Speaker 1: John, Hello, morning, Melton. There's so much to talk about.
Speaker 1: I don't know where to start, and really importantly, so
Speaker 1: much to talk about in areas where you and I
Speaker 1: have just been right.
Speaker 2: That's always the best idious to talk about. I feel.
Speaker 1: I know, I know now you've written and we're not
Speaker 1: going to talk about this. I just want to write
Speaker 1: down a market so everyone knows that we were right.
Speaker 1: You've written about the Japanese equity market today, and you
Speaker 1: and I have been talking for a while about her.
Speaker 1: Japanese equity is farty, cheap, everything's changing. When I say well,
Speaker 1: I mean it really a very long while. And finally
Speaker 1: they've broken through what our old friend Jonathan Allen mused
Speaker 1: to call the iron coffin lid, which means that the
Speaker 1: only way is up right, just say yes, because we're
Speaker 1: all going to talk about this. They can go and
Speaker 1: read Money Distilled and read all about it there. Your
Speaker 1: job is just to say yes, yes, excellent. The thing
Speaker 1: I really want to talk about today is the other
Speaker 1: thing that you and I have been writing about for
Speaker 1: a long time. We've been writing about her. Nobody understands
Speaker 1: how widely spread read the tax burden is in the UK,
Speaker 1: so we read you and I how many years ago
Speaker 1: now we read an article I think in the New
Speaker 1: York Times about fourteen twenty fourteen, because we also have
Speaker 1: good memories, which is important to rather. You have a
Speaker 1: good memory, and sometimes you remind me about stuff we've
Speaker 1: talked about in the past, and we've read this article
Speaker 1: which we thought was absolutely amazing because it explained the
Speaker 1: fluidity of income earning in the US and how over
Speaker 1: a lifetime people are sometimes in the bottom quintile of earning,
Speaker 1: sometimes in the top quintile of earning, often in the
Speaker 1: middle quintiles, et cetera. But seventy six percent of people,
Speaker 1: according to the study, passed through the top quintile of
Speaker 1: income generation in the US at least once during a career.
Speaker 1: And you know what the top quintile income in the
Speaker 1: US is.
Speaker 2: As you know, it's on my head.
Speaker 1: No, luckily I do. Back when back when the article
Speaker 1: was written, it was was slightly lower, but it's now
Speaker 1: about to two hundred and sixty nine thousand dollars, or
Speaker 1: that was the number last year. So that mean seventy
Speaker 1: six percent of income tax paying workers in the US,
Speaker 1: at some point during a year earn around two hundred
Speaker 1: and seventy thousand dollars. Absolutely amazing and a great testament
Speaker 1: to the meritocracy and fluidity of the US economy. Now,
Speaker 1: everybody thinks that that is not the case in the UK,
Speaker 1: right So when we had all this stuff up from
Speaker 1: the IFS this week explaining that in a couple of years,
Speaker 1: twenty percent of income tax paying workers in the UK
Speaker 1: would end up in the forty percent bracket, everyone went, oh,
Speaker 1: my god, that's awful twenty percent of people. And you
Speaker 1: and I thought back, and we remembered that article that
Speaker 1: we'd read, and we thought, twenty percent people is the
Speaker 1: bottom band there, because in fact there'll be fluidity in
Speaker 1: the UK economy as well. Incomes are not static, particularly
Speaker 1: in the private sector. They move around the place all
Speaker 1: the time. You can sometimes be in a lower bracket,
Speaker 1: you can sometimes be in a higher bracket. Let's go
Speaker 1: back to the quintiles move around the place inside these
Speaker 1: going to us. And what we didn't know though, is
Speaker 1: exactly what those numbers might look like in the UK.
Speaker 1: And now I'm handing out to you because one of
Speaker 1: our brilliant colleagues at Bloomberg pointed us to some ons
Speaker 1: data which gave us some clues.
Speaker 2: Right, Yeah, So Conrad in the office very kindly dugout
Speaker 2: this particular port called income dynamics. I think is that
Speaker 2: the name of the report, and it's often I mean,
Speaker 2: it's nowhere on there is granular. I think that was
Speaker 2: an academic study that the US was referencing, and so
Speaker 2: that I had actually gone through an entire lifetime. But
Speaker 2: even looking at just ten years, what this study found
Speaker 2: was that while people in the top quin title in
Speaker 2: twenty ten were more likely to stay there for the
Speaker 2: whole time, between twenty ten and twenty twenty, you still
Speaker 2: found just basically half of them weren't there by the
Speaker 2: time that the decade ended. You also found that more
Speaker 2: than half the people who started in the bottom quint
Speaker 2: title had then moved out of it by the time
Speaker 2: that kind of decade ended. And in the middle there's
Speaker 2: virtually there was just a lot of moving about, so
Speaker 2: people were in the second and then the third, and
Speaker 2: then the fourth and vice versa. So the point isn't
Speaker 2: so much that, and I mean there are specific kind
Speaker 2: of statistics and money distilled from earlier this week, but
Speaker 2: the point is that, yes, there is a lot of
Speaker 2: income fluidity here too, and there might not be as
Speaker 2: much as the US. In fact, I'd be astonished if
Speaker 2: there is as much as in the US, because obviously
Speaker 2: the US is the kind of kreme de la creme
Speaker 2: of meritocracy and kind of capitalist dynamic and all that
Speaker 2: sort of stuff. But it's very clear that, as you said,
Speaker 2: the idea that twenty percent of income tax payers will
Speaker 2: be paying forty percent tax is a very low bar estimate.
Speaker 2: And I would wager that the majority of work use
Speaker 2: as in more than half will pay forty percent income
Speaker 2: tax at some point during their careers. And I think
Speaker 2: that the important thing about that is that it should
Speaker 2: make us think about this differently. I mean the one
Speaker 2: actually that I pick up on and I think we
Speaker 2: should discuss this another time, But we're always talking about
Speaker 2: who you know, maybe tax relief on pensions is skewed,
Speaker 2: and two it should be done differently. But the thing is,
Speaker 2: if there are points in most people's careers where they
Speaker 2: are forty percent tax payers, those are also the times
Speaker 2: in their lives where they're going to be wanting to
Speaker 2: put away as much as possible for their pensions. So
Speaker 2: perhaps this idea kind of flattening the tax releaf and pensions,
Speaker 2: isn't such a good idea and not is it actually
Speaker 2: particularly fair, particularly in anyone who has yet to be benefit
Speaker 2: from that tax relief. That's slightly separate issue.
