The Exchanges

Q As you look at what's happened over the last couple of weeks in the markets, it seems that the speed of this drawdown across equities and credit is violent to say nothing else. Do you have any views as to why that might be the case compared to other crisis moments in the markets?

A I could take a stab at it. It's dangerous to adhere labels and descriptions to specific events. It'll come out in time, the enormous leverage, and frankly, the enormous losses that have been sustained during this period, and the cool eye of financial history will judge them. But I think the speed of the move, let's think about what often causes abrupt moves in any financial instrument, and it's not just An unpredictable regime shift. It's that people might be over reliant on short term market financing to underpin their positions. That's often a nascent problem. Too much overnight repo to basically refinancing their positions every 24 hours, which can be dangerous. You've also had changes in correlations as a result of two enormous brewing supply side shocks with COVID 19 and the dispute between the Saudis and the Russians. And often when you get these exogenous shocks, correlations flip. And there were an awful lot of strategies out there, Ted, predicated on the fact that a correlations across risk instruments, most of all between stocks and bonds was stable and predictable. And if it's stable and predictable, you can model leverage on that and be somewhat comfortable in your returns. And second thing is that volatility itself was predictable. And if volatility is predictable, I can scale up my exposure to all sorts of risk assets around the world. And I have to say that peopl…

AI assessment note: “I think the speed of the move, let's think about what often causes abrupt moves”

Q What information do you read that you get a lot out of that other people might not know about?

A There is a tremendous amount of information in testimony provided to various parliamentary committees around the world. Now, I know that sounds awfully anorak, but I'll give you a very important example. By definition, if I'm testifying to a House of Commons or House of Lords committee, I am doing so under oath, meaning that it's likely to be more reliable than what you read in the Times or the FT, which will be an interpretation of what's happening in the world. In other words, someone else's view of what's happening. And when it comes to social media companies, the House of Commons Digital Media Committee has been holding hearings in London and Washington about the role and activities of these social media platforms. And not just because I'm personally interested in it, but I've been reading the transcripts of these committee hearings, and it's absolutely awful. And the sanctimonious hypocrisy, not to mention borderline law breaking, that comes screaming out of these transcripts, is just appalling. And it's there in the public domain. And when it comes to a Facebook or a Twitter or some of these other platforms, there are real problems pending. And I found it very helpful, well ahead of this Cambridge Analytica stuff, to just go to the website of the House of Commons and calmly read it, and it is the most appalling. Now, self-indictment's a strong term, but metaphorically, th…

AI assessment note: “There is a tremendous amount of information in testimony provided to various parliamentary committees”

Q some of the right tails. You gave a little hint of Renme B target allocation zero as a left tail, and now we're talking about what feels like the wily coyote after chasing the roadrunner, maybe going off the volatility cliff and then saying, whoops, down below. So those are two little examples, maybe not so little. What are you most concerned about today in the markets that you see?

A At the highest level, it's a very simple one. You have no idea what sufficiently restrictive monetary policy is until you are beyond it. That's the tricky thing. And if the Fed is genuine about risk management with regards to inflation, the Fed is incentivized to overdo it. I mean, let's think about the 2009 to 2019 period because there wasn't much inflation. From a risk management perspective, if in doubt, the Fed was strongly incentivized to be dovish, which they were, and that's flipped. If in doubt, you keep going, and it's not that cliche until something breaks. You keep going until you see evidence, not in advance, in arrears, that tighter monetary policy and higher real policy rates are starting to bite. You're seeing some softening in the US labor market, a little bit of tightening of credit for the real economy, but nowhere near enough To signal the all clear on inflation. I mean, we'll see. Like, seven percent Fed funds or something. We're obviously not there yet. And hand in hand with sufficiently restrictive monetary policy is wider credit spreads. But there's one intermediate point, which I regret I've neglected until now, but it's important in flagging the left tail of what could go wrong. Very roughly speaking, we had 20 years in the US where nominal GDP was about four percent, inflation was about two percent, which meant that you had real GDP of about two percen…

AI assessment note: “You have no idea what sufficiently restrictive monetary policy is until you are beyond it.”

