starting
Speaker 1: to come down.
Speaker 3: Right, And the interesting thing about high corporate profits is
Speaker 3: that there has been this expect it's been for years.
Speaker 3: I mean, they've been very high in recent years. But
Speaker 3: I mean, I remember you know, years ago people talk
Speaker 3: about corporate profits being high and they had to mean revert, right, Yeah,
Speaker 3: there was this assumption that they were at unsustainable levels,
Speaker 3: and people talked about this in the wake of the
Speaker 3: Great Financial Crisis, that corporate profits were very high and
Speaker 3: it was only a matter of time before labor would
Speaker 3: take a greater share out of profits, et cetera. Anyway,
Speaker 3: the point is, though they've been high and they've stayed high.
Speaker 1: I'm glad you mentioned mean reversion because today we have
Speaker 1: really the perfect guest. We have someone who forecast that
Speaker 1: profits were going to mean revert, they were going to fall.
Speaker 1: This was a prognostication that was made back in the
Speaker 1: very early days of twenty twelve, so right after the
Speaker 1: two thousand and eight financial crisis, when everyone was sort
Speaker 1: of scratching their heads about why they recovery. The economic
Speaker 1: recovery was slow and painful, but the recovery in corporate
Speaker 1: profit margins was quite quick, yes, and dramatic. So this
Speaker 1: particular guest made the forecast that eventually profits would mean revert. However,
Speaker 1: it is now more than ten years later they didn't
Speaker 1: mean revert, and our guest has just published a giant
Speaker 1: mea culpa, which is something that you don't see that
Speaker 1: often in the world of financial research. So kudos to
Speaker 1: the guest for doing that. And we are going to
Speaker 1: dig in about why corporate profits remain so high.
Speaker 3: I can't wait. This is a really important topic. And
Speaker 3: again with this sort of new boom in the stock
Speaker 3: market really over the last couple of months again kind
Speaker 3: of you know, we're a bull market again with stocks
Speaker 3: last October, last fall really negative, just absolutely on a
Speaker 3: tear lately recording this June fifteenth. What's driving at how
Speaker 3: sustainable is? These are great questions to dive into now.
Speaker 1: Yeah, and we're going to talk about valuations too, because
Speaker 1: of course profits valuations sort of naturally go together. But
Speaker 1: without further ado, I think I already gave it away,
Speaker 1: but we are speaking with James Montier. He is, of
Speaker 1: course a strategist over at GMO, someone we've wanted to
Speaker 1: talk to for a very long time. So I'm glad
Speaker 1: we could finally have a mom James, thanks so much
Speaker 1: for joining odd Lots.
Speaker 4: Thank you very much for having me. Guys really appreciate it.
Speaker 1: So I want to sound genuine here. I really applaud
Speaker 1: someone revisiting their previous work and thinking about it again
Speaker 1: and saying having the honesty to say I was wrong.
Speaker 1: So talk us through just to begin with, how did
Speaker 1: this sort of maya kulpa come about?
Speaker 4: So? I guess it really stems from just a longevity
Speaker 4: in the business. When you've been in it as long
Speaker 4: as I have, you cannot possibly claim to have anything
Speaker 4: approximating a kind of group track record for forecasting. And
Speaker 4: I've written before, many many years ago, when I was
Speaker 4: back a Dresna on the folly of forecasting and how
Speaker 4: stupid it is to actually attempt to forecast things. And
Speaker 4: yet I still do it. And I think if one's
Speaker 4: going to do that, there's a whole.
Speaker 1: Industry dedicated to doing it, So you're not the only one.
Speaker 4: Absolutely, Yeah, the entire financial industry seems to think it
Speaker 4: can tell the future. We make Gypsies with their crystal
Speaker 4: balls look positively reasonable with our accuracy, and so I've
Speaker 4: long long taken to the view that we really have
Speaker 4: to go back and examine our mistakes. Right. There's this
Speaker 4: concept of the growth mindset that Carol Dweck wrote about
Speaker 4: years ago, and it really is that the only way
Speaker 4: of learning is to embrace your mistakes right. If you
Speaker 4: get it right, fine, you got it right, but you
Speaker 4: don't learn anything. If you get something wrong. There's the
Speaker 4: opportunity to learn something. You know, why did you get
Speaker 4: it wrong? And so for me, as I've gone over
Speaker 4: the years and I guess I've aged and an ego
Speaker 4: has died. You know that kind of enthusiasm of exuberance
Speaker 4: of youth where you're like, yeah, I mean vincible, I'm
Speaker 4: always right, and you're like, no, the market's just wagh,
Speaker 4: you're down. Over time, you've been wrong. And I think
Speaker 4: what's particularly fascinating to me is when you have a
Speaker 4: long term forecast. You know, the short term ones are
Speaker 4: just noised right, any goody would be right tomorrow, who knows.
Speaker 4: But the long term views, where you're talked about mean
Speaker 4: reversion in your intro and mean reversion doesn't happen, that
Speaker 4: really gets interesting to me. And I've always kind of
Speaker 4: piken those examples of where I've been wrong now ten
Speaker 4: years after the fact and so, okay, what on earth
Speaker 4: did I miss? Because for me, it's all about learning.
Speaker 4: How do I improve? I'm fifty two years old this year,
Speaker 4: and I'm still stupid enough to think that I can
Speaker 4: learn and maybe get better. I probably won't get better,
Speaker 4: but at least I can learn.