Speaker 1: Well, I think I just pick up that one quickly.
Speaker 1: Oh yeah, I obviously I agree with you on everything,
Speaker 1: and I particularly agree with you on this, and it's
Speaker 1: one of the main reasons why I feel that the
Speaker 1: annual allowance is the problem, that the lifetime allowance was
Speaker 1: never the problem. The problem is the annual allowance because
Speaker 1: as soon as people get to a point, which as
Speaker 1: it turns out, more people than you think do, get
Speaker 1: to their few high earning years, those are the years
Speaker 1: when they're then told they're not allowed to contry be
Speaker 1: very much into a pension. And that's where the problem comes,
Speaker 1: you know. So it's the whole system is set up
Speaker 1: with the belief that politicians have because most politicians cannot
Speaker 1: see be on the end of their own noses, they
Speaker 1: believe that everybody's income is like there's the same every year.
Speaker 1: Because anyone who works in the public sector will, particularly
Speaker 1: as an MP, because you don't get promoted or demoted
Speaker 1: outside going in and out of the cabinet, right, their income,
Speaker 1: bar a little inflation adjustment, remains static year after year
Speaker 1: after year, and they make policies for that situation, not
Speaker 1: for the situation which these these numbers that we're looking
Speaker 1: at show most people on or in.
Speaker 3: See.
Speaker 1: I'll give you wyes.
Speaker 2: Think that's an interesting point. The one thing I would
Speaker 2: say is I just query slightly whether they have that excuse,
Speaker 2: because I mean.
Speaker 1: You're too nice to have I been too nice.
Speaker 2: I mean, career politicians may have a sort of static income,
Speaker 2: but I mean, you know, every four years they run
Speaker 2: the risky getting thrown out in their backsides and then
Speaker 2: they don't have anything. And then also there's all the
Speaker 2: ones who you know, quite rightly in my view, kind
Speaker 2: of make money on the side. So in a funny
Speaker 2: kind of I think they should be more used to,
Speaker 2: you know, ups and downs in their their annual income
Speaker 2: than so I'm not sure that they have the excuse
Speaker 2: that I could see if they want normal public sector workers,
Speaker 2: you know, because there's like pay grades and bands and
Speaker 2: all that sort of stuff, and it generally is kind
Speaker 2: of matter, you know, as long as you stay in work,
Speaker 2: you go up the way. But with politicians, they have
Speaker 2: a much more volatile career path if they're at all
Speaker 2: I mean, if they're at all ambitious. So it just
Speaker 2: strikes me that actually, I'm not sure they have that excuse.
Speaker 1: Well, they're just making crap then anyway, that was that
Speaker 1: was a sign. Where were you actually going with this conversation?
Speaker 2: I have totally forgotten already, But no, I think it's
Speaker 2: it's this thing of well, actually, the other interesting about
Speaker 2: this politically is that I do think that people will
Speaker 2: start to notice because it's been popular to talk about taxing,
Speaker 2: you know, the rich and then throwing income at a
Speaker 2: certain level in as being the rich, and the more
Speaker 2: people who get hit by higher rate tax not to
Speaker 2: mention kind of horrendous kind of marginal tax rates as
Speaker 2: child benefits, withdrawing, etc. The less likely that charge is
Speaker 2: to stick.
Speaker 1: I mean.
Speaker 2: One of the things that I thought was interested and
Speaker 2: quite clever about the way the IFS publicized this is
Speaker 2: they made the point that in the early nineteen nineties,
Speaker 2: virtually no nurse toll was paying forty percent tax, and
Speaker 2: by twenty twenty seven, some poate one in eight of
Speaker 2: them will be paying twenty percent. One in four teachers
Speaker 2: almost like I mean like well over our third to
Speaker 2: police officers.
Speaker 1: Yeah, but that's at one static point. Yeah, exactly, Many
Speaker 1: many more of them will move through this rate over
Speaker 1: their careers. And that's the key thing. The point that
Speaker 1: we're desperately trying to get across to everybody is that
Speaker 1: it might be one in four policemen in two years
Speaker 1: if you if you take a static point, but it'll
Speaker 1: be many, many, many more of a career. So this
Speaker 1: explains why, and this is really important listen our politicians.
Speaker 1: This explains why electorates are generally against the top rate
Speaker 1: of taxes going up, because they know that there's a
Speaker 1: very strong chance that they're going to pay that rate
Speaker 1: of tax at some point, and it's going to be
Speaker 1: in the one or two years when they suddenly go,
Speaker 1: oh wow, I'm really earning now. Someone else took everything.
Speaker 2: Yeah, it's yeah. They should learn that and they're going.
Speaker 2: I mean the point thing that worries means they'll learn
Speaker 2: the wrong lesson and they'll decide to just shunt a
Speaker 2: load of tacks when it's something else and make our
Speaker 2: lives miserable that way. But yes, I think the focus
Speaker 2: needs to fall on how do we make more money? Overall,
Speaker 2: how do we grow the pie again rather than sitting
Speaker 2: kind of you don't threaten about saving bets here and
Speaker 2: there and cutting this and cutting that, and all of
Speaker 2: that kind of goes back to we should have a
Speaker 2: smaller state, et cetera, et cetera, regulation, you.
Speaker 1: Know, and that we had horrible productivity numbers. Again today,
Speaker 1: focus on growing, focus on productivity read money to stilled
Speaker 1: by the way, because there's also some bits and bobs
Speaker 1: in there. There's a growing body of anecdotal evidence at
Speaker 1: least that people are virting with their feet and wealth
Speaker 1: creators are beginning to leave the UK for warmer climbs
Speaker 1: in every possible way. So that's very important. I just
Speaker 1: want to leave you with these numbers again. We've told
Speaker 1: you them before, but in this podcast, but listen again.
