Russell Napier on The Solid Ground, Anatomy of a Bear, The Library of Mistakes and Value | S07 E45

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Value: After Hours is a podcast about value investing, Fintwit, and all things finance and investment by investors Tobias Carlisle, …

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I think we're live. This is Value After Hours. I am Tobias Carile, joined as always by my co-host, Jake Taylor. Our very special guest today is Russell Napia. Uh he's best known perhaps for his book, The Anatomy of a Bear, uh his research service, uh The Solid Ground, uh or his uh the library of mistakes that Jake gave us. uh uh a veggies on a few weeks ago. Um Russell, welcome. >> Great. Thank you, Tobias. Thanks, Jake. Good to see Jake. You could make it to Edinburgh and get to the library. >> Yeah, I much appreciate uh arranging the tour for me and uh I had a great time and then I tried to bring back some of the the things that I saw there to the uh to the audience. So, it was much appreciated. >> Just for a minute, I thought you were going to say you tried to bring back some of the books, but thank good [laughter] Thank goodness you didn't. >> No, couldn't fit them all in my suitcase. Russell, I want to just introduce you to folks who perhaps don't know. I think that um you've done a lot of work on financial history and it's your view, your philosophy that financial history is perhaps a better way to learn than uh economic theory and to that end that's why you've created the library of financial mistakes and written the books and documented so so on. And you've also spent a lot of time looking at very deep bare markets and the uh characteristics of those markets, what a bottom would look like and so on. Is that is that a fair representation of Have I missed anything? >> No, that's about it. I mean just why financial history and why not economic theory? So financial history includes psychology, philosophy, sociology, politics and surely surely when we look out the window today, we realize that we need some of that in our understanding of finance, economics and investment. And I think it's possible to leave university with a degree in finance and not have any of it. Certainly no understanding of economic financial history. Perhaps not even comparative economic thought, never mind politics, sociology, and philosophy. So we stand as an an adjunct to any traditional training in uh in finance, economics and investment. >> And where's the breakdown there? Is it that like there's there initial assumption that's made in economics that then is the keystone that you pull that out and the whole edifice collapses. >> There is there is that is the rational economic man who I am yet to meet. I have a I have a library of 5,000 books and he's not in any of the either. And of course there's a problem because he's not rational. He's not entirely motivated by economics. And of course he's not even a man because half the population of the world are not men. So the problem is that the field of economics has sort of sort of chip away at the rational economic man. He's not completely rational. He's slightly irrational. Uh but fundamentally it's the edifice as you say there's there's something wrong at the core of this. And of course we live in an age where we can understand human behavior much better because we have uh MRI machines, rapid eye scanners where there are breakthroughs going on in neuroscience and psychology. But economics hasn't really adapted that yet because if you take out the rational economic man that cornerstone, many of the equations really don't make a lot of sense anymore. In fact, the whole mathematization of the field to turn it from a social science to a wannabe physical science crumbles. So the rational economic man is a bit like, you know, those guys in the old westerns. It probably take him a long time to die. He'll stumble around, hit a few chairs, crash through a desk, go through a saloon wall, over a window, through a horse, and only then will he be dead. But the death of the rational economic man, I think, has begun, but I think it'll be a long slow death. But Max Plank famously said, uh, science advances one obituary at a time. So we're not expecting revolution here, but we can do our little bit for evolution. Do >> do the behavioral economists uh does their line of inquiry sort of appeal to you as a as a reject as someone people who are rejecting rational economic men? >> Well, I think they're chipping away. I think that's the problem. They're looking for the irrational bits and that isn't enough. I think you need to go back to the very core of this and say, well, what is this person? Rather than to modify the rational economic man. So I'm not critical. I mean it's a huge breakthrough. It's a tremendous thing. Uh and you know but if you think of the work particularly I'm thinking of the work of Daniel Canaman. A lot of it relates to the psychology of the individual and one thing we know about this business is its group psychology and I think there's so much more we can can do. I think it won't be the chipping away by behavioral. Uh all the behavioral stuff will fit very neatly into a new theory uh once we find out what this person really is like. And as I said, advances in neuroscience and psychology mean that can happen. And the behavioral economist will be incredibly useful in being part of that. Uh but they'll just be part of it. I think the root cause lies deeper than slight irrationality. And Russell, do you think there's any of this uh maybe the slow death of this is could be attributed to, you know, we've [clears throat] seen