Speaker 1: Bloomberg Audio Studios, podcasts, radio news.
Speaker 2: It's sort of easier to recognize that the regime is
Speaker 2: changing than to understand what it will change into. But
Speaker 2: if you think about all those things I mentioned there,
Speaker 2: which is you know, globalization, the sort of frictionless movement
Speaker 2: of capital and labor and supply chains, I think those
Speaker 2: things are going into reverse. And as they go into reverse,
Speaker 2: it introduces more friction into the system. It requires, you know,
Speaker 2: national interest to be put at the sort of top
Speaker 2: of the priority list for governments. I think we're all
Speaker 2: going to get used to the idea of America first
Speaker 2: by British, by Canadian. The Italians have got their own
Speaker 2: version of it. And these things are going to require
Speaker 2: more capital to be deployed at home. There's more sort
Speaker 2: of you know, more demand on the physical constraints of
Speaker 2: the world, which gives rise to produce supplicce inflation. All
Speaker 2: of these things are sort of more friction probably stick
Speaker 2: here inflation.
Speaker 1: Welcome to Marrin Talks Money, the podcast in which people
Speaker 1: who know the markets explain the markets. I am Maren
Speaker 1: Sumset Web and this week I'm speaking with Ed Cole.
Speaker 1: Ed is head of Multi Strategy equities within solutions at
Speaker 1: Man Group and was lost on the show back in
Speaker 1: April twenty twenty five, then we spoke about the great
Speaker 1: rotation and why at the time Chinese stocks looked like
Speaker 1: pretty good investments. Well Ed is back, and on today's
Speaker 1: show we talk about what we talk about everything. We
Speaker 1: talk about AI bubble or not bubble? Is it evaluation bubble?
Speaker 1: Is it an earnings bubble? Or is it really absolutely fine?
Speaker 1: We talk about Japan, we talk about small gaps, We
Speaker 1: talk about the end of the sixty forty portfolio and
Speaker 1: how you should diversify from here, and we finish up
Speaker 1: with a really good sounding book for you to take
Speaker 1: to the beach. Ed welcome back to Marion Talks Money.
Speaker 1: Thank you very much for coming on again.
Speaker 2: Thanks for having me, Maren, great pleasure to be here.
Speaker 1: Last time we spoke, we talked at length about the
Speaker 1: end of American exceptionalism. We talked about how we expected
Speaker 1: other markets to outperform, or at least to perform better
Speaker 1: than the US.
Speaker 3: Let me talk abou something link about.
Speaker 1: Chinese equities and you know how they looked attractive and
Speaker 1: where investors should look at the moment.
Speaker 3: A lot has happened since then.
Speaker 1: We last spoke before, before the war in the Middle East,
Speaker 1: before the Great Ai Bubble really got going, and a
Speaker 1: few other little bits and bobs have happened since then.
Speaker 1: So when do it' we saut with an update, We're
Speaker 1: how are you feeling now about our previous conversation about
Speaker 1: American acceptionalism, about the great rotation out of the US.
Speaker 2: Well, I'm marked my own homework actually in advance of this.
Speaker 2: So it was a thank you little more than a
Speaker 2: year ago that we spoke, and it was it's always
Speaker 2: a little gall lings after go back and listen to
Speaker 2: yourself as a starting point, and then listen to yourself
Speaker 2: and recognize the extent to which you've probably got things wrong.
Speaker 2: I was a bit surprised that some of what I
Speaker 2: said has actually played out reasonably well. I think you
Speaker 2: and I were probably both on the same page that
Speaker 2: nothing's particularly exceptional other than hype cycles, and we're certainly
Speaker 2: in a hype cycle now. But just looking back over
Speaker 2: sort of fifty two weeks of returns, and I've put
Speaker 2: all this in constant currency, so the S and P
Speaker 2: and the mag seven, which is I guess what people
Speaker 2: think of as exceptional are both up about twenty percent
Speaker 2: in the last twelve months. European dollars is up about
Speaker 2: eighteen so that bit didn't really work out particularly well. Amazingly,
Speaker 2: inside the US, the Russell two thousand, which is the
Speaker 2: small cap index or small and MidCap has a bit
Speaker 2: more of a value tilt, is up thirty eight percent.
Speaker 2: For all that exceptionalism and all of that apparent leadership
Speaker 2: by the tech tech giants, it's actually been more cyclical,
Speaker 2: more value UI smaller cap companies that have not just outperformed,
Speaker 2: but outperformed materially.
Speaker 3: I think we did. We did talk about that, didn't we.
Speaker 1: We did think that part of the rotation would be
Speaker 1: in TV smaller cap value names, not just in the
Speaker 1: US but everywhere.
Speaker 2: Yes, but everywhere exactly. And then the other extraordinary one,
Speaker 2: a couple of other extraordinary ones, is that the emerging
Speaker 2: markets have had a phenomenal year in many ways, driven
Speaker 2: by the same thing that occupies the headlines everywhere in
Speaker 2: the world. So emerging market's up nearly fifty percent over
Speaker 2: the last twelve months.
Speaker 1: Yeah, but I think we have to stop and talk
Speaker 1: about that briefly before we move on and say that
Speaker 1: that is not emerging markets that have got absolutely nothing
Speaker 1: whatsoever to do with emerging markets. That is three giant
Speaker 1: companies in Taiwan and Korea, and we've talked about that
Speaker 1: on this pod quite a lot to say, you know,
Speaker 1: if you want emerging markets exposure, do not buy an
Speaker 1: emerging markets index because you're going to get an AI momentum.