Speaker 1: You think that in the UK the rich of the
Speaker 1: rich and the poorer the poor, But in this quintear
Speaker 1: data we've been looking at over the ten year period,
Speaker 1: nearly fifty percent of those in the top quartile at
Speaker 1: the beginning were not there at the end, and over
Speaker 1: sixty percent of those who are in the bottom quartile
Speaker 1: at the beginning were not there at the end. The
Speaker 1: rich are not the rich and the poor are not
Speaker 1: the poor. There's a lot of fluidity in the UK,
Speaker 1: right John.
Speaker 2: Yep, it's not all lost, and you know.
Speaker 1: Maybe the US is better, but I wonder I'd really
Speaker 1: like to have proper data on this right.
Speaker 2: Hopefully somebody out there listening right now is the start
Speaker 2: offices or a university somewhere. You might have this data.
Speaker 2: You might be looking at it.
Speaker 1: Send it to us, Send it to us. Put your
Speaker 1: political prejudices aside one at universities, send us the data.
Speaker 1: Welcome to Merendalk's Money, the podcast in which people who
Speaker 1: know the markets explain the markets. I'm Meren sum Set
Speaker 1: where this week a conversation with Sharon Bell, Managing director
Speaker 1: and senior European equity strategist at Goldman Sachs. Yes, our
Speaker 1: first guest from Goldman Sachs. Sharon, thank you so much
Speaker 1: for joining us today. We hugely appreciate it.
Speaker 4: Thank you, Thanks for in fighting me kind.
Speaker 1: Of come now listen. I want I know, I know
Speaker 1: that you're basically one of those rare guests we have
Speaker 1: who knows absolutely everything. And you know, I could ask
Speaker 1: you about any market around the world and you'd know
Speaker 1: the answer. So what I'd like to do, if you
Speaker 1: don't mind, and I think that their listeners will love this,
Speaker 1: is just start by saying, could you give us an
Speaker 1: overview the huge question right an overview of global markets
Speaker 1: at the moment? What is going on out there, what
Speaker 1: are the main dynamics bind market moves, and what should
Speaker 1: we be looking at.
Speaker 4: I will tell you everything, But in some ways I
Speaker 4: think global markets is surprised people this year.
Speaker 3: On the positive side, a lot of investors expected weaker
Speaker 3: returns this year. We've had pretty strong returns actually, especially
Speaker 3: in Europe, double digit returns for a lot of indices
Speaker 3: already and we're not even halfway through the year. And
Speaker 3: the US market as well, especially the NASDAK, but the
Speaker 3: S and P five hundred as well up to year
Speaker 3: to date, so reasonably good returns on equities, and particularly
Speaker 3: given all the things that actually face interest rates have
Speaker 3: been rising, commodity prices have come down, growth has definitely slowed,
Speaker 3: orbit not in recession yet, so in some ways I
Speaker 3: would say the market's been quite resilient so far this year.
Speaker 3: And then on top of all of that, we've had
Speaker 3: all the stress in the US banks with some bank failures, etc.
Speaker 3: And concerns about slowing a loan growth as well. But
Speaker 3: I guess the things that have really boosted the market
Speaker 3: and helped the market, especially in Europe, which is my
Speaker 3: focus is energy, is gas prices weren't as high as
Speaker 3: people feed worried about coming into this year.
Speaker 4: They came down.
Speaker 3: That's how the consumer, it's how governments as well, hell,
Speaker 3: because they promised to cushion the consumer from higher prices. Also,
Speaker 3: the contagion, the feared contagion from the bank stress in
Speaker 3: the US hasn't been as bad yet as feared.
Speaker 4: Of course that could come.
Speaker 3: But at the moment we've only seen a small tightening
Speaker 3: and credit conditions and a small fall in loan growth.
Speaker 3: So I'd say that markets have digested things relatively well.
Speaker 3: But our main concern for the equity market at the moment,
Speaker 3: particularly in the US, is that it's not cheap. It
Speaker 3: trades on a pe ratio of sort of eighteen to
Speaker 3: nineteen times, that's about its twenty year average. And of
Speaker 3: course there is now another asset class out there which
Speaker 3: is quite attractive, offering you four or five percent yield,
Speaker 3: and that's short term rates.
Speaker 4: Given where interest rates are now.
Speaker 3: So I would say resilient, but a little bit mixed,
Speaker 3: and we do have and that returns will be low
Speaker 3: from here.
Speaker 1: Yeah. So basically when you say resilient, what you mean
Speaker 1: is it's too resilient, it's scarily resilient. Something doesn't feel
Speaker 1: quite right. I mean, last year, we had this sense
Speaker 1: that we were going to revert to some kind of
Speaker 1: valuation norm and possibly you know, profit margins were going
Speaker 1: to revert to some beginning to revert some kind of
Speaker 1: historical norm as well, and that that was something that
Speaker 1: we'd see going through into this year. And some of
Speaker 1: that didn't happen this year. Instead, we've seen a reversion
Speaker 1: back to the dynamic of the last few years, the
Speaker 1: prove twenty twenty two years, as opposed to a continuation
Speaker 1: of the dynamic of twenty twenty two. Very unexpected.
Speaker 3: Yes, I'd say that's probably fair in a number of senses.
Speaker 3: One in the sense that great expectations have started to
Speaker 3: come down, so that twenty twenty two was very characterized
Speaker 3: by high inflation, inflation constantly surprising on the upside, economists
Speaker 3: had to let go of this idea that it was transient.
Speaker 3: It turned out that inflation was very sticky. Last year,
Speaker 3: our interest rates had to go up and were constantly
Speaker 3: rising above people's expertsations. So while this year, I think
Speaker 3: a big boost equities in many ways has been the
Speaker 3: expectation that interest rates will be peaking.
Speaker 4: We in fact, do you think that interest rates have
Speaker 4: peaked now in the US at the short end.
Speaker 3: Where we differ, I think from the consensus is that
Speaker 3: we don't expect them to come down very rapidly, so
Speaker 3: we think rates will plateau for a period of time.
Speaker 3: But yes, you're right, it's been very resilient, and maybe
Speaker 3: overly resilient, not reflecting some of the risks out there,
Speaker 3: which is that the remainder of this year you'll like
Speaker 3: to see very slow grows. There's a risk of recession.