rates from, let's say, early 80s to maybe 2021 going from 15 to zero for and, you know, no one needs to be that smart or needs to really like be that self-reflective when everything's just kind of going up into the right and levitating from rates. So if we were to imagine ourselves as maybe I've heard Jim Grant say here recently that you know we could be in another rates regime for the next 30 years or however much these rate cycles take. Maybe we will have to be a little bit more reflective of these things and maybe they're u any any thoughts on that? Yeah, I think that's absolutely right and I would particularly go to the the nexus between government and market and we had that long decline in rates but we also had for a lot of that period not recently we had a decline in the role of government relative to markets and in that world it's possible to believe that the markets become more important the mathematics become more important and then one morning you wake up and realize that the uh the clunking fist of the government is kind of getting involved in economic decision-making again and you know what then you need to understand the clunking fist uh you need to sort of adjust and rethink how this works. How does this man, woman, rational or otherwise fit within that system. So in other words, a structural change. So once you get a structural change and that is as you say the end of that long decline in rates, but also I think a structural change in the relationship between the state and markets, you need a whole new skill set. Actually I think it exists. most emerging market investors I know and fully understand how the government interferes in capital allocation corruption frankly as well so we have lived in a system and we've come to learn the rules of the system it's been sort of infranchised in economic thought and economic theory but at least I always say to fund managers today if you want someone to look after your portfolio go and hire a South African or a Brazilian you know they they have a different skill set and it may be one we all need now so you're absolutely It's time now to to start thinking differently and we're not in a vacuum. We have other people who've done it before and we have historical examples to to call upon. >> Russell, when you say uh when you when you talk about the government, are you talking about fiscal measures that popular governments make or are you talking about central banks or is it all rolled up into one? >> Yeah, I think that's the interesting thing because if I asked you what is the role of government in markets, we'd go fiscal or monetary and I'm not talking about either of those. I'm talking about regulatory and the certainly the period from 45 to 7980 which is the period I do think from which we can gain a lot of insights actually the power was in the use of the regulatory state in the allocation of capital now that was directly by interference with uh funds investment funds pension funds life funds uh and basically getting them to invest where you wanted them to invest in that case mainly government bonds but if you were in mainland Europe there were lots of industrial sector sectors and infrastructure clearly all had to be rebuilt after World War II. So I'm talking about that's really the task of the regulatory state rather than the fiscal state. Now we know that for many developed world economies the government is kind of tapped out on borrowing. Uh well they're not tapped out if they can manipulate the wealth of a nation, the savings of a nation. So I that's what I mean about Brazilians and South Africans understanding it. These guys were not did not lose their savings necessarily through the misuse of fiscal and monetary authority though misuse of monetary authorities played a role they lost it through the misuse of the regulatory authority of the state and we can see it it's happening it is happening live in front of our eyes even in a country like the United States of America where the rule of law is you know u enshrined really even there we can see the government using leverage to redirect private sector capital flows even not even of American American corporations. I mean, there's quite a lot of leverage by the US administration on Korean and Japanese uh uh corporations. So, that's that's what concerns me, the regulatory state. And of course, it's not something that people write about because it's kind of tedious and boring and has been, as you pointed out, J kind of irrelevant for 30 or 40 odd years, but it isn't irrelevant anymore. >> One of the difficulties, I think, with that regulatory state is it's a little bit faceless. It's hard to find a person or a name or anybody who's making an argument for it. It's just sort of exists there a little bit undetected. >> Yeah, I think it's a great point uh device to because I think what is interesting about it is it's not even necessarily by design. It's like whack-a-ole. You know, the market delivers something the government doesn't want and the regulatory state is put into action to deliver something else. So there may not be some great controlling hand sitting, you know, sitting in the White House or sitting in Westminster, sitting in the rice chancellory. they may just be reacting to market prices, but if you keep whacking the mole with the regulatory hammer, you structure a whole new type of business government relationship. So, uh, if there's a mastermind out there, I've yet to meet him or her. Uh, no doubt maybe one day there will be, but at the minute I think it's reactionary, but you know, what does it matter to us? We have to live with it whether there's a guiding master