Speaker 2: Trade absolutely fair. And of course, you know, EM has
Speaker 2: always been in many ways the factory for what the
Speaker 2: developed world is con huming. And you know, the monetizing
Speaker 2: AI is still really a developed world story. And of
Speaker 2: course those three companies are the picks and shovels that
Speaker 2: are manufacturing what it is that the Western world needs
Speaker 2: to consume for this particular growth cycle. The other surprising
Speaker 2: bit in it, though, is that on shore Chinese equities
Speaker 2: there's been a massive bifurcation between offshore Chinese equities and
Speaker 2: on shore Chinese equities. On Shore Chinese equities are really
Speaker 2: interesting market because they're super super deep and super broad
Speaker 2: and quite lots of inefficiency, lots of opportunity to route
Speaker 2: out on shore China. Chinese equities are up nearly thirty
Speaker 2: percent in dollars over the last year, so You're absolutely
Speaker 2: right in index terms, in em there's something very much
Speaker 2: going on amongst those big semiconductor names in both memory
Speaker 2: and logic. But below the hood there are many other
Speaker 2: stories going on as well. So I think we could
Speaker 2: probably take a step. I'm going to sort of probably
Speaker 2: mark my scorecard as could do better altogether. Not terrible,
Speaker 2: not terrible at all, But I think that and I
Speaker 2: think probably we also talked about golden Bitcoin, we might
Speaker 2: come from.
Speaker 3: Yes, it would definitely come back to that.
Speaker 2: But I look, I think I suppose, on the one hand,
Speaker 2: in sort of scores, it looks as though there has
Speaker 2: been some rotation. On the other hand, in terms of narrative,
Speaker 2: America probably would be patting itself on the back for
Speaker 2: looking more exceptional than ever in terms of having the
Speaker 2: companies that are absolutely at the tip of the spear
Speaker 2: in what's going on in AI and AI monetization and
Speaker 2: you know, and there's a question mark in all of that,
Speaker 2: which I'm sure going to get onto about how sustainability
Speaker 2: all is.
Speaker 1: Well, why don't we start with that, Well, actually we've
Speaker 1: started already. Why don't we move on to the AI
Speaker 1: hype cycle and how that is going? I mean, we're
Speaker 1: talking in a very volatile week twenty fourth of guine
Speaker 1: by the way, and so there's been quite quite a
Speaker 1: lot going on. Tuesday this week was a lightly mad
Speaker 1: day with all sorts of movements in tech and the
Speaker 1: cost of the Korean index down nearly ten percent in
Speaker 1: one day because of the again, because of these big
Speaker 1: AI and ms. Do you think we are reaching the
Speaker 1: top of the hype cycle? We're getting to the bit
Speaker 1: where everyone saying, okay AI is great. We get that
Speaker 1: there's a marvelous technology. It can do fabulous things for us,
Speaker 1: but nonetheless it needs to be monetized, and that path
Speaker 1: is slightly less certain in particularly in terms of the
Speaker 1: volumes required. It's slightly less certain than we thought. We've
Speaker 1: seen quite a lot of companies begin to talk about
Speaker 1: something we've discussed on this podcast quite a lot, which
Speaker 1: is saying, well, is there a cheaper way to do
Speaker 1: this and looking at some of the open source models
Speaker 1: that they can run on their own computers and owned
Speaker 1: networks without recourse to the big expensive companies, et cetera.
Speaker 2: But I suppose I hesitate to say yes, we're at
Speaker 2: the top. It's incredibly hard to know it will be
Speaker 2: hard to know in some ways until we're quite a
Speaker 2: long way away from the top, because tops are typically
Speaker 2: quite noisy. If I stack a step back, i'm I'm
Speaker 2: my glass is half empty as a person, which is
Speaker 2: both good and bad in this business. But I think
Speaker 2: that if I just sort of forced myself a little
Speaker 2: bit to listen to the other side, I would tend
Speaker 2: to agree with you in sorts of hype cycle or
Speaker 2: bubble if I take a step back and listen to
Speaker 2: the other side. And we have quite lively debates in
Speaker 2: my company about this, the bulls will say right now
Speaker 2: that actually the market's derated this year. You know, the
Speaker 2: earnings revisions have been so extreme, and I've been extreme everywhere.
Speaker 2: It hasn't just been an AI story. You've seen it
Speaker 2: even in the Russell two thousand that I talked about
Speaker 2: enormous earnings revisions. On the positive side, that there is
Speaker 2: something going on in terms of a strong economy, and
Speaker 2: clearly the hype that we see in AI is this
Speaker 2: is the ball argument justified by what's happened in terms
Speaker 2: of earnings revisions. So unlike other bubbles, you can look
Speaker 2: at this right now today and say the market is
Speaker 2: not that expensive if the earnings estimates come through. That's
Speaker 2: something we talked about a year ago, you and I.
Speaker 2: If the owning estimates come through, then the market doesn't
Speaker 2: look expensive. Now I would take a step back and say,
Speaker 2: and I think this gets exactly to your point about monetization.
Speaker 2: I would take a step back and say that those
Speaker 2: earnings revisions today are predicated on an earnings estimates rather
Speaker 2: today are predicated on an assumption that compute is scarce,
Speaker 2: and that if you are an Asian semiconductive manufacturing company,
Speaker 2: your capacity to keep your price moving in a world
Speaker 2: where it previously was very deflationary is high, and therefore
Speaker 2: both volume and price are in your favor. And that's
Speaker 2: a phenomenal environment to be selling the hardware that people need.
