WEBVTT - The Bull Case for Defense Stocks Could Be for Real 0:00:02.600 --> 0:00:07.400 You're listening to Asia Centric from Bloomberg Intelligence, the podcast 0:00:07.440 --> 0:00:10.520 that pulls back the curtain non global business so you 0:00:10.600 --> 0:00:15.120 can invest better across the Pacific rim. I'm Tom Corbett 0:00:15.160 --> 0:00:16.280 in Hong Kong. 0:00:16.239 --> 0:00:19.960 And I'm John Lee. Equity markets appear to see smell 0:00:20.280 --> 0:00:24.319 and hear no evil. The MSCI China Index is in 0:00:24.360 --> 0:00:27.240 a bull run, up twenty percent from its lows. The 0:00:27.320 --> 0:00:30.120 S and P five hundred is still up nine percent 0:00:30.200 --> 0:00:30.920 this year. 0:00:31.000 --> 0:00:34.919 But Chinese and US stocks could be ignoring a fundamental 0:00:35.080 --> 0:00:39.600 shift in the narrative. Geopolitical risks run fast and thick. 0:00:39.880 --> 0:00:44.760 Global military spending is rising, and investors are shifting their 0:00:44.800 --> 0:00:46.560 priorities accordingly. 0:00:46.479 --> 0:00:49.559 Where do the risks and opportunities lie and how can 0:00:49.680 --> 0:00:53.440 invest this profit from the worldwide increase in defense spending. 0:00:53.960 --> 0:00:58.280 Let's bring in Sean Darby, equity strategist at Miss zu 0:00:58.360 --> 0:01:02.480 Ho Securities. Sean, it's great to have you on Asia centerc. 0:01:03.000 --> 0:01:06.039 Good morning, Tom and John am also very grateful to 0:01:06.120 --> 0:01:11.320 be your participants in this podcast. Thank you, Sean. 0:01:11.840 --> 0:01:15.160 The world's equity markets are on a tier. The geopolitical 0:01:15.240 --> 0:01:18.560 backdrop seems to be fraught with risks, though in the 0:01:18.680 --> 0:01:22.360 US and China as well. Stocks are very strong. What's 0:01:22.440 --> 0:01:26.120 going on? Are the markets ignoring risks? Do they know 0:01:26.200 --> 0:01:26.880 something we don't? 0:01:27.680 --> 0:01:33.199 I suppose equity investors are conditioned to follow growth signals, 0:01:33.280 --> 0:01:37.160 and for the best part of the last twenty five years, 0:01:37.440 --> 0:01:41.880 equity investors had good reason to ignore inflation worries and 0:01:42.319 --> 0:01:44.960 really relied on the growth signals as being the way 0:01:45.000 --> 0:01:49.840 to add or subtract beta to those stock portfolios. And 0:01:50.000 --> 0:01:52.840 put it in the context of just general ass allocation. 0:01:53.520 --> 0:01:58.520 You had a what's called a negative correlation between government 0:01:58.720 --> 0:02:01.920 on prices and equity prices, so when you had bad 0:02:02.000 --> 0:02:05.760 news inequities, it would be a good time for bonds. 0:02:05.800 --> 0:02:09.919 And that correlation started in two thousand when we went 0:02:09.960 --> 0:02:13.240 into this world of low inflation. So it's very different 0:02:13.320 --> 0:02:16.280 dynamics now in the sense that we've not necessarily got 0:02:16.360 --> 0:02:20.480 those deflationary or disinflationary winds, but market participants seem to 0:02:20.520 --> 0:02:24.400 be still conditioned to that one frame of how news 0:02:24.480 --> 0:02:28.079 is taken in terms of growth, and that's generally been 0:02:28.120 --> 0:02:31.000 a good environment for equity investors, and it's no different now. 0:02:31.040 --> 0:02:34.919 In fact, looking across the board, there's very few markets 0:02:34.960 --> 0:02:37.560 globally that are in actually a genuine bear market. 0:02:38.560 --> 0:02:42.160 And when it comes to geopolitical risks, the general playbook 0:02:42.280 --> 0:02:45.320 seems to be that, you know, if there's risks, investors 0:02:45.680 --> 0:02:49.720 head towards safe haven assets. Sometimes oil prices rise, but 0:02:49.840 --> 0:02:53.280 defense docks are usually seen as a great head. Do 0:02:53.360 --> 0:02:56.560 you think geopolitical risks will continue to rise in the 0:02:56.600 --> 0:02:57.400 medium term? 0:02:57.919 --> 0:03:01.120 I do. I'm afraid so. Geopol politics is not an 0:03:01.200 --> 0:03:05.000 easy one for gain equity investors or any asset class 0:03:05.000 --> 0:03:08.600 investors to be able to frame and to measure. There's 0:03:08.639 --> 