Q How about some opportunities that you're seeing outside the US?

A Oh, there's plenty. It's often interesting to spend time on the things that are less discussed. One of those that's been on the top of my list for some months is Japan. And I don't mean the debate about the Bank of Japan and yield curve control, although that's important. I don't mean the debate in Japan about inflation, although that's important, nor the yen. It's just this really strong structural tailwind in Japan as a result of French shoring, as Janet Yellen calls it, or moving more manufacturing to like-minded national partners and so forth. Japan is well placed there, but there's something else, Ted. There's this amazing story of reform in Japan over the past several years, restructuring dormant companies, giving them a good kicking. Well, if you want to be listed, and you keep having all this cash on your balance sheet, and you're not doing anything with it, I'm sorry, we're going to have to delist you, short yourselves out. One of the happiest hunting grounds For one private equity firm over the past decade has been Japan because they've been able to buy and restructure all these businesses in line exactly with the late Mr. Abe and the current Kushida are interested in, which is this restructuring of corporate Japan, making it fit for purpose. It's like the Inflation Reduction Act. There's a structural tailwind there. That's not about macroeconomics per se, but is goin…

AI assessment note: “One of those that's been on the top of my list for some months is Japan.”

Q It might make sense to wrap with one of your favorite questions, which is, so what? So we've been talking about a lot of the strategic implications of what's happening in the Ukraine and the energy markets on rates on some of the other markets around the world. What do we do with this?

A The largest so what to me is, what if the sanctions don't work? What's next? Not only that, but what's the extrapolation read across to China? And what does this all mean for Taiwan? That's the big so what for me. Now, I know this is not an immediate, okay, I need to do something right now. I get that. But I'm really thinking hard about, we've got this situation where large global financial institutions, I should say banks really, Are self-sanctioning all their Russian counterparty exposure. What does the world look like if we all start to self-sanction Chinese exposure? Because many, not all, but many of the arguments that people are deploying now to justify sanctions and other penalties against Putin and his regime, you swap a couple of words around, and it makes you think this is Taiwan at some stage, and that's what I'm really worried about. Now, look, The counterargument is, you must be kidding me. The economic cost of the West self-sanctioning from renminbi assets, Chinese supply chains on the Chinese economy, you must be kidding me, because there's a huge cost to pay. And Xi Jinping has played a blinder by betting that the more entangled Western capitalism was in the Chinese economy and financial system and renminbi assets, The much lower, the pain threshold that the West might have to ever punish China or Chinese adventurism across the Taiwan Straits. I don't know. But …

AI assessment note: “The largest so what to me is, what if the sanctions don't work?”

Q How about turning to China? A lot going on the trade war and changes in the economic picture domestically.

A It's breathtaking to watch what is the biggest macro prudential experiment of all, which is China trying to come to grips With its shadow banking sector. And for the past two and a half years, China has been focused on a deleveraging campaign. And there's been endless commentary over the past two years about how China must stimulate, or something's going to break, or something's going to blow up, or the Renminbi's going to go down. You know, it's endless commentary about what can go wrong. Now, to be clear, Shadow credit creation, if you will, in China has been the engine of growth, and for two and a half years the Chinese have not been trying to deflate shadow banking as much as arrest the growth of it, and they know full well that from time to time that will cause problems in terms of credit intermediation to households and SMEs, which are critical. We saw an example of that in late 2018. So successful was the deleveraging campaign, if you want to think about it that way in China, that they turned the spigots off too much, that the credit stopped flowing to households and SMEs, and then in early 2019 they had to correct again. Well, what's interesting is through most of last year, especially the last two quarters, Ted, the commentary was, oh, trade war, Chinese economy slowing, yes to both. Oh, there's some problems with credit provision to SMEs and households, ongoing proble…

AI assessment note: “China trying to come to grips With its shadow banking sector.”