Speaker 2: If we discover that compute is not scarce, then I
Speaker 2: think the picture will change pretty materially. Now, why would
Speaker 2: compute not be scarce? So I think the first thing
Speaker 2: is even alluded to. It is actually an understanding that
Speaker 2: perhaps you just don't need these leading edge llms to
Speaker 2: perform the kind of tasks that we're performing. You know,
Speaker 2: we use AI to an enormous extent at work. We
Speaker 2: have you know, kind of coding co pilots all of
Speaker 2: us can use and it's incredibly powerful. But actually, as
Speaker 2: a portfolio manager rather than a courant developer, I don't
Speaker 2: need to use the leading edge models. It's absolutely clear,
Speaker 2: and so you can do a very simple tweak which
Speaker 2: is just say, well, let's start moving away from the
Speaker 2: leading edge so we don't have to use take up
Speaker 2: all of that capacity in the most expensive part of
Speaker 2: the stack. So that's one which is just not using
Speaker 2: the leading edge. The other is perhaps not using the
Speaker 2: llms at all, so small language models ways of actually
Speaker 2: dealing with discrete tasks. The other angle is you know,
Speaker 2: not using the US models that are you know, the
Speaker 2: premium price. So of course we all know that the
Speaker 2: you know, the cost of a Chinese model is much
Speaker 2: much closer to the cost of production of that model.
Speaker 2: And I think it's entirely conceivable that certain businesses and
Speaker 2: enterprises are going to carry on using you know, the
Speaker 2: premium models all the time, but there will be other
Speaker 2: applications that don't. And then I think the other thing
Speaker 2: is actually fascinating news that came out overnight, which was
Speaker 2: the sort of world world ranking of supercomputers. I don't
Speaker 2: know if you saw this, but there's a Chinese supercomputer
Speaker 2: called Lineshine in Shenzen that's just won the crown of
Speaker 2: most powerful supercomputer, and it's entirely powered by CPUs, not GPUs,
Speaker 2: again demonstrating that actually it isn't all about how much
Speaker 2: compute you throw at something. It's often, you know, about
Speaker 2: the way that the things engineered and implemented. So there
Speaker 2: are enough reasons to think it's possible that we could
Speaker 2: end up with a serious headwind for this if the
Speaker 2: market continues to be driven by the idea that actually
Speaker 2: computers scarce and therefore you know, those names in a
Speaker 2: that we've talked about continue to be the leaders. I
Speaker 2: don't know when please please.
Speaker 1: Ask you to explain to our non AI literate listeners
Speaker 1: a difference between CPUs and GPUs.
Speaker 2: Yeah, so gpuser called graphics processing units, and those are
Speaker 2: the kind of just much much more advanced, much powerful,
Speaker 2: much much more energy energy, energy intensive, Yeah, much more
Speaker 2: powerful logic semiconductor, So they do the thinking. That's the
Speaker 2: semiconductor that does the thinking, and a CPU is a
Speaker 2: much more basic version of it. It's what we all
Speaker 2: used to have in our home PCs before, you know,
Speaker 2: before there was a sort of step change in technology.
Speaker 2: In other words, it's a more basic function, more basic,
Speaker 2: less less powered, and requires less energy intensity to make
Speaker 2: it work. And I think it's you know, there's been
Speaker 2: a story you and I spoke last year, not a
Speaker 2: million miles after the deep seat news, and in many
Speaker 2: ways it's the sort of continuation of the same thing.
Speaker 2: That you don't have to keep throwing the most leading
Speaker 2: edge chip at every thing in order to push things further.
Speaker 2: There's an awful lot about the way you engineer these processes, and.
Speaker 1: That that leads on to two possibilities. One that this
Speaker 1: is an earnings bubble more than a valuation bubble. Obviously
Speaker 1: they're connected, but it's an earnings bubble first, and that's
Speaker 1: the first thing. And the second thing is that it
Speaker 1: is possible that the huge amount of capex being thrown
Speaker 1: at data centers might turn out to be too much.
Speaker 2: To absolutely agree. I think the the the argument I said,
Speaker 2: the sort of bulls argument that it's not a bubble
Speaker 2: because because earnings revisions have been so powerful, if earnings
Speaker 2: collapse because monetization doesn't work, the market's going to look
Speaker 2: a hell of a lot more expensive. And I think
Speaker 2: I think a fascinating you know, prison to look at
Speaker 2: this through is actually that those Korean semiconductor memory companies,
Speaker 2: you know, those have historically been cyclical. And the way
Speaker 2: we treat a cyclical company, the sort of orthodox way
Speaker 2: to treat a cyclical company, is you sell it when
Speaker 2: it's cheap, because it's earnings and revisions are sort of
Speaker 2: you know, they're not going to stay up there. Right.
Speaker 2: You grow up in this business learning to sell those
Speaker 2: things when they're cheap and buy them them avery expensive.
Speaker 2: If in fact, this is not a secular trend in
Speaker 2: in earnings but a cyclical or a blowoff moment or
Speaker 2: a bubble or as you call it, then actually what
Speaker 2: we're going to find is that the market's a hell
Speaker 2: of a lot more expensive than it looks.
Speaker 3: Yeah, and this is just a normal cyclical Yeah. And
Speaker 3: I think I think the other thing extreme but normal extreme. Yeah.
Speaker 2: The other thing in all of that, which I think,
Speaker 2: you know, when it all happened a year ago, a
Speaker 2: bit sort of ten months ago, everyone was perplexed and
Speaker 2: we've all moved on. Because we have short attention spans.
Speaker 2: We also have to go back to the to the
Speaker 2: realization that a lot of these earnings revisions are part
Speaker 2: of that incredible circularity of you know of vendor financing,
Speaker 2: where you know, where the customer invests in the invests
Speaker 2: stock in the company to place orders for the chips.
Speaker 2: And there was all those extraordinary diagrams that went round
Speaker 2: that showed this ecosystem where everyone was both customer and
Speaker 2: off take for the same same ecosystem. And there's this
Speaker 2: sort of multiplication of earnings revisions that's going through the system.