hand or whether there or whether there isn't. the minute it's all dressed up under the guise of the re-industrialization and reducing reliance upon Chinese uh uh Chinese supply chains uh defense you know those those are the reasons that we need this now once you put the national security thing on it then you can do a lot of this now the new US national security document was published on the 5th of December it's a stunning 29page document because about half of it is to do with economics >> national security document and it's about who America's enemies are and how they have to be punished, who Americans allies are and how they have to be economically benefited and all of the industries that America has to invest in. So using the regulatory state when national security is at stake is the easy way to go about it and and we're in we're in that world. Uh so at the minute it would seem if you read the documents that the guiding hand of this is actually the secretary of war. I'm not sure that's correct, but anyway, at the first blush, this is about preparation for cold war, but I think it'll be much more than that in due course. >> I mean, is there's an irony to me that we that the US has to look more like China in order to not be too beholden to China. >> It's fantastic. I mean I mean I know this will sound u bizarre but I made that point in 1998 during [laughter] during during the Asian financial crisis when I I traveled down to Bali. I lived in Hong Kong then to meet a group of US multinational corporations and they were absolutely cocka hoop. You know the crony capitalism of Asia had been destroyed. Free market capitalism was coming to Asia. Victory was declared. Dare I say mission accomplished. The banner was run. Uh but my point was that in North Asia, which I would include Japan, Taiwan, Korea, and of course, China, there's a very different form of capitalism up there, and it wouldn't be so easily dislodged. I call it so social capitalism. It's not really or hadn't really been focused on return on equity and return on capital. Uh and that was a difficult nut to crack. And so it's proved that the ability and willingness of the Chinese to constantly overinvest and that is the regulatory state at play there has destroyed returns from many good companies in the developed world and as you say Jake has kind of forced us to become a little bit more like them. So they became a little bit more like us. Now we're becoming a little bit more like them for the avoidance of doubt. We don't become communist China. Uh but yeah we're sort of sliding along the continuum uh a little bit. So that syn to me in 1998 it always seemed likely that that synthesis would come along unless someone had very quickly stopped China abusing its exchange rate whether you know using tariffs or something else and of course that didn't didn't happen. So there's a sort of a synthesis going on. As you say, it is rather ironical that we're becoming uh more like China. >> When you have the the government uh controlling the financial system, you have a little bit of subordination of the financial system to the government. So the financial system starts seeking the government's ends. That becomes a I think you've described it as as financial repression. is that and and that's what that was the the era from 45 to 79 was an era of financial repression and now it seems like we've entered back into one again. I don't know when when do you when do you start the date of the >> well can we unpack what that means a little bit first like what are the actual what's the government telling the banks or whatever the mechanisms are of that >> sure so it's not it's not my term it dates to the 60s and as far as I can work out it's a it's a I think he's an American despite his name Ronald McKinnon uh very Scottish name but I think he's an American he came up with the term financial repression it was aimed more at emerging markets but it was effectively how the state uses the savings of a people for its political ends. So the mechanisms are manifold actually in fact it's interesting you can class them in two tr two two two uh two two groups how to get savings where you want it to be through telling it to be there and then the other one is how to make other things so unattractive that they have to go there and and it's a matter of doing doing both so obviously the easy one is to go to say life insurance funds and say as of tomorrow we want 20% of all your assets in US British French German government bonds and that usually happens s during warfare. So that's the most overt thing. Now what you could do there and the reason you would do that is to hold bond yields down while nominal GDP growth is strong. So there'll be a high element of inflation in that and over a prolonged period of time your debt to GDP comes down and the government gets fully funded and everything the government wants to fund gets fully funded but debt to GDP is is coming down. That would be the obvious way to do it. Here in the United Kingdom, we have a thing called the mansion house accord in which numerous pension funds under threat of what's called mandation have agreed to invest a lot of money in uh in direct investment here in the United Kingdom selling overseas assets or at least almost certainly selling overseas assets to fund that. So that's uh carrots and sticks I suppose you'd say to get that. But then all you another very nice example I think is residential property. So residential property in a free market is a has a yield, but it's a sort of an inflation linked yield. And if you put in rent controls, you take out the inflation protection in the yield. And