Q Within that, what are you hearing of some of the favorite ways to play that theme?

A There are certain ETFs. There are certain businesses. People are looking at specific businesses that are doing the build out. The fluors, the Schlumbergers, insert any major US industrial supplier here, the warehouses, all that sort of thing, even the steel. One example I've been looking at over the past three months is a UK company named Ashtead. They have a very, very strong US business, Sunbelt Rentals. Ashtead gave their earnings up. They presented all sorts of charts. On the spillovers of the Inflation Reduction Act. And to see a list of all these, frankly, not mega projects, but hyper projects that are coming out is absolutely staggering and whisper it. But this is the sort of industrial capex you normally only see in wartime. It's immense. So whether it be an Ash Ted or certain of those other names, they to me seem very well placed to take advantage of this. And then there'll also be other businesses that will be required to train up the workforce and everything else. So there's a whole range of multiples. And by the way, I should add, Ted, that it's not just the Inflation Reduction Act at the federal level. There are also many states providing similar incentives, but this is one of the most profoundly impactful fiscal programs that we've seen in a long, long time. And frankly, if Mr. Trump had announced the Inflation Reduction Act, The world would be jumping up and down…

AI assessment note: “People are looking at specific businesses that are doing the build out. The fluors, the Schlumbergers”

Q Where would we see the lack of functioning of the treasury curve as you're paying attention to that?

A This is where I'm afraid we need to get a little bit technical. For the past five years, there has been a positive carry trade available to relative value fixed income traders around the world, and it has been very profitable. And for reasons we won't get into, treasury futures are trading more expensive than their equivalent duration treasury bonds. So for example, if I'm a relative value fixed income fund, I could buy a 10 year treasury. Leveret via repo, which got very tight for these guys last September. And I can sell the equivalent amount of 10 year treasury futures against it. And let's say, for example, earn positive five to seven basis points. Now that's normally a fairly stable, predictable relationship and it's fixed income arbitrage, one Oh one. There's nothing new about it. People have been doing it for decades. So I say to myself, Ted, I am going to lever up a long treasury bond position. I'm going to sell a tremendous amount of futures against it. And all in all, I might run that position for four or five years, 40 to 50 times levered. And I know that sounds extreme. But that's what people do. And it worked very well for five years until it didn't. So that's the first indigestion problem for the Treasury bond market. And then, surprisingly for a lot of people, what promulgated the colossal unwind of all these RV positions was the Fed cutting those 50 basis points…

AI assessment note: “treasury futures are trading more expensive than their equivalent duration treasury bonds”

Q Well, it's confusing times, and so I would love to start by asking you, what is most on your client's mind?

A It's like every family car journey, are we there yet? That's the number one question. Are we there yet? Is monetary policy sufficiently restrictive? How should I think about credit growth stocks? How should I think about opportunities? Are we there yet? Is there a rising probability that central bankers can finally signal mission accomplished? So yeah, are we there yet? It's the number one challenge for all of us. Is it safe to take on more risk? Should we be more defensive? Have we outlawed recessions? All these kind of questions, and it's been a very remarkable three years and a very remarkable 18 months, because I don't think any of us would have imagined that in the context of the most rapid rate hikes any of us have experienced, that the fallout of that could be so limited.

AI assessment note: “are we there yet? That's the number one question.”

Q is what you've just described is the Fed assuming, let's just call it at best mark to market losses at banks. Someone has to take these losses. We do have this eight percent deficit. Where does this go? How long can you keep Socializing these losses without what seems like a political will to either raise taxes or rein in budgets such that eventually you can pay off these losses.