Speaker 2: So it isn't just the case that one company's order
Speaker 2: book suddenly looks different. It's that that has a ripple
Speaker 2: through effect from the company that's building the model, through
Speaker 2: to the hyperscala, through to the company that's making the
Speaker 2: memory chip, through to the company that's making the logic chip.
Speaker 2: So all of them are enormously interrelated. We all scratched
Speaker 2: our heads in September October last year when all of
Speaker 2: those deals were announced and sort of laughed a bit
Speaker 2: and moved on, And now here we are with that
Speaker 2: being at least one factor that's contributed enormously to the
Speaker 2: growth in earnings expectations. All quite fragile sounding, Yeah, it
Speaker 2: could be or we could find that actually the productivity
Speaker 2: gains are so extraordinary, and that businesses learn quite quickly
Speaker 2: that they can't do without it, that their competitors are
Speaker 2: starting to make advances because they are being prepared to
Speaker 2: take on the cost of tokens, and you know, and
Speaker 2: they make that part of their ongoing budget. So I,
Speaker 2: you know, I look at this after twenty five years
Speaker 2: in markets and think it looks in many ways like
Speaker 2: a bubble, and it talks like a bubble, and it
Speaker 2: walks like a bubble. But I also have to be
Speaker 2: open minded in a way that I probably wasn't when
Speaker 2: I was twenty five, that there are paths in, there
Speaker 2: are path dependencies, there are ways through this where actually
Speaker 2: perhaps it doesn't go pop.
Speaker 1: And either way, this is not Emperor's New clothes. The
Speaker 1: technology is exciting and valid, and either way leads to
Speaker 1: astonishing productivity gains. That's simply a matter of whether the
Speaker 1: valuations are right or wrong.
Speaker 2: So just yeah, yeah, definitely. I think there's one one
Speaker 2: really fascinating way to think about all bubbles is that
Speaker 2: actually the majority of them are productive in a sense
Speaker 2: that what they do is they suck capital into something
Speaker 2: that is ultimately almostly changing for society or changing for
Speaker 2: a political economy. You know, you can look at the
Speaker 2: you know, the sort of nation building in the US,
Speaker 2: the railway bubble in the US, you know, even parts
Speaker 2: of the Roaring twenties actually, which was sort of beginning
Speaker 2: of like domestic consumption taking off, the dot com you know.
Speaker 2: The norm is that that these bubbles bring capital into something.
Speaker 2: There's some malinvestment along the way, but the technology remains.
Speaker 2: What's not normal is something closer to the GFC or
Speaker 2: the kind of very tail end of the Roaring twenties,
Speaker 2: when it's pure speculation. South Sea, you know, tulips, where
Speaker 2: there's where there is nothing, nothing sort of transformational about.
Speaker 1: I'm want to pick you up on tulips actually interesting
Speaker 1: sps I mean yes, always cited as an extraordinary bubble
Speaker 1: that left nothing behind it, you know, exponential rises in
Speaker 1: the prices of tulip bulb and then a collapse that
Speaker 1: leaves everyone.
Speaker 3: Destroyed, et cetera, et cetera.
Speaker 1: But you know, here we are and the Netherlands are
Speaker 1: still one of the greatest flower exporters in the world, right,
Speaker 1: and where do you go when you want to buy
Speaker 1: amazing tulip bulbs. What do you buy when you go
Speaker 1: when you go to Holland and you want to bring
Speaker 1: back a souvenir chilip bulbs?
Speaker 3: Right, it left an amazing like the.
Speaker 1: Long term chulip bubble was ages ago, and there it is.
Speaker 1: The legacy of the tulips is still there in the
Speaker 1: in a huge industrial infrastructure the production of these flowers,
Speaker 1: and in a massive tourist infrastructure.
Speaker 3: So now I won't hear a word against the tulip bubble.
Speaker 2: No, okay, I stand corrected, and they are, of course
Speaker 2: wonderfully beautiful.
Speaker 3: Yes, exactly right.
Speaker 1: Let's move on from bubbles to a paper that you
Speaker 1: wrote recently that I'm interested in. I know our listeners
Speaker 1: will be interested in about diversification in an age of
Speaker 1: inflation and the change that has come there. I know.
Speaker 1: But you think that we're moving into what we're in
Speaker 1: and staying in a more inflation environment that we've been.
Speaker 3: Used to over the last forty years pre COVID.
Speaker 2: Of course, yeah, I mean we do, we think I
Speaker 2: think you know. Actually this is in some way informed
Speaker 2: by the kind of conversations we have with many of
Speaker 2: our largest clients, and it's really interesting to us how
Speaker 2: there are many, many different conversations coming from asset allocation
Speaker 2: teams in these big institutional businesses, which are all touching
Speaker 2: on the fact on the sort of realization that the
Speaker 2: world is changing, that the pre sets that we lived
Speaker 2: through from you know, the sort of mid nineties onwards,
Speaker 2: probably until the Brexit referendum ten years ago this week,
Speaker 2: there was a set of characteristics that were pretty stable.
Speaker 2: And those characteristics were, you know, the kind of primacy
Speaker 2: of globalization, stimization of supply chain, stability in Western politics,
Speaker 2: low inflation, financialization of everything because low inflation allowed for that,
Speaker 2: and this wonderful kind of basis for multi asset investing,
Speaker 2: which was that stocks and bonds were negatively correlated, meaning
Speaker 2: that when your bomb, when your stock portfolio hit the skids,
Speaker 2: your bomb portfolio would typically partially bail you out.
Speaker 1: Which happened earlier this week. By the way, I mean
Speaker 1: that that happened on Tuesday.