Speaker 3: So why do we go back to start? Why don't
Speaker 3: we go back ten years or a little more? I
Speaker 3: guess to your call in twenty twelve, and at the
Speaker 3: time there's a chart in your newest white paper that's useful.
Speaker 3: It shows that at the time when you sort of
Speaker 3: sort of rain the alarm about corporate profits US NEPA
Speaker 3: profit margins is a share of GNP. They're about ten percent,
Speaker 3: which was well higher than anything we had seen. And
Speaker 3: say the fifty years or I guess seven years prior,
Speaker 3: they've sort of gotten as high as nine percent, but
Speaker 3: they had gotten really high at that point. So what
Speaker 3: do we start there, like talk about the conditions that
Speaker 3: had gotten us in twenty twelve to an extraordinary high
Speaker 3: level of corporate profit margins.
Speaker 4: Sure, So the framework I tend to use to understand
Speaker 4: these things is something called the Kalechi equation.
Speaker 3: Which many of our many odd Logs listeners. We did
Speaker 3: a full episode on Koleetchki and.
Speaker 1: Well Collecki Tribua.
Speaker 3: Yeah, so this is home term for odd logs listeners.
Speaker 3: But yes, keep going exactly.
Speaker 4: Yeah, good old yeah, and it did all the hard
Speaker 4: work for me. And I was fortunate enough when I
Speaker 4: was at university all those years ago to have someone
Speaker 4: who actually taught this stuff and arrogant enough at the
Speaker 4: time to ignore it. Back then, I was a full
Speaker 4: believer in rational ex expectations and I was a mathematical
Speaker 4: and columnist, and the beauty of rational expectations was really
Speaker 4: awesome to me. And then I realized as I began
Speaker 4: my career in finance that actually that was just a terrible,
Speaker 4: terrible framework for thinking. And I fell back on these
Speaker 4: tools that i'd been taught that i'd kind of thrown
Speaker 4: out when I was being taught them. In fact, I
Speaker 4: saw my old lecturer a good few years ago sadly
Speaker 4: at the funeral and had to apologize to him for
Speaker 4: my extreme arrogance when I was a student and tell
Speaker 4: him that the stuff he'd actually taught me was the
Speaker 4: only stuff I actually used these days. And I used
Speaker 4: this equation to kind of frame the world and try
Speaker 4: and understand profits. And it comes down to this view
Speaker 4: that profits can really be decomposed from a macro point
Speaker 4: of view. The beauty of a macro framework is it
Speaker 4: imposes conditions that tend to get missed when you're dealing
Speaker 4: with kind of micro topics. So often you'll hear people say, oh,
Speaker 4: now profit margins are high because they crushed their suppliers. Well,
Speaker 4: the problem is from an aggregate point of view, that
Speaker 4: doesn't make any sense lens. Right, it might be true
Speaker 4: for that one individual company, but it can't be true
Speaker 4: in aggregate because those suppliers profits are also companies, right, yeah, exactly,
Speaker 4: they get their inputs, So everybody's output is somebody else's
Speaker 4: input kind of thing. Right, So you can't get higher
Speaker 4: profits by squshing in aggregate, by squashing your your suppliers,
Speaker 4: because they just end up with a lot of profits.
Speaker 4: So when you take a macro lens, it gives you
Speaker 4: a kind of framework that is coherent and consistent, and
Speaker 4: that's a really powerful style. So the collect equation says, hey, look,
Speaker 4: there's a few drivers of profits. There's net investment. If
Speaker 4: you go out and you buy stuff that's going to
Speaker 4: add to productive capacity, that's going to be good for profits.
Speaker 4: It makes sense as a corporate you're investing in your future,
Speaker 4: but you are providing profits to somebody else. Again, we
Speaker 4: get that kind of no firm can bootstrap itself out
Speaker 4: of that situation, but it does in aggregate create profits.
Speaker 4: Dividends are another source of profits. Now it sounds weird
Speaker 4: because we always think about dividends being paid out of profits,
Speaker 4: but dividends, of course are an income flow to a
Speaker 4: household somewhere, and ultimately they are therefore a form of
Speaker 4: spending or potential spending. Then you get the kind of
Speaker 4: negatives that drag on profits. So if households choose to save,
Speaker 4: that's obviously a drag. You know, I'm not spending all
Speaker 4: of their income they're saving. That's going to drag profits
Speaker 4: down if governments are saving it, And that turns out
Speaker 4: to be kind of the opposite of what governments do.
Speaker 4: But if governments were saving, that too would be a drag.
Speaker 4: And if the foreign sector is saving, that too drags
Speaker 4: down profits. And so when I was looking back in
Speaker 4: twenty twelve, we had pretty big fiscal deficits. Investment had
Speaker 4: fallen dramatically and effectively the government deficits had expanded to
Speaker 4: fill some of that gap, and I foolishly made the
Speaker 4: forecast that it was really the government deficits that were
Speaker 4: going to have to come down, and that was going
Speaker 4: to be the macro driver of the profit margin mean
Speaker 4: reversion that we kind of all expected.
Speaker 1: So, just on that note, why did you think that
Speaker 1: government spending would come down? Because nowadays, I mean, we've had,
Speaker 1: you know, successive years of the US deficit getting bigger
Speaker 1: and bigger and bigger, and it's almost taken for granted
Speaker 1: at this point that it's just going to keep growing.