0:03:11.680 been some work done by some of the Federal Reserve 0:03:11.760 --> 0:03:15.120 Board which produced data going back to the nineteen hundreds, 0:03:15.840 --> 0:03:20.040 and what they do show is that geopolitical events tend 0:03:20.120 --> 0:03:23.560 to occur in clusters, and that you get periods of 0:03:23.639 --> 0:03:28.200 time when geopolitics is a very very strong feature of 0:03:28.280 --> 0:03:30.800 the news headlines, and then it can go away for 0:03:30.800 --> 0:03:34.800 almost two or three decades. And in the context of 0:03:34.960 --> 0:03:38.560 the environment that we've been really talking about, the last 0:03:38.640 --> 0:03:42.720 real period of heightened geopolitics was really around the Cold 0:03:42.760 --> 0:03:47.160 War between America and the Allies and Russia, and really 0:03:47.200 --> 0:03:51.080 from that period from the late nineteen seventies late nineteen eighties, 0:03:51.440 --> 0:03:56.680 we didn't have to incorporate geopolitical risks into our asset 0:03:56.720 --> 0:04:00.480 allocation models because they tended to be either very localized 0:04:00.480 --> 0:04:04.640 affairs or didn't actually infringe upon the developed world at all. 0:04:05.240 --> 0:04:07.440 So I think the takeaway really is that none of 0:04:07.480 --> 0:04:11.640 us in the current investment environment have the experience of 0:04:11.720 --> 0:04:14.240 dealing with geopolitical events, which may mean that we're not 0:04:14.360 --> 0:04:19.039 very good at accommodating that information. And secondly, genuinely, the 0:04:19.120 --> 0:04:22.679 last time we've had a real rise in geopolitical risk 0:04:22.800 --> 0:04:26.120 has been really almost thirty to forty years ago, So again, 0:04:26.480 --> 0:04:28.640 most of us would not have been investing around that 0:04:28.720 --> 0:04:29.440 period of time. 0:04:30.960 --> 0:04:33.960 So, Sean Darby, you're looking at a generation of investors 0:04:34.000 --> 0:04:37.919 that may not have seen this narrative in the past. 0:04:38.080 --> 0:04:41.159 How would you characterize the change we're undergoing? Would you 0:04:41.200 --> 0:04:44.480 describe it as a paradigm shift? Is that too much 0:04:44.520 --> 0:04:45.360 of an overstatement? 0:04:45.960 --> 0:04:48.880 No, you're right, Tom, I think it is a paradigm shift. 0:04:48.920 --> 0:04:51.760 And the way to think about it is that from 0:04:51.839 --> 0:04:55.839 the response function of governments, for the best part of 0:04:55.920 --> 0:04:59.480 the last thirty years, they've been cutting military budgets as 0:04:59.480 --> 0:05:03.000 a percentage of GDP. So irrespective of some of the 0:05:03.040 --> 0:05:07.160 news headlines and against some of the localized military conflicts 0:05:07.279 --> 0:05:12.240 or tensions. The real trend line has been for governments 0:05:12.279 --> 0:05:16.000 to cut military expenditure as a percent of GDP. So 0:05:16.040 --> 0:05:18.919 if you were looking at this in terms of profits 0:05:19.000 --> 0:05:23.359 for the global economy and all for the major benchmarks, 0:05:23.760 --> 0:05:27.479 the profits coming from the aerospace and defense indices was 0:05:27.520 --> 0:05:31.839 actually diminishing and diminishing very rapidly against that against health 0:05:31.880 --> 0:05:35.760 care and tech. So, again coming back to that earlier question, 0:05:36.160 --> 0:05:39.960 the narrative for investors has been one of which these 0:05:39.960 --> 0:05:45.880 sectors did not necessarily produce outsized profit cycles because the 0:05:45.920 --> 0:05:50.080 government is by and largely the biggest expend purchaser of 0:05:50.160 --> 0:05:53.440 this equipment, and they were actually cutting defense for the 0:05:53.520 --> 0:05:54.720 last thirty years. 0:05:56.279 --> 0:06:00.360 And Sean, which Asian countries and companies do you think 0:06:01.000 --> 0:06:03.479 most exposed to this boom in defense spending? 