Speaker 3: Old fashioned stuff. But it did happen.
Speaker 2: Yeah, it did happen. I mean, I think what we're
Speaker 2: really thinking about here is what happens on more than
Speaker 2: a day, and it certainly didn't happen in March, where
Speaker 2: stocks got hit very hard and so did bonds, and
Speaker 2: so did gold. So I think, you know, the way
Speaker 2: we recognize it's sort of easier to recognize that the
Speaker 2: regime is changing than to understand what it will change into.
Speaker 2: But if you think about all those things I mentioned there,
Speaker 2: which is you know, globalization, the sort of frictionless movement
Speaker 2: of capital and labor and supply chains, I think those
Speaker 2: things are going into reverse. And as they go into reverse,
Speaker 2: it introduces more friction into the system. It requires you know,
Speaker 2: national interest to be put at the sort of top
Speaker 2: of the priority list for governments. You know, I think
Speaker 2: we're all going to get used to the idea of
Speaker 2: America first by British, by Canadian. The Italians have got
Speaker 2: their own version of it. And these things are going
Speaker 2: to require more capital to be de deployed at home.
Speaker 2: There's more sort of you know, more demand on the
Speaker 2: physical constraints of the world, which gives rise to produce supplies. Inflation.
Speaker 2: All of these things are sort of more friction, probably
Speaker 2: stickier inflation.
Speaker 3: There's us conversations about that.
Speaker 1: You know, we've talked, I think we might have talked
Speaker 1: previously about capital controls and the odd defining that your
Speaker 1: money is confined within a country, or appropriated for the pension,
Speaker 1: pension in particular, appropriated for domestic domestic infrastructure needs, etc.
Speaker 1: One of the conversations in the UK at the moment
Speaker 1: endless leaking of possible tax things, right, but one of
Speaker 1: them is that the introduction of an exit tax. So
Speaker 1: if you do want to leave the UK to escape
Speaker 1: an oppressive tax regime, you get to pay a partner
Speaker 1: taxes on the way out. So you know, that's another
Speaker 1: bizarre thing in this new world of ours, isn't.
Speaker 2: It absolutely right?
Speaker 3: It's exactly so.
Speaker 2: I mean, you know, a hallmark of neoliberalism and globalization
Speaker 2: was the liberalization of capital accounts, and this is sort
Speaker 2: of the opposite of that, which is that you know,
Speaker 2: the capital resources sort of economy are required at home.
Speaker 2: Japan will be really interesting to watch in that respect.
Speaker 2: I mean, you know, they've now got interest rates at
Speaker 2: one percent, Inflation is certainly high in their own context,
Speaker 2: the yen is extraordinarily weak. They're finding it difficult to
Speaker 2: work out how to cap that. My take on it,
Speaker 2: purely personal view, is that at some point, you know,
Speaker 2: if you go back, gosh, is it twelve thirteen is
Speaker 2: to our bay part of our Bay's plan in Japan
Speaker 2: was to depreciate the yen to get to sort of
Speaker 2: try and move away from disinflation deflation. And one of
Speaker 2: the things they did in that respect was they change
Speaker 2: the ratios of onshore and offshore investment for the pension
Speaker 2: funds in Japan. The pension fund system in Japan is
Speaker 2: absolutely enormous, and you know, I think it's entirely possible
Speaker 2: that some point that what they'll do is reverse that,
Speaker 2: as they'll start requiring Japanese pension funds to start buying
Speaker 2: more Japanese assets. But I think the critical thing when
Speaker 2: you think about investing, whether you're investing your ISA or
Speaker 2: investing the assets of a sovereign wealth fund, is that
Speaker 2: the approach that we've all typically used as is changing enormously.
Speaker 2: You know, the sixty forty is the sort of mainstay
Speaker 2: of wealth investing and has been for all of our lifetimes,
Speaker 2: and it rests on the assumption, as I said already,
Speaker 2: that bonds andequities negatively correlated. You know, we've done some
Speaker 2: work at looking at what happens in similar drawdowns in
Speaker 2: environments where bonds are negatively correlated versus positively correlated. Nineteen
Speaker 2: seventy four, the equity draw down was the same size
Speaker 2: as it was in two thousand and eight, So you
Speaker 2: lost about forty percent in world equities in both nineteen
Speaker 2: seventy four and two thousand and eight. In nineteen seventy four,
Speaker 2: which was obviously an inflationary environment, stocks and bonds were
Speaker 2: positively correlated, and you lost I think something close to
Speaker 2: thirty percent in the sixty forty portfolio. In two thousand
Speaker 2: and eight, it was a much much smaller loss because
Speaker 2: bonds really really kicked in. And I think the point
Speaker 2: is that, you know, what we worry about is not
Speaker 2: runaway inflation, but rather once you once the genie is
Speaker 2: out of the bottle with respect to inflation targets, it's
Speaker 2: very hard to get it back in again. And I
Speaker 2: think you can see that. You can see that kind
Speaker 2: of I mean, you can see that in the UK,
Speaker 2: where we don't have very strong real growth. But you know,
Speaker 2: in the UK CPI is running it close to three percent.
Speaker 2: Services CPI is at three point eight percent and is
Speaker 2: moving higher. And that's an economy where real GDP growth
Speaker 2: is about one percent. So this isn't a function of
Speaker 2: a runaway demand the US, which is obviously growing at
Speaker 2: a much more rapid clip. There's a terrific inflation series
Speaker 2: run by the San Francisco FED, and they break down PCE,
Speaker 2: which is one of the which is the Fed's preferred
Speaker 2: measure of inflation, at least before wash. We'll see if
Speaker 2: it changes. But they break down PCE into what they
Speaker 2: call cyclical components, so those that are sensitive to the
Speaker 2: economy and acyclical components. Core PCE is running about three
Speaker 2: point three percent as of the last data for April.