therefore, my residential property doesn't look as attractive as a bond. Well, not necessarily anymore. So there are ways of doing that. You can have very high transaction taxes on equities and no transaction taxes on bonds, which is what the United Kingdom uh did in this period. So the the end goal of all of this is to bring down debt to GDP. But today as well there's a new goal which is to prepare for cold war which we keep getting told over and over and over again by our politicians is imminent. I think the population doesn't want to believe in frankly. Uh but that's what we're preparing for and uh so you now need to also get some of that capital going to fund that re-industrialization program. One final thing I think you should add that's a balance sheet that is kind of fixed. Obviously the savings rate can go up year to year and it goes up a little bit but right at the core of this has to be the commercial banking system. One of the reasons I think commercial banks have done so well this year is a dawning realization that in this system commercial banks are key to it uh and over the long term that may not be wonderful for bank profitability. Uh but it's a kind of reinter reintermediation of credit assets here after a 40-year disintermediation that's probably going to good for bankers. And of course, the beauty of banks is their balance sheets can expand. That's not a fixed pull of money. That's the nature of fractional reserve banking. It creates its own liabilities when it creates its assets. So that's going to be a key key tool for any financial repression. Also, it creates the the money you need to have higher nominal GDP growth. So, I don't know if that unpacked it or lumped it all together. I suspect maybe lumped it all together, but I mean, as you can see, and I think I I didn't say I wouldn't say I've scraped the surface, but I we could talk five, six other things that the regulatory state would would bring to bear on on achieving this goal. >> James Montier, who's a he's a GMO now, but he he wrote a he wrote a paper in I think it was 2010 calling for the era of financial repression. And I'm I'm guessing that was sort of probably based on what had occurred through the global financial crisis and some of the steps that had been taken then that were then starting to manifest in 2010. And he made the point that they can take decades to work through these regimes. Do you have do you have any sort of expectation for I mean we're 15 years in are we 15 25 years to go? So that so there is some reason for optimism in the anglosphere but pessimism elsewhere which is not what you get. What you get if you use the word debt people think mad anglo they're always gearing the hell out of everything. So I happened to look at the data this morning. So if you take the United States of America total debt to GDP so that's the government and the private sector we're kind of back to 2009 levels. Now 2009 levels were very high but at least we're going to 2009 levels. If you just take the private sector, forget the government, the US private sector debt to GDP is back to 2001 levels, [clears throat] >> you get pretty similar answers for the United Kingdom. Actually, our private sector debt to GDP is back to 2000 levels. So, I guess I mean they're an interesting comparison because the United States has had really good economic growth over that period of deleveraging, which is a stunning achievement. It may be that there's been some misallocation of capital along the way. uh the United Kingdom has had a gross deleveraging and frankly it's been a pretty rough [snorts] 15 years for the economy. So, so there's some good news uh you know and where has this got us to? Well, we're not Germany. The United Kingdom, United States are not Germany, but we're getting closer. Then, of course, you get to the other end of the scale uh which would be China, Japan, and France. Now, those are not the three that people bring up when we talk about inflating away debts, countries with debt problems. Well, they haven't even begun this process yet. I mean they haven't even started their debt to GDP since the great financial crisis has been going up and going up dramatically in all three countries. Uh particularly China and France. So I think the answer to the question is there is some of this to come for the UK and the US. Uh but we're down at uh 240% of GDP for the US, 234% of GDP for the United Kingdom. France is at 322%. uh Japan at two uh 380% and China is just bursting through 300%. So we may find that some of the heavy lifting of financial repression is is more in France, Japan and China than it is in the UK and the US. But yeah, James is right. It takes a long time. By the way, [clears throat] Ray Dalio refers to this as beautiful to leveraging. I don't call it beautiful because if you own government bonds, you lose an absolute fortune. So it is beautiful by the way compared to all the other alternatives unless you can get exceptionally high real GDP growth. So to that extent the word beautiful is uh better than austerity default to hyperinflation. But uh if you're saver if you're a saver there's not much that's beautiful about it. And as James was writing that piece we had a remember his name here a British policy maker who wrote a book on the same thing saying you know we did this after World War II. We can do it again. Let's run a financial repression. Uh there are other things behind that financial repression. By the way it is a period when de wealth inequality comes down. So for certain parts of the political spectrum, it's really quite attractive because you're taking money from savers and giving it