A One of my clients reminded me yesterday of the difference between emerging markets and developed markets. And he said, in a crisis, emerging markets see their yields go up And in a crisis, developed markets see their yields go down. The reason being that developed markets by and large are permitted by reason of standing to print their way out of trouble. And that's generally true of developed markets. When there's a crisis, because there's perceived policy credibility, yields tend to fall. And unsurprisingly, in the world's reserve currency, The United States has benefited from exactly that. But it feels a bit different this time, because again, that budget deficit situation, the US relying on the kindness of strangers. Some of the biggest recyclers of dollars do not appear to be terribly in love with US treasuries anymore. And then you've got these growing socialized losses. You have high inflation. In the background, I hear every day all these voices saying, oh yes, don't worry, the Fed will be compelled to do yield curve control to peg the Treasury curve. That's how we get out of Dodge. And I'm like, well, ok, if we dare to believe that the Fed is going to be the money printer of first resort, and basically buy the entire Treasury curve, where does that put the dollar? That's all to be resolved in the future, but of course, you're asking the right question. Socialization of …

AI assessment note: “Depends on your ability to roll over all your sovereign debt at a fairly predictable”

Q What does the maximum regret look like in your client's eyes?

A Let's again think in practical terms. One client said to me this morning, we are all Euro stocks banks now. Everything is trading off estimated or real damage to European financials combined with a bit of energy volatility. And let's just stick with that. For a number of good fundamental reasons, global investors were starting to return to European financials. There are a number of good fundamental structural changes afoot. European banks were starting to return an awful lot of capital, boost buybacks, increase dividends. The economic outlook in Europe, up until recently, looked pretty good, and you saw a slow, steady appreciation in European bank stocks. Well, not anymore, and everyone's now an expert about how bad the situation's going to be in Europe, and indeed, Ted, if one takes the belligerent pronouncements Of European politicians and policymakers at face value, it seems that in an effort to thwart Mr. Putin, Europe is prepared to tolerate a recession, or at least something that looks awfully like a textbook definition of stagflation. So unsurprisingly, there's been some people trying to get out of their positions in European financials, but that's the short-term money. The long-term money is like, oh dear, We had a number of cogent reasons to own European financial institutions, but this is a very real exogenous shock. What do we do? Now, in putting some numbers on it, …

AI assessment note: “then it's a bit of a dilemma for the patient long-only investor”

Q You know, should rates normalize? Can we afford this? And what happens? Take me through your thoughts.

A When I think about central bank reaction functions, First and foremost, I say to myself, what would I do if I was one of them? That's got to be the starting point. And we know so well, Ted, that there's been this great tendency over the years by market observers and commentators to project their opinion onto central banks. They will, they must, they should, they shouldn't. This is crazy. Doesn't matter. It just Doesn't matter. And if you imagine what it's like to be sitting around that table when the Federal Open Markets Committee meets in Washington with their mandate and their institutional imperatives, and not only that, but everything they've had to do over the past several years, you too would be slow and gradual. And if inflation does perk up, that is a high class problem to have, given everything you've had to do. It has been the only game in town, particularly in Europe, and probably will be in most jurisdictions for a long time to come. So we can huff and puff about balance sheets, or we can say, what are these people most likely to do in their seat? What are their incentives? That's the key point. Now, the Fed gets criticized for their communication, and I have to say, over the past 18 months, they have been so transparent and so clear about what they're trying to do, and yet, up until recently, markets were fighting it. I mean, you had this extraordinary event in Mar…

AI assessment note: “you too would be slow and gradual”

Q All right, let me rephrase the question. Are there any things that you see that you suspect are common knowledge that you have a different opinion about?