Speaker 2: About sixty percent of that comes from the acyclical components,
Speaker 2: and that's been accelerating over the last two or three years.
Speaker 2: So you're in an environment in the US where this
Speaker 2: is this thing about sticky inflation. Once genies out of
Speaker 2: the bottle, it becomes sticky, it starts to feed inflation expectations,
Speaker 2: and it's very, very hard to get it down again.
Speaker 2: That doesn't mean, you know that what we saw in
Speaker 2: twenty twenty two inflation was high single digit It doesn't
Speaker 2: mean that's what we're going to have. But what it
Speaker 2: does mean is that what we used to do, which
Speaker 2: is inflation being at or around the targets of all
Speaker 2: central banks at about two percent, that looks increasingly unlikely.
Speaker 2: And the reason we would then worry about that is
Speaker 2: it means that you can have environments where the hands
Speaker 2: of central banks can be more tied in terms of
Speaker 2: their response to a crisis. If they're faced with a
Speaker 2: if they're faced with the crisis that's driven by inflation,
Speaker 2: they may well be raising rates into that, which is
Speaker 2: what we saw in twenty twenty two. And if they're
Speaker 2: faced with a crisis where inflation is very sticky and
Speaker 2: they don't have enough conviction that it's going to roll over,
Speaker 2: they may not be able to provide what in markets
Speaker 2: we call the central bank put the protection that we're
Speaker 2: used to. And so that can mean that, you know,
Speaker 2: all of the reaction functions and interactions that we've seen
Speaker 2: over the last thirty years can start to change.
Speaker 1: So we've been used constantly to every time something goes wrong,
Speaker 1: central bankstep in, slash rates and everything's just fine again somehow.
Speaker 2: Yeah, and again have to be humble. That could be
Speaker 2: the case, but I think becomes more difficult when inflation
Speaker 2: remains sticky.
Speaker 1: But the core difference then being that previously most of
Speaker 1: these crises could be put down put at the door
Speaker 1: of demand, these demand related crisis and so you slash
Speaker 1: interest rate gen you're off to the races again. But
Speaker 1: if they are supply created crisis, you can't do the same.
Speaker 3: It doesn't work in the same way.
Speaker 2: Yeah, and then you have to ask how robust is
Speaker 2: the portfolio that you're sitting with. How much is it
Speaker 2: an artifact of the old regime, and how much is
Speaker 2: it something that's actually robust to a changing world where
Speaker 2: we don't entirely understand where all the risks are coming from.
Speaker 3: But how do you shift your portfolio?
Speaker 2: What do you do?
Speaker 1: Where is your diversifier? And now we're not going to
Speaker 1: we're not going to get listeners out of equities. That's
Speaker 1: never going to happen. But yet anyway.
Speaker 2: Well, well we could we can go a bit back
Speaker 2: to the conversation we had a year ago, which is
Speaker 2: you diversify the you diversify where our equities are.
Speaker 1: I mean, last time is it? At the beginning we
Speaker 1: talked quite a lot about China. Where where would you
Speaker 1: look now?
Speaker 2: I think if we if I sort of think about
Speaker 2: it in terms of styles, I think higher inflation plus
Speaker 2: greater fixed capital investment in economies, and the fixed capital
Speaker 2: investment is you know capex, that's a function of all
Speaker 2: of the reshoring or energy expansion, all of these sorts
Speaker 2: of things. The combination of inflation plus that tendency suggests
Speaker 2: to me that you want to be in what we
Speaker 2: call shorter duration cash flows, so things with things that
Speaker 2: have a real fixed capital base rather than the sort
Speaker 2: of intangible assets of the last cycle.
Speaker 3: Okay, so it's the halo trade, hard assets, low ups lescens.
Speaker 2: Yes, exactly. Yes, I think there's an awful lot of
Speaker 2: value in that. I think that you know that you
Speaker 2: will find a lot of those companies outside of large caps.
Speaker 2: I'm sort of repeating what I said again last year,
Speaker 2: but I think these.
Speaker 3: Are probably still value on the small caps.
Speaker 2: Yeah, smaller caps for sure. I have to say I
Speaker 2: and this is a personal Everything I'm saying is a
Speaker 2: personal view, but I think that you know, I think
Speaker 2: we had a very weak dollar, which helped a lot
Speaker 2: of the rest of the world. The dollar then got
Speaker 2: a bit bid again around Iran, most recently in the
Speaker 2: last week. It's been bid again because the markets read
Speaker 2: on Wash was that he's hawkish. My take is really
Speaker 2: what Wash is doing personal view is that he's he's
Speaker 2: really he's guiding us towards a different type of guidance.
Speaker 2: He's essentially saying this, you know, forward guidance is finished
Speaker 2: and we're going to be a bit less data dependent.
Speaker 2: I don't think that means he's extremely hawkish. I tend
Speaker 2: to think it probably means the dollar is going to
Speaker 2: be a bit weaker and there are dollar beneficiaries out
Speaker 2: there to be had in equity. So equities, you know,
Speaker 2: I think you can continue to divers if I continue
Speaker 2: to look for that. As you say, halo is a
Speaker 2: good way to think about it. I think then, you know,
Speaker 2: then you have to question, well, what role the bonds
Speaker 2: have in your portfolio. Bonds still have a fantastic role
Speaker 2: in the portfolio, I think, you know, particularly for us
Speaker 2: in the UK, you get this opportunity from time to
Speaker 2: time to buy a low coupon bond with a discounter
Speaker 2: part and you don't pay capital gainst tax on that
Speaker 2: if you can hold it to maturity. So you know,
Speaker 2: these are still really excellent ways to get a kind
Speaker 2: of guaranteed return with a tax efficient approach. But I
Speaker 2: would what I think, what we the way we think
Speaker 2: about that is bonds have many uses, but it may
Speaker 2: not be that they are reliably diversifiers. You know, we
Speaker 2: think that this is actually a golden age for alternative investing.