Speaker 1: But why did you think that spending would actually reduce
Speaker 1: back in twenty twelve.
Speaker 4: So I think it was it was a product of
Speaker 4: two things. So I was standing there on twenty twelve
Speaker 4: looking at the fiscal deficit and we're, you know, POSTGFC,
Speaker 4: and during the GFC, of course, the fiscal deficit exploded
Speaker 4: to levels that frankly, we hadn't ever seen before, which
Speaker 4: are now dwarfed by what we experienced in COVID, but
Speaker 4: back then were really exceptional. And it was that kind
Speaker 4: of extremely high level of fiscal deficit over the post
Speaker 4: GFC or the GFC, and it's kind of hangover if
Speaker 4: you like. That really had me thinking, right, it's got
Speaker 4: to come down, right, governments can't continue spending at this rate.
Speaker 4: And that's that was undoubtedly the thing I got wrong.
Speaker 4: Because it's simply never seen, at least in the US
Speaker 4: fiscal deficits of such magnitude for such a period of time.
Speaker 4: I should, of course have learned from my experiences with
Speaker 4: regard to Japan, where they'd already been running very large
Speaker 4: fiscal deficits. But at that time I hadn't really figured
Speaker 4: out that kind of secular stagnation and the kind of
Speaker 4: is the US turning Japanese was going to be the
Speaker 4: road path? It took me a little bit longer. I
Speaker 4: began to write about that towards the end of twenty twelve.
Speaker 4: Actually I began to figure out that actually that was
Speaker 4: probably a more likely template. I should have actually listened
Speaker 4: my old colleague out Albert Edwards from and he'd been
Speaker 4: telling me this for years, the US was turning Japanese,
Speaker 4: and I was like, yeah, whatever, its a great line,
Speaker 4: and it's the sun by the vapors. It's all cool.
Speaker 4: But I kind of just ignored him, and I really
Speaker 4: shouldn't have done, because it turns out he was spot off.
Speaker 3: We start to move over the course of that next decade,
Speaker 3: we didn't see the big contraction in the deficit as
Speaker 3: many people expected, and then, of course with COVID deficits
Speaker 3: blew out again and are significantly wider than you know.
Speaker 3: Twenty twelve was obviously a great time in retrospect to
Speaker 3: buy stocks. And if you just bought the sort of
Speaker 3: broad stock market in the US and twenty twelve and
Speaker 3: held to it today, you would have done quite well.
Speaker 3: If we decompose the returns over that last ten or
Speaker 3: eleven years, how much can we attribute to corporate profitability
Speaker 3: from the from those years to those stock returns.
Speaker 4: So yeah, I said, this is a really good way
Speaker 4: of framing it, and I think the way I tend
Speaker 4: to look at it don't have the decon right to hand.
Speaker 4: I have done it before, actually looking at the kind
Speaker 4: of drivers. But what I found is, by far and
Speaker 4: away the most important factor turned out to be valuation
Speaker 4: rather than profits. Profits were good, you know, they stayed high,
Speaker 4: but they did come down compared to the kind of
Speaker 4: absolute peak that we reached in twenty twelve. So profit
Speaker 4: margins and that kind of new levels of corporate profitability,
Speaker 4: although they didn't mean revert, they didn't continue to go up.
Speaker 4: And therefore the key driver of the performance that we've
Speaker 4: witnessed is actually been valuation and that I think is
Speaker 4: as Ever, here's the progostfication for you, of course, for
Speaker 4: concern right as a value based investor, when I see
Speaker 4: a market that is essentially being driven by multiple expansion,
Speaker 4: that makes me kind of nervous. And so yeah, the
Speaker 4: fact that margins didn't come down, but they didn't go
Speaker 4: up from twenty twelve actually kind of they came down
Speaker 4: a little bit, and they've stayed over that decade higher
Speaker 4: than they were historically, but they didn't rise from twenty twelve.
Speaker 4: They average. That I think tells you that the evaluations
Speaker 4: have been a massive part of this problem.
Speaker 1: Just setting aside valuations for a second, I mean, if
Speaker 1: we look at some of the fundamentals in the macro
Speaker 1: economy that might have boosted profits, one of the things
Speaker 1: in your equation is dividends, as you've laid out previously,
Speaker 1: And I think there are people out there who would
Speaker 1: argue that companies have gotten bigger, they've gotten more pricing power,
Speaker 1: maybe with monopolistic tendencies. Could that be genuinely boosting profitability.
Speaker 4: It's really fascinating. I think that the increasing dividends is
Speaker 4: certainly a noteworthy feature, right, Dividends in the last decade
Speaker 4: have indeed been significantly higher than they were over most
Speaker 4: of history. The causes of that, I think are also
Speaker 4: interesting to me. The fact that dividends have increased is
Speaker 4: really has to be combined with what happened to investment,
Speaker 4: because I think investment and dividends, as com buying, is
Speaker 4: a corporate payout decision. Right, you can either invest or
Speaker 4: you can pay dividends. Those are at a very crude level,
Speaker 4: those are your two options. And what we've seen over
Speaker 4: the last decade, compared to let's say the nineteen fifties onwards,
Speaker 4: investment roughly halved and dividends roughly doubled. And so you
Speaker 4: saw this switch in payout from a world in which
Speaker 4: corporates wanted to invest to a world in which corporates
Speaker 4: chose to distribute. Now to what extent that is driven
Speaker 4: by increasing concentration and monopolistic power, I think is a
Speaker 4: open question, and it's certainly one that I intend to
Speaker 4: return to. I did some work internally which I haven't
Speaker 4: published yet, but it's the next one in the or
Speaker 4: maybe sneak pre y later. Yeah, exactly. Yeah. Three, I've
Speaker 4: written like three papers that are now in the works.