0:06:04.360 --> 0:06:07.640 That's a very good question. So first of all, to 0:06:07.640 --> 0:06:11.520 put it into a global context, the aerospace and defense 0:06:11.640 --> 0:06:16.880 indices have done relatively well. Now, so as that expenditure 0:06:16.920 --> 0:06:19.799 has started to pick up with the conflict in Ukraine 0:06:20.200 --> 0:06:23.719 and other geopolitical tensions in perhaps the South China seas, 0:06:24.160 --> 0:06:27.560 the aerospace and defense in diseees have started to see 0:06:27.600 --> 0:06:31.400 a profit shift back to them, and that's possibly the 0:06:31.440 --> 0:06:34.600 most pronounced has actually been in the European in decease. 0:06:34.680 --> 0:06:39.240 They've been dramatically out for performed the eurostop first of all. 0:06:39.880 --> 0:06:44.680 In this time zone. What's been interesting is that there's 0:06:44.720 --> 0:06:48.760 been pressure on countries to increase their military expenditure, and 0:06:48.839 --> 0:06:52.280 the most notable has actually been in Japan. Japan has 0:06:52.320 --> 0:06:56.120 come out with the headline numbers which are very, very 0:06:56.160 --> 0:07:01.440 significantly above anything that they've ever done in terms of expenditure, 0:07:01.880 --> 0:07:05.159 and certainly that narrative has been one feature of the 0:07:05.200 --> 0:07:10.720 last five to six years as China's maritime prowess has gained, 0:07:10.720 --> 0:07:14.480 so certainly in Japan has been a very significant change 0:07:14.560 --> 0:07:17.440 in the defense spending. Just to put it into context, 0:07:18.040 --> 0:07:22.480 the average military expenditure globally, if you use twenty twenty 0:07:22.520 --> 0:07:25.080 two to twenty three figures, was close to around just 0:07:25.200 --> 0:07:29.520 two percent of GDP. At the peak of the Cold War, 0:07:29.880 --> 0:07:33.040 it was over six percent. So just to get a 0:07:33.080 --> 0:07:36.480 framing of where we're starting from, we're only just beginning 0:07:36.800 --> 0:07:40.600 to see those numbers change, and for a country like Japan, 0:07:41.240 --> 0:07:45.120 the numbers have actually been extremely low, again below two 0:07:45.160 --> 0:07:48.280 percent of GDP. For the best part of the last 0:07:48.320 --> 0:07:52.160 twenty five thirty years. So Japan has been one of 0:07:52.160 --> 0:07:56.600 those economies which is broken away in terms of expenditure 0:07:56.640 --> 0:08:01.120 of GDP, and because the index tops or the nick 0:08:01.640 --> 0:08:05.440 as a large amount of defense related companies that tend 0:08:05.480 --> 0:08:08.480 to be industrials. That's been shown up in some of 0:08:08.520 --> 0:08:14.240 those numbers. The second economy that's actually benefited quite dramatically 0:08:14.280 --> 0:08:18.520 from the turnaround and expenditure has been South Korea. South 0:08:18.560 --> 0:08:22.200 Korea has always had a very large expenditure of military 0:08:22.320 --> 0:08:26.440 costs to GDP, and because they've also had the in 0:08:26.640 --> 0:08:32.560 situ factories and munitions, they've been able to benefit from 0:08:32.559 --> 0:08:37.080 this sweeping change of orders as the war in the 0:08:37.240 --> 0:08:42.800 Ukraine has intensified. So South Korea, strangely enough, has benefited 0:08:42.840 --> 0:08:46.760 from what has been an external conflict, are not necessarily 0:08:46.760 --> 0:08:50.040 one which they've been sort of perhaps we say, been 0:08:50.120 --> 0:08:53.640 set for, or the conflict that they've imagined that they 0:08:53.679 --> 0:08:57.040 would have with North Korea. Just two other points to note. 0:08:57.280 --> 0:09:03.040 The multipliers on military expenders are extremely high, So when 0:09:03.040 --> 0:09:05.439 you look at governments around the world when they want 0:09:05.440 --> 0:09:08.480 to stimulate an economy, most will turn to some form 0:09:08.480 --> 0:09:12.120 of fixed acid investment building some roads, building some airports 0:09:12.280 --> 0:09:17.120 and so forth. But the multipliers from defense equipment expenditure 0:09:17.320 --> 0:09:21.400 is very very significant because you're involve in very large 0:09:21.440 --> 0:09:24.640 ticket items which have to be built over long periods 0:09:24.679 --> 0:09:28.040 of time. So in terms of the impact from the 0:09:28.080 --> 0:09:31.800 expenditure on GDP and on profits, they can last a 0:09:32.000 --> 0:09:34.560 very very long time. And again I think this is 0:09:34.600 --> 