Speaker 2: To be frank that that alternative assets alternative investments have
Speaker 2: been quite out of fashion for a long time. They
Speaker 2: haven't been required because it's been an environment where the
Speaker 2: returns you got from equities were so fantastic that you
Speaker 2: just didn't need to bother thinking about diversifying any a
Speaker 2: way to things that are lower return and lower volatility.
Speaker 2: But liquid alternatives that have little or no beta to
Speaker 2: the market, that are genuinely diversifying, and a liquid what.
Speaker 3: Is a what is a liquid alternative asset?
Speaker 2: Liquid alternatives are you know, funds that are not directional,
Speaker 2: so hedge funds in nomenculture, but they are, you know,
Speaker 2: in our world, extremely diversified. They combine many different approaches
Speaker 2: to capturing different risk premium in markets. They're not directional,
Speaker 2: they may be market neutral, and their ways to essentially
Speaker 2: extract returns out of the market that don't rely on
Speaker 2: what's happening in beta, They don't rely on market direction.
Speaker 2: It's interesting that you know that these have been very
Speaker 2: out of fashion for a long time.
Speaker 1: Both while you don't need you don't need them. You
Speaker 1: can be long only at ten to fifteen percent a year.
Speaker 1: You don't need somebody that's going to go market neutral
Speaker 1: for you.
Speaker 2: Exactly right. And actually, but in the institutional case, so
Speaker 2: with our biggest investors, it was it wasn't so much
Speaker 2: we'll just have more public equities, it's we'll have more privates,
Speaker 2: and that that decision is starting to be reframed again.
Speaker 2: And the interesting thing about actually a lot of liquid
Speaker 2: alternatives hedge funds is that many of them in fact
Speaker 2: benefit from higher inflation. I mean, we've done quite a
Speaker 2: lot of work at looking at equity long short in
Speaker 2: different different inflationary regimes. Equity on short tends to do
Speaker 2: better when inflation's high. I think the reason for that
Speaker 2: is because as interest rates move higher, as the refinancing
Speaker 2: of debt becomes more expensive, companies are required to do
Speaker 2: more idiosyncratic remedial work to keep their head above water.
Speaker 2: But yeah, we think that as inflation moves high, and
Speaker 2: as interest rates through hire and the cost of debt
Speaker 2: moves higher, it forces companies to do more and that
Speaker 2: means you get more dispersion, and that makes a greater
Speaker 2: opportunity for stop picking, selecting good from bad, and so
Speaker 2: returns to equity market neutral equity laun short strategies get
Speaker 2: better as inflation goes up, so that's quite an interesting diversifier.
Speaker 2: I think the trick in all this is diversify your diversifiers.
Speaker 2: In the past, we didn't need to. You just bought bonds.
Speaker 2: Today you need to have a much much broader toolkit.
Speaker 3: Explain to me.
Speaker 1: I really enjoyed your euphemism about decisions about privates being reframed.
Speaker 2: I think that that you go back to the nineteen
Speaker 2: eighties when the endowment model emerged, which was the sort
Speaker 2: of bible of investing in you know, investing across a
Speaker 2: much broader pool of assets and including privates in it.
Speaker 2: There was an illiquidity premium right if you were able,
Speaker 2: if you were an endowment or an asset owner that
Speaker 2: had a very very long time frame for your liabilities,
Speaker 2: if you you know, required your money over very long
Speaker 2: periods of time, there was an inquidity premium that you
Speaker 2: could harvest, which was, if I'm prepared to lock my
Speaker 2: money up, I will be rewarded for that. And there
Speaker 2: was you know, the cohort of managers provide those services
Speaker 2: was much smaller. Today, the universe has grown enormously. Many
Speaker 2: people with much shorter liabilities have been pushed into it,
Speaker 2: and we can see that, you know, the exits for
Speaker 2: many private companies in the equity space are much more
Speaker 2: challenged and the returns that are diminishing over time. And
Speaker 2: I think what we certainly see among not all of
Speaker 2: our institutional clients, but certainly some of them, is that
Speaker 2: you know that the returns are starting to become a
Speaker 2: bit underwhelming. There is probably more risk that they have
Speaker 2: in their private equity portfolio that looks comparable to their
Speaker 2: public equity portfolio that you know that it may be
Speaker 2: in both VC and P and private credit. There's more
Speaker 2: of the AI ecosystem in there, you know, than they
Speaker 2: previously was the case. So it's less diversifying and in
Speaker 2: many ways, you know, in the next cycle, if there's
Speaker 2: a down leg, there will be the same downward vulnerability
Speaker 2: in these assets that there is in their public portfolio.
Speaker 2: So I think, you know, certainly the com among some
Speaker 2: of our institutional investors is moving onto thinking well, these
Speaker 2: are probably not going to be diversifying for us now.
Speaker 1: Yeah, So moving to the bit where lack of liquidity
Speaker 1: will come with a discount rather than a premium.
Speaker 2: Which makes more logical sense. It may well be that
Speaker 2: case exactly right. Yeah, yeah, so yeah. I think everyone
Speaker 2: in essence, whether you're a CIO of a sovereign wealth
Speaker 2: found managing half a trillion dollars or someone making decisions
Speaker 2: about you know, their ISA, we're all faced with the
Speaker 2: same question today about how you achieve diversification from this great,
Speaker 2: big common factor, which is, you know, concentration in markets
Speaker 2: and beta and expensive valuation.