Speaker 4: There's one more after that, which is going to be
Speaker 4: the one on monopoly, I think, and what I showed
Speaker 4: was monopoly can redistribute profits between corporates, but doesn't actually
Speaker 4: raise the absolute level of profits terribly much because what
Speaker 4: tends to happen is there are other offsetting factors. So
Speaker 4: I think these shift in the corporate payout policy is
Speaker 4: probably a function of monopoly. But it's not hugely surprising
Speaker 4: to me that when I combine investment and dividends and
Speaker 4: compare them over history, they haven't really as a pair
Speaker 4: driven this expansion of margins that we've seen, And so
Speaker 4: that fits very nicely with the work I've done, which
Speaker 4: again actually follows from Kleetski. It is such an amazing
Speaker 4: man and so important, and yet so few people know
Speaker 4: of him, Thank goodness. The odd lots listeners are a
Speaker 4: different breed. But you know, you walk around and there,
Speaker 4: why are you quoting some long dead Polish economists? And yeah,
Speaker 4: even worse from an American point of view, Yeah, he
Speaker 4: was associated with Marx. It's oh no, the end of
Speaker 4: the world is nigh. He talked to Rosa Luxembourg, this
Speaker 4: kind of thing. But he did a whole load of
Speaker 4: work on what he called the monopoly power and it's
Speaker 4: using some of his insights that I can now demonstrate
Speaker 4: in a very simple little model that actually monopolies do
Speaker 4: not rise the aggregate level of profits.
Speaker 3: Well, let me ask you another question, and it's sort
Speaker 3: of it's another thing that I remember we and by me,
Speaker 3: we I mean like sort of like you know, people
Speaker 3: who are like blogging ten years ago and trying to
Speaker 3: figure this stuff out. But another story that people told
Speaker 3: and maybe tell is that, Okay, you see these profit
Speaker 3: margins at extremely high levels, and that it represents some
Speaker 3: tilting of the balance between capital and labor. The labor's
Speaker 3: share of GDP has declined, or unionization or labor bargaining
Speaker 3: power has weakened steadily over the years. And you could
Speaker 3: put two lines on a chart, and unions are going
Speaker 3: down and profit margins are going up. Is there a
Speaker 3: zero sumness in this in terms of like how much
Speaker 3: is how much on your cruise to corporate province versus say,
Speaker 3: how much workers can get?
Speaker 4: Yeah, absolutely there is. And this was really what let's
Speaker 4: get again was talking about with his monopoly power theory, right,
Speaker 4: He was talking about exactly this issue, the distribution of
Speaker 4: the economic pie, if you like. He wrote a wonderful
Speaker 4: paper on the political aspects of full employment, all about
Speaker 4: why corporates don't actually want full employment, despite the fact
Speaker 4: that it would seem like a good idea because obviously
Speaker 4: the economy would be booming, everybody be spending, that would
Speaker 4: be trendous. But actually his argument was that corporates would
Speaker 4: really not like that because it would give exactly the
Speaker 4: point you raise their labor too much bargaining power. And
Speaker 4: I think one of the things that people have got
Speaker 4: wrong in the whole kind of inflation story that we've
Speaker 4: heard over the last few years is the kind of
Speaker 4: permanence and that whole team transitory versus team permanent and
Speaker 4: all this kind of thing. Yeah, to me, the big
Speaker 4: thing that really drives all of this is exactly the
Speaker 4: dynamic you're talking about, which is, do you have the
Speaker 4: conditions for a wage price spiral? And I have been
Speaker 4: unable to see any evidence of really significant, prolonged recapturing
Speaker 4: of labour's bargaining power. I think that that's absolutely true.
Speaker 4: This whole dynamic is really fascinating and massively integral to
Speaker 4: understanding what we are going through, what we've been through,
Speaker 4: and potentially the danger of forecasting in where we will
Speaker 4: be going. But it's to me that that distribution between
Speaker 4: labor and capital is really important, and it's tied in
Speaker 4: with monopoly, it's tied in with these kinds of issues
Speaker 4: we're talking about the profit margins. But the really nice
Speaker 4: thing about the Kalechi equation is that it sits above
Speaker 4: all of that and it frames it all. So I've
Speaker 4: described it as like Lord of the Rings. I'm a nerd.
Speaker 4: I love the Lord of the rings, and the Kaleki
Speaker 4: equation is kind of the one ring, right. It can
Speaker 4: bring all the others and bind them in the darkness.
Speaker 4: And so having that overarching framework is really useful. It
Speaker 4: allows us to understand what's been going on with profits
Speaker 4: and therefore think about what may happen with him in
Speaker 4: the future. And what you have really is if you'd
Speaker 4: seen a huge amount of corporate power relative to labor normally,
Speaker 4: that would lead to wage suppression, which indeed we have seen.