Speaker 3: It's not in our forecast, but there's certainly a risk
Speaker 3: of that. And there's also not much risk premium priced
Speaker 3: into equities. I guess you would say, because the yould
Speaker 3: you can get another other assets is quite attractive relative
Speaker 3: to equity.
Speaker 1: Okay, so let's just stick briefly with the interest rate
Speaker 1: inflation dynamics. So you're expecting that rates have pretty much
Speaker 1: plattered what peaked, shall we say, But are going to
Speaker 1: stay at this kind of level for a longer period
Speaker 1: than some others might think. Does that also suggests that
Speaker 1: you expect inflation to remain reasonably high in the short
Speaker 1: to medium term.
Speaker 3: We do expect inflation to come down. Inflation has already
Speaker 3: come down from its peaks in most places to remain
Speaker 3: quite sticky and high in the UK, but in most
Speaker 3: places and the US inflation recently printed below five percent
Speaker 3: headline inflation. Core inflation has been coming down to so
Speaker 3: that is helpful for global economies because you won't need
Speaker 3: such heart interest rate rises if inflation is already starting
Speaker 3: to normalize. The fact that energy prices and commodity prices
Speaker 3: have come down from their peaks as well, it's also
Speaker 3: helpful in.
Speaker 4: Bringing down inflation. But there are some elements of inflation
Speaker 4: that are like to be sticky.
Speaker 3: The service sector still looks very strong, and that's services
Speaker 3: consumption is a big part of economies in pretty much
Speaker 3: all Western economies. Also, wage growths, although it's come down
Speaker 3: off its peaks in the US, are still very high
Speaker 3: and in Europe there is often two year wage deals,
Speaker 3: so it took a wa Wages to pick up in Europe,
Speaker 3: member sort of a year org. Also, people were constantly
Speaker 3: asking why aren't German wages picking up more? But I
Speaker 3: think that's largely because the two year deals. You're starting
Speaker 3: to see those come through now. Also, labor markets are
Speaker 3: very tight still. We keep hearing about this, and pretty
Speaker 3: much every country labor markets are tight, and again that's
Speaker 3: going to be higher wages.
Speaker 4: Higher wages feeds into core inflation.
Speaker 3: So for those reasons, we think inflation will come down,
Speaker 3: but it's not going to come down rapidly in the
Speaker 3: way that it would have done before because of this
Speaker 3: tight labor market.
Speaker 1: It's interesting, I mean, wages, fast rising wages seem to
Speaker 1: be the major worry. I mean, in some sense, of course,
Speaker 1: there's not a worry. If wonderful, If people can keep
Speaker 1: their real incomes constant, right, or even if real wages
Speaker 1: don't go up a little, possibly even significantly, that's a
Speaker 1: good thing in general. But of course it's very bad
Speaker 1: for inflation. And one of the things that people keep
Speaker 1: telling me is that again this rising wages is transient,
Speaker 1: that it's a one off that will get high rises
Speaker 1: that this year, but then that'll be that. But I
Speaker 1: keep looking even thinking, well, hang on, a take you know,
Speaker 1: after many, many years of people not demanding high wage
Speaker 1: rises because they haven't seen high levels of inflation, they
Speaker 1: now understand the inflation dynamic and see what happens when
Speaker 1: inflation is high and erodes their real learnings, etc. So
Speaker 1: it seems to me that there's been a bit of
Speaker 1: a sea change in the way that labor and the
Speaker 1: unions approach wage increases, and that this could easily carry
Speaker 1: on for many years from here. Them say inflation settles
Speaker 1: that four percent as opposed to two percent, which seems
Speaker 1: quite likely, right, or that it's volatile around four percent,
Speaker 1: why would the unions and workers in general not demand
Speaker 1: with rises next year of another five six seven percent.
Speaker 1: I mean, private sector wages are running at what about
Speaker 1: seven percent at the moment. It's hard for me to
Speaker 1: see why that wouldn't continue next year.
Speaker 4: Yeah, I understand. I have a lot of sympathy with
Speaker 4: that view.
Speaker 3: I think that real wages have deteriorated over time. Even
Speaker 3: nominal wages have been reading and good in the last
Speaker 3: couple of years, and then for a long time, medium
Speaker 3: wages in real terms haven't really increased. So I think
Speaker 3: this is a bit of a fight back by workers
Speaker 3: and unions in particular to regain some of that income
Speaker 3: over time. Company margins are quite high, so they could
Speaker 3: try and push for higher wages workers take a little
Speaker 3: bit more of the share of the overall pie of
Speaker 3: the economy. And I think that the other thing which
Speaker 3: is the cause allowing allowing this is the tightness of
Speaker 3: the labor market. And I think there's a few potential
Speaker 3: reasons for why the labor market is so tight, but
Speaker 3: you see it in many different regions, and I do
Speaker 3: think there's an element of different things going on here.
Speaker 3: One of them is just's cyclically quite tight, but also
Speaker 3: I wonder if it's structurally a bit more type now
Speaker 3: given declining working auge populations, not necessarily declining overall populations,
Speaker 3: but declining working out population.
Speaker 4: In Europe, we're seeing.
Speaker 3: Population declines of half percent to one percent a year
Speaker 3: in terms of working age population that's quite large accumulates
Speaker 3: very very quickly, so that decline in working as population
Speaker 3: means those workers now have potentially more power.
Speaker 4: And then another trend is that in the.
Speaker 3: Last couple of decades, companies either moved their workforce to
Speaker 3: the emerging world, to China in particular, where wages were cheaper.
Speaker 3: Wages have gone up in those places now, so slightly
Speaker 3: less obvious move. But also there are concerns about moving
Speaker 3: your labor force to those areas, given geopolitical risk, given
Speaker 3: what's happened with Russia, given that the ESG dynamics as well,
Speaker 3: wanting to bring your supply chain back home to your region,
Speaker 3: given political policies as well.
Speaker 4: The Inflation Production Act in the US has got.
Speaker 3: An element of local supply, and so has the Green
Speaker 3: Deal in Europe as well, I got an element of
Speaker 3: local supply.
Speaker 4: So there's a couple of things going on.
Speaker 3: Policies trying to support bringing labor back into some particular region.