Speaker 1: Might we do some of that diversification with gold? It's
Speaker 1: pretty horrible a few months.
Speaker 2: Yeah, I mean, look, I think I think gold still
Speaker 2: is a very interesting asset. I have to say right now,
Speaker 2: based on what I've just said about the dollar, I
Speaker 2: quite like it personally. I think that actually, you know,
Speaker 2: if we start to work out overcoming weeks and months,
Speaker 2: that what Warsh has said is not explicitly hawkish, but
Speaker 2: more giving himself the flexibility to respond to a changing
Speaker 2: outlook as he sees it, and I think he will
Speaker 2: be less data dependent and more dependent on his expectation
Speaker 2: for what's happening in the economy. So it's a bit
Speaker 2: more opaque. I think if that's the case, and that
Speaker 2: a lot of people who know Arsh say that's how
Speaker 2: he thinks, then it's a week dollar, and I think
Speaker 2: it was a week dollar. We're probably going to see
Speaker 2: some support coming back under gold. I don't think that
Speaker 2: the the demand from the rest of the world central
Speaker 2: banks for gold has changed. You know, part of fragmentation
Speaker 2: deglobalization is that people are looking for other reserve assets
Speaker 2: other than the dollar. So I don't think that's changed.
Speaker 2: So yeah, I think there's some back.
Speaker 1: Toup of demand from the certain bank remains a week
Speaker 1: dollar gives.
Speaker 2: It some some sre and some impetus to move higher.
Speaker 2: Maybe the way to question the role of gold is,
Speaker 2: as we saw in March, is that that at various
Speaker 2: points in time, can become a risk on asset rather
Speaker 2: than a diversifying asset. So I think it's an interesting
Speaker 2: asset to have in your portfolio, but it isn't necessarily
Speaker 2: something reliably that you want to bank on to bail
Speaker 2: you out when equities are doing badly.
Speaker 3: We talked last time when we were talking about gold,
Speaker 3: well we always do this. We talked about God.
Speaker 1: We also talked about cryptocurrencies, and in particular we talked
Speaker 1: about bitcoin slightly separate asset to other crypto.
Speaker 3: Any change in your views there.
Speaker 2: I mean, no other than other than I'm really, really
Speaker 2: amazed that the amount of policy support crypto has had
Speaker 2: in the last sixteen months. Never in my imagination would
Speaker 2: I have I conceived of the possibility that it could
Speaker 2: have that much policy support in terms of sort of
Speaker 2: you know, legitimization and regulation and do as badly as
Speaker 2: it has. So I think we're sitting here today scratching
Speaker 2: our head and wondering what the utility of crypto is.
Speaker 2: I mean, maybe that just makes it the very best
Speaker 2: time to buy it because everyone hates it. But you know,
Speaker 2: I think you asked me the question last time, gold
Speaker 2: or crypto, and I think, or I hope I said gold.
Speaker 2: You did, and I would still say the same today.
Speaker 3: Yeah, it's difficult, isn't it.
Speaker 1: And we on and on and on we go about
Speaker 1: the use case, the use case, the use case, and
Speaker 1: we never really quite get a compelling enough answer.
Speaker 2: No, I think that's right.
Speaker 3: Okay, last question, last question, onto the fun. But what
Speaker 3: are you going to take to the beach with you?
Speaker 3: Book Wise?
Speaker 1: Book Wise, I don't want to hear about your towel
Speaker 1: and your sontime. What book are you going to take
Speaker 1: on a holiday?
Speaker 2: I would recommend if people are going to the beach
Speaker 2: and they want a really inspiring book. I don't normally
Speaker 2: read non fiction, and I've just read a book called
Speaker 2: The Wide Wide c which came out a couple of
Speaker 2: years ago and is an account of Captain Cook's last
Speaker 2: circumnavigation of the world. And it's a really extraordinary story,
Speaker 2: both how meticulously it's been put together from historical record
Speaker 2: of the time, but actually the thing that I found
Speaker 2: overwhelming at times was that it is only two hundred
Speaker 2: and fifty years ago, and it's extraordinary to remind ourselves
Speaker 2: at this pace of sort of you know, you know,
Speaker 2: acceleration in progress all the time, how young modernity is
Speaker 2: that only two hundred and fifty years ago Cook was
Speaker 2: meeting people that had never encountered outsiders before and was
Speaker 2: exploring parts of the world that weren't charted. And I
Speaker 2: think it's so easy to sort of sit in the
Speaker 2: moment we're in and assume that you know that things
Speaker 2: will progress sort of forever along a path. But it's
Speaker 2: only two hundred and fifty years ago that we didn't
Speaker 2: even know what our own world looked like.
Speaker 3: Excellent. I'm sold. I'm ordering it right now.
Speaker 1: Thank you, Ed, and thank you so much for joining
Speaker 1: us today.
Speaker 2: Thank you.
Speaker 3: Thanks for listening to this week's Marin Talks Money.
Speaker 1: If you like us, show, rate to review, and subscribe
Speaker 1: wherever you listen to podcasts. Thank you for sending your
Speaker 1: questions or comments to Merrin Money at Bloomberg dot net.
Speaker 1: You can also follow me and John on Twitter or x.
Speaker 1: I'm at Mariners W and John is John Underscore Stuffy.
Speaker 1: This episode was hosted by Me marenthumsep Web. It was
Speaker 1: produced by Samasadi and Moses and sound designed by Blake
Speaker 1: Maples and Aaron Caspers Russell.
Speaker 3: Thanks to Ed Cole.