0:09:38.320 something very different from what equity investors would normally be 0:09:38.360 --> 0:09:41.319 looking for, where you build a fab plant in eighteen 0:09:41.400 --> 0:09:44.240 months and in thirty six months you've got profits generating 0:09:44.720 --> 0:09:50.160 orders for ships, aircraft, tanks, large defense items. They can 0:09:50.200 --> 0:09:53.480 go on for six seven years, and the maintenance costs 0:09:53.480 --> 0:09:57.120 and upgrades can be quite dramatic. So this is not 0:09:57.200 --> 0:09:59.760 a short run impact on profits. It's going to have 0:09:59.800 --> 0:10:02.880 a very very long one as we go forward into 0:10:02.880 --> 0:10:06.520 this sort of new dimension, sort of new era in 0:10:06.640 --> 0:10:08.440 terms of defense spending. 0:10:10.080 --> 0:10:14.280 So how can investors reposition themselves to align themselves with 0:10:14.400 --> 0:10:16.400 the opportunity if you want to call it that, and 0:10:16.440 --> 0:10:19.800 these shifted national priorities should they look at it? Is 0:10:19.800 --> 0:10:22.080 this a case of glass half full or glass half 0:10:22.080 --> 0:10:23.840 outdy Well, that's. 0:10:23.679 --> 0:10:26.640 A very good question, Tom. The first is that the 0:10:26.720 --> 0:10:29.960 type of expenditure now that we're going to have come 0:10:30.040 --> 0:10:35.040 under the defense bracket won't just be hard IT ticket items. 0:10:35.440 --> 0:10:41.319 It'll be things such as abilities to use drones, specialized 0:10:41.920 --> 0:10:47.319 navigational equipment. There'll be measures to counteract, as we say, 0:10:47.360 --> 0:10:52.800 computer malware. All of these type of new threats to 0:10:53.160 --> 0:10:57.800 economic systems are becoming increasingly important. And just as a 0:10:57.800 --> 0:11:01.320 maunter of interest in Europe and Europe and the UK, 0:11:02.080 --> 0:11:05.480 they've had to start to spend money on protecting their 0:11:05.600 --> 0:11:10.160 underwater pipelines and cable networks. So again, the threats to 0:11:10.200 --> 0:11:13.360 the system have become very different to what we would 0:11:13.360 --> 0:11:16.480 have expected thirty or forty years ago. So even though 0:11:16.480 --> 0:11:21.240 the aerospace and defense industry sees are defined by this 0:11:21.440 --> 0:11:24.040 type of big ticket items, you're going to see a 0:11:24.080 --> 0:11:27.240 trickle down effect into a lot of other sectors, potentially 0:11:27.760 --> 0:11:31.440 in the software industry, as people have to also protect 0:11:31.480 --> 0:11:35.080 their IT integrity far more from government. So that's the 0:11:35.120 --> 0:11:38.600 first thing to say. The second is quite interestingly, and 0:11:38.600 --> 0:11:42.280 it's something that's afflicted the energy sector, is that because 0:11:42.320 --> 0:11:46.400 of the ESG overlay from many equity investors, they can't 0:11:46.440 --> 0:11:50.520 actually participate in the defense industry. It's a sort of 0:11:50.520 --> 0:11:54.680 off the ground, off the territory area. So if you're 0:11:54.720 --> 0:11:57.960 an equity investor at the moment and you've been out 0:11:57.960 --> 0:12:00.800 of energy in the last three years, defense in the 0:12:00.880 --> 0:12:04.880 last two or three years, you've had some pretty difficult narrative. 0:12:05.000 --> 0:12:11.000 You're forced into very very concentrated bets in very concentrated companies. 0:12:11.520 --> 0:12:14.359 So that's the second thing is that the ESG framework, 0:12:14.400 --> 0:12:16.800 which didn't exist of course thirty or forty years ago, 0:12:16.920 --> 0:12:20.640 has made defense area a sort of very difficult one 0:12:20.800 --> 0:12:24.520 in which they can run their portfolios around. I think 0:12:24.520 --> 0:12:27.920 the last thing to say is that in contrast to 0:12:28.880 --> 0:12:32.560 what we saw in the sixties or seventies, when most 0:12:32.679 --> 0:12:37.160 military equipment companies were actually nationalized or semi nationalized idea 0:12:37.280 --> 0:12:40.880 were under the government, these companies now are listed, So 0:12:40.920 --> 0:12:45.440 there's a lot more choice for portfolio managers in terms 0:12:45.480 --> 0:12:48.439 