Speaker 4: You know, wages have certainly not kept up with productivity.
Speaker 4: And here I go being wrong again. In twenty eighteen
Speaker 4: I wrote a note called late cycle Lament, and here
Speaker 4: we are still in a late cycle and I use
Speaker 4: some work by another very very insightful economist, Launce Taylor,
Speaker 4: who sadly died a couple of years ago.
Speaker 2: Now.
Speaker 4: He showed how we could look at wage repression and
Speaker 4: the corporates had effectively been holding wages down relative to productivity,
Speaker 4: which I thought was a very interesting take on the
Speaker 4: kind of monopoly theme because it was to me less
Speaker 4: about monopoly power and the way we normally think about it,
Speaker 4: and that perhaps is more associated with the degreed flation
Speaker 4: story that we've heard more recently, which is corporates using
Speaker 4: their pricing power, but much more about what one would
Speaker 4: call monopsony, where it was more like you had a
Speaker 4: single buyer rather than a single seller of a product.
Speaker 4: In this case was the corporates were acting like a
Speaker 4: single buyer of labor and had squashed labor down. Now,
Speaker 4: it doesn't actually explain why over the last decade we've
Speaker 4: had high profit margins, because had they been squishing labor down,
Speaker 4: I would have expected household savings to have to decline,
Speaker 4: But by freak of accident, in the sample that I
Speaker 4: looked at, it turned out that household savings had been
Speaker 4: exactly the same. Now, some of that is driven by COVID,
Speaker 4: because obviously it was a huge spike in household savings
Speaker 4: during COVID, but some of it is not quite adequately
Speaker 4: represented by the average of the floor of averages, if
Speaker 4: you like. But in between these two samples, at least
Speaker 4: the nineteen fifties to twenty twelve and then twenty twelve
Speaker 4: and afterwards, we know that household savings haven't been the
Speaker 4: big engine or be by by happenstance. I don't think
Speaker 4: I wouldn't draw any conclusion by their equality in those
Speaker 4: two samples. I think they've been driven by some pretty
Speaker 4: unusual things, but we know they're not the cause of
Speaker 4: the big surge in margins that we saw.
Speaker 1: Yeah, I remember monopsonly was like a big yeah topic.
Speaker 1: I think it was the twenty eighteen Jackson Hall and
Speaker 1: Kolleki to some extent as well. Okay, so it makes
Speaker 1: me kind of wonder whether they're going to talk about
Speaker 1: profit led inflation this year. But anyway, setting aside Kaleki
Speaker 1: and monopolies, which we've been talking a lot about, can
Speaker 1: we talk a little bit more about just big government spending.
Speaker 1: Because of course, there was another very famous economist who
Speaker 1: talked about the potential for this sort of big government moment.
Speaker 1: Are we there?
Speaker 4: Absolutely? I think we are there, And you quite rightly
Speaker 4: allude to Minsky, who interestingly was a follower of Koletski,
Speaker 4: and so there is a lovely intellectual heritage fowing through
Speaker 4: these guys. And Minsky was yet absolutely a proponent of
Speaker 4: the financial instability hypothesis, which we all know and love,
Speaker 4: but also he was a big proponent of the need
Speaker 4: for big government, and he framed big government as really
Speaker 4: a more like a job guarantee scheme, which is not
Speaker 4: what we've seen, but we have as far as at
Speaker 4: least the data suggests, had an era where government spending
Speaker 4: has been considerably higher than anything we've seen before. And
Speaker 4: so yeah, I think Huiott Minsky wrote a book called
Speaker 4: Can It Happen Again? And he was referring to the
Speaker 4: Great Depression, and that book is really all about making
Speaker 4: sure it doesn't happen again. And one of his takeaways was,
Speaker 4: in the event of a private sector shutdown, as there
Speaker 4: was in the Great Depression, the only thing that can
Speaker 4: happen to offset that has to be government spending. And
Speaker 4: I think with the GFC, with COVID, we have seenments
Speaker 4: do exactly that. They really added Japan's base. For a
Speaker 4: very long time, we've seen governments do that, and so
Speaker 4: we've seen this era of big government actually and big
Speaker 4: government spending actually arrive. How long it lasts, as I
Speaker 4: confessed to the paper, I have no idea, but it's
Speaker 4: certainly there right now.
Speaker 3: Well, you know, so much government spending in the US
Speaker 3: is entitlement spending. And it seems like there's no imminent
Speaker 3: prospect of some meaningful change in social security payouts or
Speaker 3: in the change of trajectory, no iminent prospects of the
Speaker 3: change of trajectory of healthcare spending. We have a society
Speaker 3: that's getting older. It's doubtful that there's going to be
Speaker 3: any change in defense spending. There's not even that much
Speaker 3: appetite on the discretionary side, nor does it seem that big.
Speaker 3: Something I've wondered about is like, does this provide a
Speaker 3: sort of cushion of stability, as sort of like cushion
Speaker 3: of sort of macro stability and perhaps profits to ability
Speaker 3: That there is this huge chunk of spending, it's every
Speaker 3: year and guaranteed, and there's almost no political appetite to
Speaker 3: make it go down.