Speaker 3: The labor forces out a shrinking a little bit, so
Speaker 3: I think for all those reasons, you're starting to see
Speaker 3: labor looking to regain a little bit more of the pie.
Speaker 4: So I do have sympathy with that view.
Speaker 1: Yes, okay, so inflation could be slightly more sticky than
Speaker 1: many people think for quite a few years to come
Speaker 1: on that basis. Okay, So inside all this, as you know,
Speaker 1: there's one more thing I want to talk about before
Speaker 1: we go to markets that got more specific markets. You
Speaker 1: mentioned profit margins being consistently high, and that there's space
Speaker 1: in there for wage increases. But one of the things
Speaker 1: that we have been expecting, or many economists have been
Speaker 1: expecting for years, is some kind of reversion to the
Speaker 1: mean of profit margins, and particularly US profit margins, and
Speaker 1: it simply hasn't happened. And even you know, last year
Speaker 1: and this year, when we're seeing inflation coming through, when
Speaker 1: we're seeing these wage rises, and do you think, well,
Speaker 1: surely now, surely now profit margins will start to shrink,
Speaker 1: But no, what is going on there?
Speaker 3: You know? I think profit margins did come down last year,
Speaker 3: even for those really big companies, the FANG companies, the
Speaker 3: top five, also US big tech companies. Margins have started
Speaker 3: to come down for these companies. So from very very
Speaker 3: high levels, margins have come down in the US and
Speaker 3: a tiny bit in Europe as well.
Speaker 4: Estimates have started to come down.
Speaker 3: And I think that's a combination of things, but sort
Speaker 3: of rising costs certainly one of them.
Speaker 4: But margins are still pretty high.
Speaker 3: I agree, And when I say they've come down, it's
Speaker 3: quite small versus the games that margins have made in
Speaker 3: the last twenty or so years. And our US strategus
Speaker 3: have recently wrote a paper on this. Most of the
Speaker 3: games in the last twenty years or so have been
Speaker 3: in what they call costs of goods sold, so that
Speaker 3: is you're either squeezing your suppliers, we were just getting
Speaker 3: cheaper raw materials globally, and it is difficult to see
Speaker 3: that sort of constantly cheaper global raw materials persisting when
Speaker 3: we know that there hasn't been a lot of investment
Speaker 3: in recent years into commodities and things like that, which
Speaker 3: makes those markets very roadlind other reasons why you've had
Speaker 3: higher margins have been lower taxes. That doesn't seem likely
Speaker 3: at the moment given government indebtedness globally. Number all the
Speaker 3: tax cuts that Trump first put in when he came
Speaker 3: into power, and that definitely boosted s and p margins.
Speaker 3: And then another thing has been interest costs coming down
Speaker 3: constantly because you always borrowed at lower and lower rates,
Speaker 3: and that's in reversal now.
Speaker 4: So it may not be a really sharpfaul, but I
Speaker 4: do think that you will start to.
Speaker 3: See margins certainly not expand in the way that they
Speaker 3: did over the last decade.
Speaker 1: Okay, so it certainly feels like a turning point.
Speaker 3: Yes, it's certainly going to be a very different cycle
Speaker 3: this next one than it last.
Speaker 1: Okay, that doesn't sound great for exit markets.
Speaker 3: Now, and again this comes back to this point of
Speaker 3: equities levitating a little bit this year at quite high levels.
Speaker 3: I've described it as resilient in the face of starring
Speaker 3: economic growth, a sort of pattern of potential for margins
Speaker 3: which isn't so strong this next cycle, and another competing
Speaker 3: asset class, which is which is casual bonds, which now
Speaker 3: offer your better yield. Having said that, equities do have
Speaker 3: some factors which I understand which would kind of explain
Speaker 3: a little bit their resilience. I think that you have
Speaker 3: got in the biggest cap stocks in equities in.
Speaker 4: The US, You've got the tech companies.
Speaker 3: They're seen as the developers the gainers from artificial intelligence,
Speaker 3: which is a big new technology wave. Obviously that's going
Speaker 3: to influence economies and markets over this next decade. So
Speaker 3: that's that's going to be crutal for those stocks, and
Speaker 3: they are a big part of the market cap. I
Speaker 3: also think with interest rates peaking, so we think the
Speaker 3: FED has got to the peak in its cycle, and
Speaker 3: even though we don't expect a sharp cutting interest rates
Speaker 3: we're no longer interest rates rising, and that's helpful for
Speaker 3: these long duration companies, these tech companies in particular. And
Speaker 3: then in Europe you've got we call them the granolas.
Speaker 3: The biggest companies in Europe are really healthcare companies, brand
Speaker 3: and consumer goods companies, some of the big tech companies
Speaker 3: in Europe. These are by far the largest in terms
Speaker 3: of market cap. And these companies, they I think they
Speaker 3: will benefit in the next few years from trends like
Speaker 3: aging populations are going to help healthcare companies. AI will
Speaker 3: help healthcare companies as well. Some of the tech companies
Speaker 3: will benefit from AI. Brand and consumer goods is extremely strong,
Speaker 3: so I think, and protect their margins even in higher
Speaker 3: inflation environments. So some of the what's in the markets,
Speaker 3: I guess you could say what the markets are made
Speaker 3: up of?
Speaker 4: Since this environment.
Speaker 1: Okay, interesting, Let's go back to commodities, because you mentioned
Speaker 1: when we were talking about inflation that it seems unlike
Speaker 1: actually that will continue to see what we saw until
Speaker 1: a few years ago, constantly falling commodity prices exactly, so
Speaker 1: the cost of them for companies falling, falling, falling, And
Speaker 1: you mentioned those markets are much tighter. Now, is that
Speaker 1: an area where the ordinary retail investors should be invested?
Speaker 4: Do you think so? Intercommodities directly or intel?
Speaker 1: Not directly, I don't think that's a good idea, But
Speaker 1: in commodity related equities.
Speaker 3: If you're invest in commodities directly, you've got the danger
Speaker 3: that suddenly you might certainly find it in your house. Yeah,
Speaker 3: Finns and oil turning off in your golden which may
Speaker 3: obviously good.
Speaker 4: So yeah, I.