of the companies that they can select, whereas in the 0:12:48.480 --> 0:12:51.840 past most of them were actually held under the national 0:12:52.080 --> 0:12:55.760 government and there was not the same impact on profits 0:12:56.080 --> 0:12:59.240 as it would potentially be going forward. So I think 0:12:59.280 --> 0:13:04.440 from my side, the portfolio choices are much wider and 0:13:04.640 --> 0:13:09.440 much more internationalized. And again we're talking about a relative 0:13:09.559 --> 0:13:13.280 profit shift from very very low levels. Even now. You 0:13:13.320 --> 0:13:15.800 think you look at the aerospace and defense and disease 0:13:15.880 --> 0:13:18.560 in some of these countries, like in Korea Europe, they 0:13:18.559 --> 0:13:21.840 look quite well, what a extreme move, But actually we're 0:13:21.880 --> 0:13:25.240 probably only in the beginning of this cycle in many respects, 0:13:25.400 --> 0:13:27.560 given the long duration of the orders that are going 0:13:27.600 --> 0:13:29.920 to have to be initiated. 0:13:30.080 --> 0:13:32.680 For the benefit of the listener, some of these defense 0:13:32.760 --> 0:13:36.640 docks have really been on a tear Mitsubishi Heavy is 0:13:36.760 --> 0:13:39.880 up over seventy percent year to date. I think Hanwa 0:13:40.000 --> 0:13:44.240 Aerospace in Korea is also up over seventy percent. So yeah, 0:13:44.400 --> 0:13:48.080 they have been really strong. If I could just talk, 0:13:48.280 --> 0:13:52.199 you did mention Japan. At Japan's in a quite intriguing situation. 0:13:52.840 --> 0:13:57.120 They're not allowed to actually export their weapons. There seems 0:13:57.120 --> 0:14:00.640 to be some potential for changes to the constitution allowing 0:14:00.640 --> 0:14:02.920 them to export some weapons. I think there's been something 0:14:03.000 --> 0:14:05.200 US on the jet fire planes. Do you see this 0:14:05.320 --> 0:14:07.240 happening and could this be a catalyst? 0:14:07.559 --> 0:14:11.280 That's a very good question. So at the moment, there 0:14:11.400 --> 0:14:15.079 are very few countries that, for example, can build planes, 0:14:15.720 --> 0:14:20.120 put together missile systems and do the hardware, and Japan 0:14:20.240 --> 0:14:23.320 is one of those that can do that. Now, there 0:14:23.360 --> 0:14:27.120 is a precedent because as the Ukraine War developed, the 0:14:27.240 --> 0:14:31.440 German government did a u turn on exports of military equipment, 0:14:31.440 --> 0:14:34.480 particularly the Leopard tanks. So the first thing to say 0:14:34.600 --> 0:14:40.320 is that when there is an immediate need for demand 0:14:40.400 --> 0:14:44.840 for military equipment to be moved overseas or into other jurisdictions, 0:14:45.080 --> 0:14:47.600 the German government did show within Europe that it could 0:14:47.640 --> 0:14:51.120 do that. I think the issue for Japan is that 0:14:51.520 --> 0:14:54.640 it certainly can change parts of the constitution and also 0:14:54.760 --> 0:14:58.360 change certain rules. One of the things that's interesting about 0:14:58.440 --> 0:15:01.200 Japan is a lot of the military that is actually 0:15:01.320 --> 0:15:06.960 built domestically is under license from America and from other countries. 0:15:07.480 --> 0:15:11.160 So in a sense, they've got the physical capacity to 0:15:11.240 --> 0:15:15.280 build domestically, but they're actually doing it under international licenses, 0:15:15.320 --> 0:15:17.800 and that's something again very different from what we saw 0:15:17.840 --> 0:15:22.240 in the last thirty or forty years. Companies like Boeing, Array, 0:15:22.240 --> 0:15:25.640 cal and on, all of these type of military companies 0:15:25.720 --> 0:15:30.040 would normally build the equipment domestically and export it. Now 0:15:30.040 --> 0:15:32.680 a lot of it's done unlicense agreements, and I think 0:15:32.720 --> 0:15:35.280 that's very much the case for Japan. So they would 0:15:35.280 --> 0:15:38.240 also need to be mindful of the fact that some 0:15:38.280 --> 0:15:40.320 of us would need to get approved from the US 0:15:40.440 --> 0:15:43.480 or whoever they've licensed those production schedules from. 0:15:45.160 --> 0:15:49.680 Sean Darby, it's difficult to talk about this without bringing 0:15:49.760 --> 0:15:55.160 in America's fiscal situation. In the United States, debt has ballooned. 