Speaker 4: Yeah, absolutely right. You'll get some conservatives to tear their
Speaker 4: hair out that prospect of government intervention. And any number
Speaker 4: of them are interestingly fellow value investors, and I obviously
Speaker 4: missed the kool aid on that one, but they all
Speaker 4: get really hot into the collar about government spending. As
Speaker 4: an old lefty, I tend not to, but yeah, I
Speaker 4: think you're right. The big government is inherently a kind
Speaker 4: of prerequisite for stabilizing an inherently unstable system. And that's
Speaker 4: exactly what Minsky was alluding to, right. He said that
Speaker 4: big government must be big enough to ensure that swings
Speaker 4: in private investment lead to sufficient offsetting swings in government
Speaker 4: deficits so that profits are stabilized, and that was his
Speaker 4: guiding concept right now. He thought you could best do
Speaker 4: that with a job guarantee. Well, yeah, that's been talked
Speaker 4: about in universal basic income and all these other concepts
Speaker 4: get talked about, but the reality is it's been implemented
Speaker 4: in a very different way. But it's there. And as
Speaker 4: you say, it's kind of hard to imagine given the
Speaker 4: state of politics, it's kind of hard to imagine that's
Speaker 4: going to change anytimes too.
Speaker 1: You mentioned value investing just there, And of course we
Speaker 1: would be very remiss if we didn't ask you about
Speaker 1: what's going on there, because we've seen these headlines for
Speaker 1: a while now, the death of value investing, the idea
Speaker 1: that everything nowadays seems to be fueled by momentum. I
Speaker 1: wrote a story just recently about how all the most
Speaker 1: terrible stocks and assets, all the things that people were
Speaker 1: saying were overvalued for a long time, stuff like Tesla, Netflix,
Speaker 1: some long duration bonds, those are all surging once again.
Speaker 1: Is there any value to be found in value investing nowadays?
Speaker 4: I really hope. So if there isn't, then I better
Speaker 4: retire and GMO along with me. I think there is,
Speaker 4: because we know that the market's Howard Marx always puts
Speaker 4: it really well right, that the markets swing on pendulums,
Speaker 4: from the euphoria to despair and back again. And you know,
Speaker 4: go back a year and we had what my colleague
Speaker 4: Beninca delightfully called jomo. So rather than the fomo, the
Speaker 4: fear of missing out, we had the joy of missing out. Finally.
Speaker 4: You know, all the crap that had gone up didn't
Speaker 4: and some of the stuff we owned actually went up.
Speaker 4: But it was like yes, and now we're back to
Speaker 4: the other world. And so our JOYMO was very short lived.
Speaker 4: And GMO we have experienced any number of these horrific
Speaker 4: experiences where in the long term you can be right
Speaker 4: and in the short term utterly wrong. And that's an
Speaker 4: incredibly painful thing. And it's why value investing is so hard,
Speaker 4: because you can sit there, you can do your work,
Speaker 4: you can kind of gather your intrinsic value, you know
Speaker 4: what fair value, if you like, should be, and then
Speaker 4: mister market turns up and decides, yeah, he's in a
Speaker 4: manic phase today and so ignores any kind of anchor
Speaker 4: of valuation right up until he doesn't, and suddenly he
Speaker 4: wakes up one day and decides he does. And the
Speaker 4: problem is you never know when that is, and that
Speaker 4: kind of that's the classic uncertainty of It's what makes
Speaker 4: being a value investor so hard. Right, If that wasn't there,
Speaker 4: I guess everyone will be a value investor and value
Speaker 4: presumably wouldn't work. But because there is this collective madness
Speaker 4: of crowds experience. Joe, you mentioned AI right at the start.
Speaker 4: Will that be the next bubble? Yeah? Yeah, God only knows, right,
Speaker 4: it's got all the hallmarks of it. It's a technical,
Speaker 4: technological innovation that gets everybody excited historically that that's kind
Speaker 4: of classic bubble breeding territory it could be. And sorry, go.
Speaker 3: Ahead, well no, just to play Devil's advocate for a second.
Speaker 3: I mean, obviously, the twenty tens were this extraordinary decade
Speaker 3: for big tech, and maybe we're good, you know, big
Speaker 3: tech is raillyant again lately, but this handful of big tech.
Speaker 3: But the other thing about that decade is it's not
Speaker 3: just that those stocks did well. Those companies did really well.
Speaker 3: And Amazon and Google and all these names were far
Speaker 3: more profitable in twenty nineteen than I think people in
Speaker 3: twenty twelve would have guessed about where they'd be in
Speaker 3: twenty nineteen. I mean, they really did do extraordinary well
Speaker 3: from like a business and profit standpoint, So I mean,
Speaker 3: setting aside you know, valuations and multiples, the companies did
Speaker 3: do really well and captured a huge share of that
Speaker 3: overall corporate profits. And so right, I mean, and so
Speaker 3: like there's other so like I don't know when you
Speaker 3: look now at once again people piling back into these names,
Speaker 3: and QQQ not really that far off from its high,
Speaker 3: Like what is the is there some reason why that
Speaker 3: can't be sustainable? And and I guess to you know,
Speaker 3: it's like if we already sort of stipulate too that
Speaker 3: there's sort of one source of profits, which is government deficits,
Speaker 3: does not seem to be going away, Like what changes
Speaker 3: this current environment?
Speaker 4: Yeah, I think the thing with those kind of companies
Speaker 4: is we go back to that that kind of beauty
Speaker 4: of the Macroft framework.