Speaker 3: Probably wouldn't recommend direct investment in commodities, but I do
Speaker 3: think that it is one of the scarce resources going forward,
Speaker 3: and therefore some exposure to commodities is a good idea.
Speaker 3: And you can get that ya the equity market, because
Speaker 3: of course there are companies which are commodity producers in
Speaker 3: the equity market, so energy stocks or the mining companies
Speaker 3: for example.
Speaker 1: And the UK is a brilliant place for that because
Speaker 1: you've got a great big miners, the reattended, b Top etc.
Speaker 1: Which pay you a fabulous yield while you said around
Speaker 1: waiting for commodity prices to go up.
Speaker 3: Yeah, So those and those companies are doing two things
Speaker 3: with their cash at the moment. They are paying a difference,
Speaker 3: and they're buying by shares, but they're not really doing
Speaker 3: one thing but their cash, which is investing it in
Speaker 3: new quantity supply.
Speaker 4: Investors aren't really paying for that at the moment, they're
Speaker 4: not key on them doing so.
Speaker 3: And now that's partly for ESG reasons, partly for environmental reasons.
Speaker 3: You want see more of cash stid towards the companies
Speaker 3: of investing in renewable projects. Certainly true that big oil
Speaker 3: and big energy is as well investing in some lower
Speaker 3: carbon projects, so some incrementally going into that, but there
Speaker 3: isn't a lot going into traditional energy production or into
Speaker 3: other commodities like industrial metal investment.
Speaker 4: So because of that, and these are quite long lead times.
Speaker 3: Because of that, these markets are quite tight, probably going
Speaker 3: to mean higher prices this next cycle than the last one.
Speaker 1: It's tricky and isn't it, though, Because if you want
Speaker 1: an environmentally friendly energy transition, you have to dig up
Speaker 1: and all a lot of metals together. You need those
Speaker 1: industrial metals, you need all those minerals, you need the
Speaker 1: rarer metals, etc.
Speaker 4: Etc.
Speaker 1: You know, and it might be nasty to dig copper up,
Speaker 1: but you can't have an energy transition without digging up
Speaker 1: an awful lot of copper.
Speaker 3: Yeah, absolutely, I mean copper is needed for electrification, which
Speaker 3: in Europe is largely going for electrification as a way
Speaker 3: of producing pollution, and that's going to require lots of cables,
Speaker 3: lots of copper, lots of investment. That requires equipment, machinery, metals,
Speaker 3: et cetera.
Speaker 4: So we will still need a lot in this next
Speaker 4: decade for that transition.
Speaker 1: So there are some hideous conflicts there in the world
Speaker 1: of ESG aren't there That always off? But you need
Speaker 1: you need to be really dirty to get clean.
Speaker 4: Maybe that's the case. I don't know.
Speaker 1: I give that to you as a title for a
Speaker 1: note one day. Thank you for that.
Speaker 3: Now.
Speaker 1: The other thing we talked a little bit about the
Speaker 1: UK is we talked about the HP and and real
Speaker 1: Jinto etc. And the yields available. And one of the
Speaker 1: things that we talk about a lot on the podcast
Speaker 1: because it's incredibly irritating is the state of the UK market.
Speaker 1: And you recently put out a note called UK in
Speaker 1: pursuit of the American Dream about the UK companies or
Speaker 1: desperate to shift their listening to the US so that
Speaker 1: they can get much higher valuations and of course the
Speaker 1: CEOs can be considerably better paid, because that's one of
Speaker 1: the big parts of moving to the US is that
Speaker 1: not just to your sholders get more money because you
Speaker 1: hope your rating goes up. But of course your your
Speaker 1: management can get paid as much as they like without
Speaker 1: being constantly nagged by shaholders as they are here. So
Speaker 1: this is true, this is happening. Is there a way
Speaker 1: out for the UK?
Speaker 3: So I think when you say it's true, it's happening,
Speaker 3: it is happening for a few companies. But I always
Speaker 3: think that if you're going too maybe you're listening, you
Speaker 3: do have to have a reason for maybe you're listening.
Speaker 3: So you need to be a company with a lot
Speaker 3: American footprint, for example, And there are to be fair
Speaker 3: lots of UK companies in that position, so that you
Speaker 3: know that mainly narrows your list of companies, but it's
Speaker 3: not really narrow. There are lots of companies in that position.
Speaker 3: So I do think you or you have to be
Speaker 3: in an area where you believe that you can attract
Speaker 3: a lot more US investment. So if you're a domestic
Speaker 3: UK company or a company with a footprint which is
Speaker 3: more European then there is really less reason for listing
Speaker 3: in the US.
Speaker 4: I think, look, it's it's a tricky one.
Speaker 3: I do feel the main reason that UK and European
Speaker 3: companies because I don't think it's just a UK issue,
Speaker 3: but the main reason that European companies are on lower
Speaker 3: valuations in US companies is that there isn't a large
Speaker 3: domestic investor base in Europe.
Speaker 4: If you look at the US.
Speaker 3: Dock market, around eighteen to ninety percent of its own
Speaker 3: domestically by the big pension funds endownment funds, but also
Speaker 3: by individuals themselves.
Speaker 4: You know, all the meme stocks and things like that.
Speaker 3: They're generally US companies that people have wanted to hold directly.
Speaker 3: If you ask most people, they would know they've heard
Speaker 3: of the Dow and the S and P and those
Speaker 3: big indices in the US, whereas investment in Europe has
Speaker 3: seen as much more niche fewer people invest and it's
Speaker 3: a smaller share of household wealth. Households in Europe tend
Speaker 3: to invest more in housing, more in bonds, and more
Speaker 3: in cash deposits, so that has been.
Speaker 4: A bit of a problem. Really Europe can't attract it all.
Speaker 3: This point about the US's deeper capital markets or yes,
Speaker 3: but that's because there are lots more domestic investors and
Speaker 3: the UK in particular, I think has an issue it.
Speaker 4: Didn't used to in the nineteen nineties.
Speaker 3: We never talked about this, and the reason we never
Speaker 3: talked about it was that eighty five percent of the
Speaker 3: market in the mid nineteen nineties was owned domestically.
Speaker 4: In the UK.