0:15:55.160 --> 0:15:58.200 In nineteen ninety two, it was what forty six percent 0:15:58.240 --> 0:16:03.440 of GDP Today it's ninety six percent. Politicians tut about it, 0:16:03.480 --> 0:16:07.880 but a handful of voices former Treasury Secretary Larry's summers, 0:16:07.960 --> 0:16:11.280 for one, it shows some sense of urgency about it. 0:16:11.360 --> 0:16:14.920 Is it time to worry? How is America's fiscal situation 0:16:15.560 --> 0:16:18.640 stacking up on your list of concerns? How is it 0:16:18.880 --> 0:16:22.720 shaping the entire geopolitical setting as it's changing. 0:16:24.120 --> 0:16:28.880 One thing about conflicts and wars is that they tend 0:16:28.880 --> 0:16:32.800 to be very inflationary. You're forced into spending whether you 0:16:32.960 --> 0:16:38.040 like it or not. So talking about paradigm shifts, the 0:16:38.160 --> 0:16:40.520 reality is that the defense budgets are going to have 0:16:40.600 --> 0:16:42.600 to go up one way or the other. There's a 0:16:42.720 --> 0:16:45.720 number of threats for these are countries, and they've been 0:16:45.800 --> 0:16:49.560 spending way below what would normally be considered to be 0:16:49.640 --> 0:16:52.760 a baseline case of something like three percent of GDP. 0:16:53.160 --> 0:16:54.920 So the first thing is you're not going to get 0:16:54.920 --> 0:16:57.480 away from that rise in the military budgets. Maybe we 0:16:57.520 --> 0:16:59.800 don't go back to where we were in the nineteen sixties, 0:17:00.120 --> 0:17:03.040 but certainly as a proportion of GDP, it's going to 0:17:03.040 --> 0:17:05.600 go up. So the debt financing for this is only 0:17:05.640 --> 0:17:09.119 going to increase. I think the odd thing about this 0:17:09.359 --> 0:17:11.480 is that it's got to be seen in the context 0:17:11.560 --> 0:17:13.639 that governments are spending an awful lot of money in 0:17:13.680 --> 0:17:16.679 other areas. At the same time, you have a huge 0:17:16.720 --> 0:17:21.240 renewables program, You've got subsidies to bring plants back on 0:17:21.520 --> 0:17:25.480 shore in the United States as well. You've got the. 0:17:25.440 --> 0:17:27.640 Chips entitlement programs in the US. 0:17:27.560 --> 0:17:33.359 Chips Acts entitlement program, subsidies for building plants. So in 0:17:33.400 --> 0:17:39.080 the whole context of expenditure by governments within the economy, 0:17:39.480 --> 0:17:42.200 the share of government spending in the economy is going 0:17:42.200 --> 0:17:44.640 to go up as well, which means much more levels 0:17:44.840 --> 0:17:48.399 of debt issurance. And that's inevitable not just in the 0:17:48.480 --> 0:17:52.800 United States but elsewhere as well. So again from an 0:17:52.800 --> 0:17:56.920 investor point of view, we've had governments generally globally, and 0:17:56.960 --> 0:17:59.240 I would say which would resonate in Europe, which were 0:17:59.320 --> 0:18:03.240 very mindful of their fiscal positions after twenty eleven. You know, 0:18:03.320 --> 0:18:06.199 there was a very conscious awareness that they would not 0:18:06.320 --> 0:18:09.600 go and similarly in Asia, countries would not go on 0:18:09.680 --> 0:18:15.320 heavy expenditures in terms of the budgets. But they're almost 0:18:15.400 --> 0:18:18.280 now forced into this, you know, coming into the COVID 0:18:18.320 --> 0:18:22.600 period with renewables program during COVID to offset the huge 0:18:22.640 --> 0:18:27.280 deflationary shock, and now post COVID where you have geopolitical 0:18:27.320 --> 0:18:30.720 pressures coming through. So to answer your question very succently, 0:18:30.920 --> 0:18:32.719 I'm afraid to say that the debt levels are going 0:18:32.760 --> 0:18:36.320 to go up, and unfortunately, debt issuance is going to 0:18:36.359 --> 0:18:40.800 be a very significant overhang for asset markets going. 0:18:40.560 --> 0:18:45.240 Forward, and then factor in inflation the impact on interest rates. 0:18:45.280 --> 0:18:47.199 It doesn't sound like a very pretty picture. 