Speaker 2: Yeah.
Speaker 4: They succeeded by eating everybody else's lunch. Yeah, right, They
Speaker 4: turned from I guess, you know, the weedy little kid
Speaker 4: to the huge jock who is wondering around thumping the
Speaker 4: weedy kid, and say I'm going to have your lunch
Speaker 4: money and your dinner money and your breakfast money as well.
Speaker 4: And that's how they won. Right, They did exceptionally well
Speaker 4: and far better than I think, You're right pretty much
Speaker 4: anyone would have said. The problem is I think that
Speaker 4: you at some point you run out of people to bully,
Speaker 4: and you run out of the playground. Images everybody graduates,
Speaker 4: and what happens then, well, your job is your jock
Speaker 4: bully is suddenly not quite so comfortable anymore. And when
Speaker 4: you then put a kind of continued growth multiple on
Speaker 4: those kinds of guys. That gets hard. You know, it's
Speaker 4: not hard to grow fast when you're really small, it's
Speaker 4: really hard to grow fast when you're really big. And
Speaker 4: that's I think always the challenge. It's that kind of
Speaker 4: growth callding growth torpedos right where people's expectations are so extreme,
Speaker 4: and the pricing of some of those stocks, not all
Speaker 4: of them by any means, but some of them is
Speaker 4: really extreme in terms of their implied growth for the future.
Speaker 4: You kind of have to scratch your head and go,
Speaker 4: where the hell is that coming from? You know, how
Speaker 4: much more advertising can alphabet really take over? How many
Speaker 4: more businesses can Amazon completely disrupt? And maybe they will, right,
Speaker 4: there will be winners, and maybe those guys are the
Speaker 4: ones that will win. But the market is pricing it
Speaker 4: as if that is an absolute certainty, and that always
Speaker 4: kind of an anytime anyone said it for sure about anything,
Speaker 4: I tend to kind of get a little nervous because
Speaker 4: I'm not even sure I exist, let loan anything else.
Speaker 4: All I know, I could be a brain in the jar,
Speaker 4: in which case I clearly lack inventinations.
Speaker 1: This is getting very existential.
Speaker 4: Yeah, right, but it's it is possible, right, and that
Speaker 4: that to me is that absolute certainty is concerned. I
Speaker 4: think it was Voltaire who said to live in doubt
Speaker 4: is unpleasant, to live in certainty is absurd, and that
Speaker 4: that that's always been my byline. Right.
Speaker 1: So we've been very focused on the US market and
Speaker 1: the idea of American stocks being priced to perfection. But
Speaker 1: of course America is not the only market out there.
Speaker 1: And I was reading just before we came on. Actually, actually, Joe,
Speaker 1: did you know there's more than half of Japanese companies
Speaker 1: trade below book value?
Speaker 2: You didn't know.
Speaker 4: I knew that.
Speaker 3: Like Japanese stocks, I think they've been doing well.
Speaker 2: I didn't know.
Speaker 1: Yeah, so they were undervalued for a long time and
Speaker 1: then this year there suddenly seems to be renewed interest.
Speaker 1: But James, to your point about value investing, is the
Speaker 1: implication here that maybe investors should be looking to non
Speaker 1: US markets?
Speaker 4: Yeah, absolutely, I think there's a couple of things people
Speaker 4: can do within the US. If you've got to be
Speaker 4: in the US. There is some stuff that's cheap, right,
Speaker 4: The really deep value, the stuff that the nobody wants
Speaker 4: to own, does actually look really compellingly achieved to US
Speaker 4: but outside of the US, I think you can do
Speaker 4: so much better. I mean, if you look at Funny
Speaker 4: you mentioned Japan, you're absolutely right about half the stocks
Speaker 4: below book. But so here's another plug. Not the next note,
Speaker 4: but the note after that is on Japan, and it's profitability.
Speaker 4: Oh yeah, one day I'll get around to punt. Then
Speaker 4: they're all just waiting to be published now. And in
Speaker 4: there I looked I did a similar analysis to the
Speaker 4: one that we've talked about today the Japan. I won't
Speaker 4: drive on that now, but chart to me was when
Speaker 4: I looked at EV to ebit DA in the US
Speaker 4: versus Japan. So in the US, you've got the US
Speaker 4: market trading on nearly fourteen times to ebit DAR. In
Speaker 4: Japan the market is trading on like five times EV
Speaker 4: to ebit. So Japan is certainly with any kind of
Speaker 4: measure that looks at anything that concerns balance sheet based analysis,
Speaker 4: Japan looks compelling. It too has had a profitability surge,
Speaker 4: now not to do the same levels as the US,
Speaker 4: but it has had this ongoing profitability surge. But I
Speaker 4: think interestingly, in Japan's case, it actually looks kind of
Speaker 4: very sustainable because it has a lot to do with
Speaker 4: de leveraging and therefore kind of more cash flow flowing
Speaker 4: through to the bottom line. You've basically had this long
Speaker 4: battle between the holders of debt and the holders of equity,
Speaker 4: and the holders of debt have been taking a lot
Speaker 4: of Japan's cash flow. Now that Japan hass de levered,
Speaker 4: which has been going on since the early nineteen nineties,
Speaker 4: you've I've got a situation where that cash flow is
Speaker 4: flowing through to the bottom line, and Japan therefore looks
Speaker 4: like it is a market where we have kind of
Speaker 4: increased profitability and low valuations. You know what's not to
Speaker 4: like there? And if you're if you're a really brave
Speaker 4: value investor, go play an EM. I mean, nobody, nobody
Speaker 4: in their right mind wants to talk about EM. And
Speaker 4: we know that social pain, the pain of being excluded,
Speaker 4: being ostracized and ridiculed, is felt in the brain in
Speaker 4: the same parts as real physical So being a value
Speaker 4: investors like having your arm broken on a regular basis,
Speaker 4: which ain't fun, right, That's why most people don't do it.