A I am struck by the number of people who claim to be China experts, because I don't know what that means. I encounter a lot of people who are very good at a particular part of understanding China. So there'll be the person who's very good on shadow banking and wealth management products and Chinese plumbing. Which unfortunately tends to mean that they look at China entirely through the prism of their knowledge, and unsurprisingly for the past 18 months, oh, it's all going to hell, you know, deleveraging. And then there'll be the person who's looking at, ah, the Chinese technology giants, and everything's going to the moon. And then there'll be the property person, and everything's going to hell, and you go round and round. Look, let's face it, unless I'm on the Politburo Standing Committee, I'm not gonna know too much, as designed. I'm just not. And this narrative that China must, would, should, they have to, this, that, and the other, I think we need to be very careful with that. So the common assumption that worries me most about China is that they must have a subprime-like crisis at some point. I'm not sure about that. A financial crisis, some kind of credit cycle, liquidity cycle, defaults, for sure. But to use that subprime mental model and apply it to something as complicated as China or anything else, I think is a bit, bit dangerous. When it comes to, for example, shadow …

AI assessment note: “the common assumption that worries me most about China is that they must have a subprime-like crisis”

Q Why don't we start with how you got started in this?

A I think it was almost an accident. I never had any inclination to get into financial markets, but my father was, and actually still is at the age of 81, a very good Australian value investor. So there was a little bit of financial markets and investing D and A there somewhere, but it wasn't until I was at university that I thought, okay, I'll make a go of that and Worked for Macquarie Bank in Sydney and foreign exchange and so forth, but I'll spare you the sad tale of my lamentable sell-side career. I think we're cutting to the chase is how did I end up running my own business for the past nine years and, you know, rather lucky than smart, and unfortunately we have to get into my experiences as an employee of AIG Financial Products.

AI assessment note: “I think it was almost an accident. I never had any inclination”

Q As you look around the world to asset markets as opposed to rate markets or currency markets, where do you see risk?

A I think the number one risk is the assumption that long-term interest rates can only go down. That's the number one risk. That underpins, I think, Nearly every major asset allocation around the world. The assumption that we are perpetually mired in some sort of secular stagnation. But Ted, secular stagnation is a euphemism for policy failure, meaning that secular stagnation is a choice. And we're just starting to see in this country, now the long-term consequences of going for it with tax cuts, not to mention the extra three hundred billion Spending that they shoved into the budget in January at this stage of the cycle? Well, there'll be some consequences, but one of those consequences might be sharply higher long-term interest rates in this country, which means that the discount rate that people need to apply to evaluate various assets for the first time in many years goes up potentially a long way, and I don't think markets are ready for that, and I think the market's ability, as we've seen recently in BTPs, to intermediate An abrupt change in thinking is impaired compared to previous cycles.

AI assessment note: “discount rate that people need to apply to evaluate various assets... goes up”

Q And what's happened with the levels of those swaps generally over these last couple of weeks?

A They have gone wider, which is no surprise. Put it this way. If JP Morgan CDS, and I want to be very clear, JP Morgan is the ultimate too big to fail because they have created themselves as the ultimate too big to fail. That is diamonds, frankly, genius. If JP Morgan senior CDS has doubled, and I don't want to mention names here, But certain buy side firms have more than doubled, which to me makes a lot of sense. And then Ted, I've been concerned about this for many years. If I'm an allocator, and this is the absurdity of our modern financial system. If I'm an allocator to a particularly large buy side firm, and I say to myself, gosh, I can't redeem, but how do I justify to my superiors that I've done my best to hedge? I start shorting that stock. And I know it's absurd, but I've actually seen it happen over the past two weeks, and that's not a good look. It's not a good look, frankly, also, when certain hedge funds are shorting the shares of their prime broker, who at the end of the day determines whether that hedge fund stays in business or not. So just to be clear, for the benefit of listeners, prudentially regulated banks are not terribly troubled by those fellows. Non-bank financial institutions who may have done some silly things. I'm watching like a hawk. And final point, all the best buy side firms with whom your listeners, to whom I should say your listeners may have a…

AI assessment note: “They have gone wider, which is no surprise.”

Q And what was the intent of what you were going to set up?