0:18:48.240 --> 0:18:50.960 Well, it wasn't one during the nineteen seventies, so that's 0:18:51.000 --> 0:18:53.679 the first thing to say. And again there wasn't the 0:18:53.720 --> 0:18:56.920 type of globalization that we had back then. Most countries 0:18:56.960 --> 0:19:00.199 were running some form of capital controls and most the 0:19:00.359 --> 0:19:05.240 debt was owned by the domestic institutions. But the reality 0:19:05.359 --> 0:19:10.720 is that this implicit policy shift between what the government 0:19:10.760 --> 0:19:14.000 wants and how central bankers want to finance. It has 0:19:14.040 --> 0:19:16.840 been going on. You know. Really once we started QI, 0:19:17.119 --> 0:19:19.800 they bought the government bonds, put it onto the balance sheet, 0:19:20.160 --> 0:19:23.480 and there was an implicit monetization of government debts anyway. 0:19:24.160 --> 0:19:26.520 So we've been in this, but not to the degree 0:19:26.560 --> 0:19:29.800 that we've ever really felt thought about that actually, this 0:19:29.920 --> 0:19:32.720 is going to be the game going forward. I think 0:19:32.760 --> 0:19:36.560 again coming back to experience levels, you have a shortage 0:19:36.560 --> 0:19:39.320 of people in Japan who've never seen interest rates go up. 0:19:39.400 --> 0:19:41.639 People are desperate to find people who know how to 0:19:41.680 --> 0:19:46.320 trade rates now. And similarly in the aerospace sectors, there's 0:19:46.440 --> 0:19:49.159 very very few analysts who actually cover these stocks have 0:19:49.359 --> 0:19:52.920 seen the type of changes going forward. And the companies, 0:19:52.960 --> 0:19:56.760 those heavy industrialized companies that John Lee mentioned would not 0:19:56.800 --> 0:20:00.520 necessarily get the same front page coverages as your tech companies, 0:20:00.520 --> 0:20:02.800 but that's profit shift is going to be very different. 0:20:03.040 --> 0:20:05.920 So the context of this and an investment framework is 0:20:05.960 --> 0:20:08.400 a much more difficult one. And as I said, it's 0:20:08.400 --> 0:20:10.840 going to be against the backdrop of much much higher 0:20:10.920 --> 0:20:13.920 yields than we anticipated nearly five or six years ago. 0:20:15.359 --> 0:20:18.000 And sure, just sticking with the US, there seems to 0:20:18.000 --> 0:20:22.920 be some growing concerns about America's manufacturing base. Now one 0:20:22.920 --> 0:20:25.560 of the biggest suppliers is Boeing. Now they've had a 0:20:25.560 --> 0:20:28.840 lot of problems on their commercial jet engine side. But 0:20:28.880 --> 0:20:32.160 there's also some news articles talking about how the US 0:20:32.359 --> 0:20:35.600 Navy is worried that their supplies are not building submarines 0:20:35.680 --> 0:20:37.920 quick enough. I think that someone seenior in the US 0:20:38.000 --> 0:20:41.359 Navy visited South Korea and Japan to see if these 0:20:41.560 --> 0:20:45.919 countries could actually supply navy vessels going forward. Is this 0:20:45.960 --> 0:20:46.680 a big issue? 0:20:47.280 --> 0:20:50.399 Yes, it is. I think again, there's been a huge 0:20:50.400 --> 0:20:54.280 hollowing out of these industries, and one of the features 0:20:54.320 --> 0:20:57.399 of the aerospace and defense industries has been like a 0:20:57.600 --> 0:21:00.320 large amount of M and A activity over the last 0:21:00.359 --> 0:21:03.720 thirty years because to survive, these companies had to scale 0:21:03.800 --> 0:21:07.560 themselves for reduced budgets, and across the board in the 0:21:07.640 --> 0:21:11.920 United States, in Europe, the number of defense and companies 0:21:11.960 --> 0:21:16.120 have been reduced and there's been quite a significant scaling 0:21:16.160 --> 0:21:19.199 and hollowing out. So in the context of trying to 0:21:19.400 --> 0:21:23.760 expand quickly, what you're finding is that not everybody has 0:21:23.800 --> 0:21:26.639 got the physical capacity to meet this level of demand. 