Speaker 4: But EM looks amazingly cheap, like the bad news is
Speaker 4: so in the price, and so I think there really
Speaker 4: are some some amazing opportunities around the world.
Speaker 3: When you publish the other day, when you publish your
Speaker 3: notes on these, can you put the Can you provide
Speaker 3: the colletch Levy equations for these? Because I always see
Speaker 3: it for the US, and I never see people make
Speaker 3: them for Japan, just as a p no request for
Speaker 3: If I can put in a like a request, like
Speaker 3: a request for the dj please make a series of
Speaker 3: charts showing these same things for other countries, because I
Speaker 3: only ever see people make it for the US.
Speaker 4: Really done, I promise you when when the Japan note
Speaker 4: comes out there, it'll be there right right up front
Speaker 4: for you.
Speaker 2: Great.
Speaker 1: We'll have to collate them all and publish them on
Speaker 1: the odd Lots website. I just saw a headline go
Speaker 1: by It says Pakistan gets no bids for fifteen, twenty
Speaker 1: and thirty year bonds. So you know, to James's point,
Speaker 1: if you want to run away from the herd, it
Speaker 1: does seem like parts of em are the place to go.
Speaker 1: At the moment, James, we're going to have to leave
Speaker 1: it there. But really appreciate you coming on. That was
Speaker 1: so much fun.
Speaker 4: Oh my pleasure. Thank you so much for having me guys, Yeah,
Speaker 4: get a bluff.
Speaker 2: That was a blast, James. We'll have to have you back.
Speaker 2: Thank you so much, Joe.
Speaker 1: I love having a self described old lefties employed at
Speaker 1: large asset managers on the show. It's so much fun.
Speaker 2: There are some of my favorite people to talk to
Speaker 2: you about. That was really good. I mean, I really
Speaker 2: enjoy it.
Speaker 3: Like I think we've both been reading James's stuff for
Speaker 3: several years and hearing him sort of like put together
Speaker 3: his way of thinking some of the mistakes. He's got
Speaker 3: the opportunities right now to look really good.
Speaker 1: The introspection, I think is really important because you do
Speaker 1: see people make these big calls and kind of gloss
Speaker 1: over mistakes they've made in the past. And really it's
Speaker 1: not about you know, schadenfreude or pointing fingers at people
Speaker 1: who got stuff wrong. It's about trying to understand the
Speaker 1: way we were thinking of things in twenty twelve and
Speaker 1: what happened differently to make those thesis, to make those
Speaker 1: theses not applicable.
Speaker 3: I do think that almost everyone in every dimension assumes
Speaker 3: some level of mean reversion right from everything right, tech
Speaker 3: versus value, deficits, labor versus capital, et cetera. So you
Speaker 3: see something at the high end of some range of
Speaker 3: a chart, you make some chart on Bloomberger, you make
Speaker 3: some chart on Fred and the numbers at the top
Speaker 3: and you say, Okay, it's going to go down. And
Speaker 3: so like, looking back, it's like, well, why didn't it
Speaker 3: go down? Why did it go up even further? Is
Speaker 3: really interesting and it sort of you know, as he puts,
Speaker 3: it makes you humble about your guests for the next
Speaker 3: ten years.
Speaker 4: Early. Yeah.
Speaker 1: Well, also James's point about maybe we are in the
Speaker 1: era of big government spending. I mean, that's a big
Speaker 1: point to make. But beyond that, the idea that that
Speaker 1: might not necessarily be good for shareholder returns is really
Speaker 1: counterintuitive to the way a lot of people think about it,
Speaker 1: because one of the big criticisms of government spending is like, oh,
Speaker 1: you're just you know, inflating corporate profit margins. And this
Speaker 1: is why there are some investors out there who like
Speaker 1: to talk about, you know, big infrastructure programs and things
Speaker 1: like that. But James made the point that that might
Speaker 1: not actually lead to a good return.
Speaker 2: Right, I'd like the knock on other value investors.
Speaker 3: This is like, don't you know where our profits are
Speaker 3: coming from dog you know what drives corporate profitability?
Speaker 2: And yeah, that's great stuff.
Speaker 1: All right, shall we leave it there.
Speaker 2: Let's leave it there.
Speaker 1: This has been another episode of the Odd Thoughts podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal. You can follow me on Twitter
Speaker 3: at the Stalwart. Follow our producers Carman Rodriguez at Carman
Speaker 3: Arman and Dashel Bennett at Dashbot. And check out all
Speaker 3: of our podcasts at Bloomberg under the handle at podcasts.
Speaker 3: And for more odd Lots content, go to Bloomberg dot
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Speaker 3: listening it
Speaker 1: In