Speaker 3: Now only around a third of the markets owned domestically
Speaker 3: in the UK, and that's because insurance and pension funds
Speaker 3: that were the big holders of UK equity having sellers
Speaker 3: in the last twenty or thirty years, and that means
Speaker 3: that there isn't really a domestic investor base which wants
Speaker 3: to buy UK listed.
Speaker 1: Shares and they've sold for that. There are all sorts
Speaker 1: of reasons. It's about their decline of defined benefit pension schemes.
Speaker 1: It's about regulation that has driven them to be supposedly
Speaker 1: more diversified or into so course stay for assets like
Speaker 1: government bonds and that kind of thing. So there've been
Speaker 1: all kinds of regulator changes that have shifted the way
Speaker 1: that the huge UK pension funds invest and it's a
Speaker 1: rather worrying when you think that you're pretty much everyone
Speaker 1: in work in the UK at the moment is inequity
Speaker 1: invested via their auto enrollment pension. But they're not really
Speaker 1: invested in the UK in the way that we like
Speaker 1: to think they should be. And this doesn't look like
Speaker 1: it's going to turn around, does it. So domestic invested
Speaker 1: us still into a much smaller degree, but still net
Speaker 1: sellers of UK stocks.
Speaker 4: Yeah, they are still net sellers.
Speaker 3: They have less and less to sell because they're a
Speaker 3: smaller share of the UK market now. But I think
Speaker 3: that they're encouraging more domestic investment in public equity, would
Speaker 3: would encourage sort of high evaluations for public equity as well,
Speaker 3: and I think that there have been in the past
Speaker 3: or of ways when you had in the late eighties
Speaker 3: and nineties a lot of privatizations for example, people became
Speaker 3: involved in those and wanted to invest in those. Insurance
Speaker 3: companies and pension funds as well did use to own
Speaker 3: a lot of UK equity, and I agree with you
Speaker 3: for regulation, asset match and reasons they.
Speaker 4: Produced that weight.
Speaker 3: But I do think a little bit more of an
Speaker 3: ecty culture in Europe and the UK will be helpful,
Speaker 3: and it's one of the reasons that you don't see
Speaker 3: such deep capital markets in Europe.
Speaker 1: Might the cheapness of the UK equity market really began
Speaker 1: to attract external investors, so foreign investors and a net
Speaker 1: bias right over the UK again not only huge scale,
Speaker 1: but net bios and the discount of the US market
Speaker 1: KA market to the US market vast. And while everyone says, oh, well,
Speaker 1: that's about sectors and it's about as not having growth
Speaker 1: and Isabella's not being tech, etcetera, etcetera, I know that
Speaker 1: even when you adjust for that, the discount is still
Speaker 1: pretty big. And we're beginning to see private equity bids
Speaker 1: forall for some of our companies, smaller ones in particular.
Speaker 1: So is there a chance that you just get to
Speaker 1: the point where the market is cheap enough that American
Speaker 1: investors in particular look at it and today, well, why
Speaker 1: are we invested here? Or we give invested in similar
Speaker 1: companies over there at half the price and we begin
Speaker 1: to see a wave of capital coming into the UK?
Speaker 1: Or is that high in this guy thinking, which I'm prone.
Speaker 3: To definitely not, I actually think this has been happening
Speaker 3: and well continued to happen. So I have a lot
Speaker 3: of conversations with global investors that see that UK up
Speaker 3: as being relatively inexpensive. So I think in a way,
Speaker 3: this gap between the US and the UK, or the
Speaker 3: US and Europe overall, there are really only are four
Speaker 3: ways it can close.
Speaker 4: It can either.
Speaker 3: Close because you see global investors buying Europe and the
Speaker 3: UK sort of fun and flows as it were, and
Speaker 3: you have seen fun flows out of the US in
Speaker 3: recent years and into Europe over the last few months,
Speaker 3: particularly sort of the end of last year very early
Speaker 3: this year, so we have seen some of that fun
Speaker 3: flow move. Another way that it can close, as you mentioned,
Speaker 3: is acquisitions. So companies buying companies are private equity companies
Speaker 3: buying public listed equity, which perhaps looks quite inexpensive. And
Speaker 3: again we have seen quite a lot of inward acquisitions
Speaker 3: into the UK in recent years, particularly smaller companies, not
Speaker 3: necessarily the high profile ones that make the news, but
Speaker 3: a lot of smaller companies.
Speaker 4: That's another way the gap could close.
Speaker 3: Another one we've talked about before is UK companies or
Speaker 3: European companies relisting in the US and trying to close
Speaker 3: the gap via that. Although I do think that will
Speaker 3: be relatively niche not not every company can or would want.
Speaker 4: To do that.
Speaker 3: And then the final way the gap could close is
Speaker 3: just that UK companies say we're too cheap, we've got
Speaker 3: cash on our balank sheet, we will use that to
Speaker 3: buy our own equity. And you've seen buybacks rise considerably
Speaker 3: in the UK, particularly amongst financials, oil companies, mining companies, etc.
Speaker 4: Which are on very low valuations.
Speaker 3: So buying back your own shares has been another route
Speaker 3: to try to close this gap.
Speaker 1: As recommended by Warren Buffett in his latest letter.
Speaker 3: Yeah, I mean look, it's also going to help in
Speaker 3: terms of improving your earnings per share. If you've got
Speaker 3: fewer shares the same number of earnings, same amount of earnings,
Speaker 3: then you'll see a better earnings per share grows over time.
Speaker 4: And the US market's.
Speaker 3: Been fantastic at achieving that in recent years, and I
Speaker 3: think increasingly, particularly if you've got If you're in a
Speaker 3: more cycnical business like a commodity business for example financials,
Speaker 3: you don't necessarily want to commit to dividends every year,
Speaker 3: but when you have additional cash, buying back shares if
Speaker 3: your share price achieved makes a lot of sense.
Speaker 1: Although there's always a slight worry that a lot of
Speaker 1: those buybacks are related to chief executive bonuses.
Speaker 3: Yeah, I mean, I guess it's one way of boosting
Speaker 3: the share price and creating should return and a lot
Speaker 3: of people would like to see more money in best
Speaker 3: did in growth, and I do think that's one area
Speaker 3: of the UK and the whole of Europe.