0:21:27.359 --> 0:21:29.239 And you know, it comes back to the fact that 0:21:29.280 --> 0:21:33.200 suddenly South Korea found its export profile for defense equipment 0:21:33.280 --> 0:21:36.159 improving purely because they're one of the few countries that 0:21:36.240 --> 0:21:39.320 still produce munitions on the scale that can provide that 0:21:39.640 --> 0:21:42.879 very rapidly. So quite right, John, I think in the 0:21:42.920 --> 0:21:46.560 short term there's a skill shortage in this particular area. 0:21:46.760 --> 0:21:50.760 It's one where there's not enough in situ physical capacity. 0:21:51.160 --> 0:21:55.280 And thirdly, you're going to rely on global allies to 0:21:55.320 --> 0:22:00.840 pick up any shortfall in the production of components and items, 0:22:01.200 --> 0:22:04.840 because again, this is just not being the level of 0:22:04.920 --> 0:22:08.880 demand out there for companies to anticipate putting in any 0:22:08.880 --> 0:22:12.119 physical capacity. So yes, there's going to be quite a 0:22:12.160 --> 0:22:14.640 significant sea change in a way we sort of buy 0:22:14.680 --> 0:22:17.399 and sell equipment from each other because there's just not 0:22:17.600 --> 0:22:20.120 enough of the companies around that can do it. 0:22:21.840 --> 0:22:25.760 Sean Darby, let me paraphrase something that Bloomberg opinion columnist 0:22:25.840 --> 0:22:29.119 Thomas Black recently wrote. He wrote, the flare up of 0:22:29.200 --> 0:22:33.679 Middle East violence, Russia's war in Ukraine, China's stance on 0:22:33.760 --> 0:22:38.440 Taiwan have all shattered the illusion of a peaceful world 0:22:38.480 --> 0:22:41.600 that had taken hold after the Berlin Wall fell in 0:22:41.680 --> 0:22:44.800 nineteen eighty nine and the collapse of the Soviet Union 0:22:44.840 --> 0:22:47.679 two years later. Is that an overstatement or is that 0:22:47.720 --> 0:22:52.840 a realistic take on where we stand today in geopolitics. 0:22:53.720 --> 0:22:55.919 I think it's a very good summary, Tom, and I 0:22:55.960 --> 0:23:00.320 think it was basically summarized being the peace dividend. And 0:23:00.400 --> 0:23:04.320 this peace dividend came through in a number of different levels. 0:23:04.640 --> 0:23:07.919 As you cut the military expenditure in countries, you were 0:23:07.960 --> 0:23:11.679 given tax cuts as consumers, so we all benefited from 0:23:11.840 --> 0:23:15.560 a low tax rate, both income and on purchases. So 0:23:15.640 --> 0:23:17.840 that's the first thing. It was a very big shift 0:23:17.880 --> 0:23:21.960 to the consumer in terms of their spending power. Secondly, 0:23:22.000 --> 0:23:26.360 of course, we benefited from waves of disinflation of goods 0:23:26.400 --> 0:23:29.960 and services because a lot of these countries came into 0:23:30.040 --> 0:23:34.480 the global economy, came through WTO and were trading partners, 0:23:34.840 --> 0:23:37.919 so you benefited from a very big drop in in 0:23:38.000 --> 0:23:42.000 the inflation rate. Thirdly, if you look at, for example, 0:23:42.080 --> 0:23:46.600 the profile of China's purchases of US treasuries, there were 0:23:46.720 --> 0:23:50.960 very big purchases of foreign debt. That's all going to change. 0:23:51.680 --> 0:23:53.600 So I think that summary, Tom is a very good 0:23:53.640 --> 0:23:56.920 one because it works on so many levels. And it 0:23:56.920 --> 0:24:00.520 comes back to this that nobody has the variance of 0:24:00.600 --> 0:24:05.520 dealing managing through the nineteen seventies and governments themselves are 0:24:05.560 --> 0:24:11.160 just trying to reorientate their economic structures. So yes, it's 0:24:11.160 --> 0:24:14.560 a very difficult world in the sense that unless you 0:24:15.440 --> 0:24:19.080 frame it in the nineteen seventies sort of backdrop, is 0:24:19.200 --> 0:24:22.359 very hard to make adjustments that quickly as to how 0:24:22.640 --> 0:24:24.200 people will manage portfolios. 0:24:26.560 --> 0:24:30.600 Our guest has been Sean Darby, equity strategist at Miss 0:24:30.720 --> 0:24:35.960 zoo Ho Securities. It's been a fascinating, engaging and eye 0:24:36.040 --> 0:24:41.399 opening conversation about japan defense spending and the investment risks 0:24:41.400 --> 0:24:46.119 and opportunities in our very rapidly changing world. Sean, it 0:24:46.160 --> 0:24:47.080 has been a pleasure. 0:24:47.480 --> 0:24:49.760 Thank you very much, Tom and John, and being very 0:24:49.760 --> 0:24:52.959