A The intent was to help investors of all kinds understand how things work. That was the premise, and as you know so well, you know, you can start with all these whiz-bang ideas and slogans of what your business is, but guess what? You learn by doing. So the first premise was, can my young family and I be at least as comfortable as we are today By having a go at this? And the answer was, yes, we can, so let's do it. And my wonderful wife was so encouraging, and I think, I'll paraphrase, but I think it was roughly, what have we got to lose? And that's what you need, right? You need that domestic support, right? And, and I was very lucky there too, but, and here's the amusing bit. So I drew up a, had a spreadsheet of all these people who'd been receiving my, in inverted commas, insights during the crisis. And I divided my distribution list into people who were a slam dunk to sign up for Aitken Advisors LLP on day one, people who were fifty-fifty, and then people who were no chance at all. And guess what? I start on day one, and nearly the entire client base is people I had bracketed is never going to sign up. It just goes to show. Yeah. It just goes to show. But look, I was very, um, I got to work with extraordinary people. Uh, I got to connect with extraordinary people, and, and of course, by the time I finally kicked off on June the first, 2009, the world had changed. The bottom …

AI assessment note: “The intent was to help investors of all kinds understand how things work.”

Q And I think at the right price, it could frankly be you and I. Well, let's take that and walk through getting into the markets, what you see as some opportunities and risks from this environment. And, and why don't we start with the opportunities? So it's not all gloom and doom.

A That's actually a really good point. It's never all doom and gloom, is it? It's never is. And as you told me when we had that lovely lunch a month ago, The hardest day to invest is today. It's always, ah, it's so hard to invest. No, it isn't. Somehow people have coped with investing for centuries, Ted. How on earth did they do it? And as we all know, there's been a whole lot worse things happening in the world than are happening today. It's not to negate some of the challenges we face, but boy, oh boy, there's been some much more difficult investing environments than June, 20, 23. So the hardest day to invest is today, and the hardest thing to do when everyone is jumping up and down and screaming like they are today is to keep an open mind. And I think I said to you in one of our earliest discussions that as much as everyone thinks macro is what's going wrong, it's so important to keep a view of the right tail of the distribution in macro, which is what's going right, or what could be going right. And it's harder and harder to do when everyone's on recession, Ross, but that's okay. First one through a few practical things. If government's going to borrow a lot of money and spend a lot of money, how do I align myself with government? Goes back to the earlier point. I think the multipliers and impact of the Inflation Reduction Act, people are barely beginning to understand how po…

AI assessment note: “multipliers and impact of the Inflation Reduction Act, people are barely beginning to understand”

Q So if you agree with the thesis, and you want to get ahead of that tsunami, what do you recommend you do with your portfolio?

A Well, first and foremost, scrub it. And then, alas, think about which labels others might apply to it. Now, if I'm fortunate to have been ahead of this, there's not much else I have to do, because I may have already tilted it towards renewables, or at least thought deeply about the climate slash ESG impact of my existing assets, and how I might be hurt if the divestment comes. So ideally, I've already adjusted. In terms of the range of assets I'm thinking about, well, get me listed wind farms. Get me Clean tech. You know, we go down the list. Get me all that sort of stuff. Get me out of Shell. Great company, but get me out because I can't be seen to have too much. Get me out of Total. And as we're discussing earlier, this is an important point. It's not just the investors that are thinking about this transformation, Ted. It's also the companies. They're not sitting still waiting to be punched by the divestment. Whether it be British Petroleum, now known as Beyond Petroleum, they tried that change a decade ago, it didn't quite work out for them, but Total, gigantic European energy company, well run, good shape, now one of the world's largest forestry businesses. Airports, not that LaGuardia is a tremendous example of a world-class airport, Ted, but should the Port Authority of New York and New Jersey stand there, or have people stand at the entrance to Newark, JFK and LaGuardia …

AI assessment note: “first and foremost, scrub it... Get me listed wind farms. Get me Clean tech.”