Speaker 4: Is not keeping pace with the US, to be fair,
Speaker 4: and I do wonder.
Speaker 3: I don't think this is necessarily the incentives placed on
Speaker 3: top management. I'm not quite sure of the reasons for it,
Speaker 3: but if you think about the US, there's a lot
Speaker 3: of incentive to on top management to do share prices
Speaker 3: by any short term means. They often have renumeration related
Speaker 3: to return on actuity or shareholder returns, which is quite
Speaker 3: short term. So, if anything, US companies should be quite
Speaker 3: short terms, but they tend not to be so much.
Speaker 3: They invest a higher share of their cash vow from
Speaker 3: operations in what we would call growth capex, which is
Speaker 3: either capital expenditure open above depreciation or R and D.
Speaker 4: SO US companies they spend.
Speaker 3: About a third of their cash vow from operations on
Speaker 3: that gross investment, whereas European companies.
Speaker 4: It's around a fifth.
Speaker 3: So even in a place like the US where there's
Speaker 3: a lots will focus on the top managements, renumeration being
Speaker 3: related to share prices, etc. Even there, they've got quite
Speaker 3: a lot more full sight and they are looking and
Speaker 3: investing for growth.
Speaker 1: Maybe we should stay invested in the US now, Sharon,
Speaker 1: With all these things that we've talked about, where do
Speaker 1: you think the most interesting parts of the market are
Speaker 1: for retail investors at the moment? So, you know, speak
Speaker 1: Japan has had a fabulous run so far this year.
Speaker 4: Is that.
Speaker 1: I know it's not quite your area, but maybe that
Speaker 1: is interesting. I know you've written recently about the luxury
Speaker 1: goods companies being very interesting. We've talked about commodities. We've
Speaker 1: talked about the UK and Europe relative to the US.
Speaker 1: But if you had to pick out a couple of
Speaker 1: areas that were particularly interesting to you and therefore should
Speaker 1: be interesting to ordinary investors right now, what do you
Speaker 1: think they would be?
Speaker 3: Yeah, So, I think for ordinary investors there's a combination
Speaker 3: of lots of different assets you can invest in right now.
Speaker 3: Even cash and bonds provide you with some reasonable return,
Speaker 3: whereas if you don't the clock three or four years ago,
Speaker 3: you were getting certainly negative real returns in those if
Speaker 3: not zero nominal returns, so.
Speaker 4: You didn't have a lot of opportunities.
Speaker 3: So I think there's an opportunity for diversification, which is
Speaker 3: always important for retail investors. For all of us, we
Speaker 3: want to diversify. I don't want to put everything into
Speaker 3: one basket and take on too much risk. But if
Speaker 3: I'm looking with be in the UK equity, which I
Speaker 3: don't think is particularly expensive at the moment. I mentioned
Speaker 3: right at the outset that US equity looks quite expensive
Speaker 3: on eighteen or nineteen times PE, the UK market is
Speaker 3: on ten or eleven, and some of the cheapest areas
Speaker 3: are financials and commodities.
Speaker 4: So as a kind of.
Speaker 3: Longer term, medium, longer term view on these areas being undersupplied,
Speaker 3: particularly commodities, and being relatively inexpensive, and the companies having
Speaker 3: options like buying back their own shares or paying additional dividends,
Speaker 3: that looks like a reasonable area. But having said that,
Speaker 3: I would have a bit of a bar bow strategy.
Speaker 3: We're going for some of this cheaper stuff that looks
Speaker 3: potentially undersupplied, but also some of the newer growth that
Speaker 3: areas look interesting. Anything that looks like it would likely
Speaker 3: gain from productivity improvements from AI for example, bits of healthcare,
Speaker 3: luxury goods, tech all look reasonable as well.
Speaker 4: From the medium term for investors, you won't get paid
Speaker 4: so much in the way of.
Speaker 3: Dividends from those or buybacks, but you probably will have nice.
Speaker 4: Longer term growth.
Speaker 1: Yeah, okay, that's interesting. Now, final question, no warning for
Speaker 1: this bitcoin or gold gold for.
Speaker 4: Me, No shadow of down are there.
Speaker 3: I think bitcoin is highly volatile asset, very difficult to
Speaker 3: pin down in any way to sort of economic fundamentals.
Speaker 3: In comparison, gold I think provides you a nice little
Speaker 3: hedge against two risks that.
Speaker 4: Are around there.
Speaker 3: One is that we do go into a deeper down
Speaker 3: term and expected maybe there is a further banking stress
Speaker 3: causing loans to tighten.
Speaker 4: Credit congits to Titan. Gold is attractive in that sense.
Speaker 3: The other risk that's out there, and we talked about
Speaker 3: a lack of supply of commodities. We talked about maybe
Speaker 3: higher inflation because of that lack of commodity supply, but
Speaker 3: also higher wage growth. Higher inflation means you really want
Speaker 3: to own real assets and gold in a sense as
Speaker 3: a real asset as well, so I prefer gold on
Speaker 3: that basis.
Speaker 1: Okay, brilliant.
Speaker 4: Do you know.
Speaker 1: I don't think I've had anybody yet He's chosen bitcoin
Speaker 1: spread my net wider. There's got to be someone out there. Sarah,
Speaker 1: thank you so much for joining us today. That was
Speaker 1: great fun. I hope we can talk against you.
Speaker 4: Thank you, thanks for inviting me.
Speaker 1: Thanks for listening to this week's Marin Talks Money. We
Speaker 1: will be back next week in the meantime. If you
Speaker 1: like our show, rate review, and subscribe wherever you listen
Speaker 1: to podcasts. This episode was hosted by Me, Marry and
Speaker 1: Sunset Web. It was produced by Some Society. Additional editing
Speaker 1: by Blake Maple's special thanks to Sharon Bell and of
Speaker 1: course as ever to John Steppe and of course our
Speaker 1: weekly reminder designed up John's daily newsletter, Money Distilled. The
Speaker 1: link is in this show notes at the top of
Speaker 1: the podcast. John and I discussed all sorts of topics.
Speaker 1: You will find detail on all those things in those
Speaker 1: Money Distilled newsletters. Do not miss them.