to debtors. Uh and genuinely speaking, you know, the the debtors are um they're more voting debtors than there are voting creditors. That's [laughter] not not not so true when you have a very old population. But even so, so there's something else behind the financial repression thing. It is a wealth redistribution tool as well. So it'll that's why it'll likely catch on. So convenient, huh? [laughter] C >> can I just take you back to the inflation that you were discussing? You said not hyperinflation but high inflation. We may have do you feel that since 2020 some of the co stimulus response in the US and the rest of the world. We've we've seen that we had we saw that very uh pronounced spike in inflation and that showed up in a lot of different uh financial series from lumber to it's sort of been this rolling spike that it inflation has now come down relative to that very high peak but it's still it's still well above the the Fed's sort of self-imposed 2% mandate. Yeah. the the two the 2% target that they seem to be trying to target from the upside rather than the downside. You you've said that you don't think that we're going to see hyperinflation, but we will see high inflation. So, can you perhaps just unpack that a little bit? >> Yeah, I mean there is a formal academic definition of hyperinflation. I think it's 60% a month. So, you know, I mean most people if you say hyperinflation they think 15% peranom. So, not 60% a month. I don't think it'll be 15% peranom either. actually the the the co experiment has given us a a reasonable guide to what the range of inflation might be which is financial repression has to be the art of the possible uh and those people who allowed inflation to get out of control realize they wouldn't be in office to deliver the art of the possible so there is a level I think we've now tested the level at which you you can't really it doesn't really work for you as a as a politician now we were in exceptional circumstances from two from 2020 to 2023 three, 40% of all the dollars ever created in human history were created. So, you know, that's uh something that isn't going to happen again. I think they're going to create a lot of money, but I really don't think they're going to do that again because the repercussions in terms of inflation uh political discern uh discontent, changes in leadership were were just too high. So, as you say, this takes a long time, but what sort of level of inflation could actually make it work uh over that long period of time? Well, four to five with 2% real. It'll get you there if you can clamp down on the growth in particularly in non-bank credits. So, something along those lines. Now, the crucial thing is would I would you have a central banker who would um who would agree to that? Does it really matter? Uh the if we look at what Scott Besson's doing with the banking system in America, he's clearly freeing it up to produce higher growth in bank credit. Higher growth in bank credit. That's the asset side of the balance sheet. The liability side is means higher growth in deposits or or money. Now the crucial question for any central banker whether appointed by Trump or anybody else is do you have the guts to go to war with the government to stop it? And uh for that we need to read uh the um the anguish of central banking written or a speech given by Arthur Burns in Belgrade in 1979 after he'd finished his term at the Fed and was largely seen as a mistake largely seen as a man who let inflation get out of the way. He said, "Look, you think I'm stupid. You think I didn't know what I should have done, but people were fighting a war in Vietnam. There was a great society program. This is what the nation needed." Now, under the guise of national security, if this is what the nation needs, what central banker appointed by Trump or anybody else steps up to the plate and says the banks mustn't grow money at that rate, we mustn't have inflation at this rate. And a very good example actually is Manuel Mackron who's given several speeches recently about how the inflation target for the ECB is far too low. Doesn't surprise me when his country's geared up the he wants higher levels of inflation. But you know French president would ever have criticized that inflation rate before but now it's uh it's fair game. So uh yeah so that I mean look I'm going to pick four to 5% inflation. That'll erode your wealth. Sorry. I mean really very very quickly unless you take action to to do something about it. >> You said that during that you said uh that it was sort of predicated on their ability to control non-bank credit. >> It seems like non-bank credit private credit is out of control in the >> How does does private equity and private credit a different wild card in the equation compared to previous runs of this? >> Yeah, they they've got to be coming to an end. One of the I mean I recommend everybody reads that national security document because in it there's a line that says the future belongs to makers. Now what that got to do with national security anyway it's in there and there's two whole paragraphs on it. So if the future belongs to makers why didn't it belong to makers in the past and who did it belong to? Well it belonged to financial engineers. That's who it belonged to. Some of the greatest fortunes in America have been made by financial engineers. And in a world where credit is somewhat constrained as discussed uh America or other nations can simply afford to allow anybody to find an existing uh income stream and gear the hell out of it. The future belongs to makers means that credits available for people who build capacity and in building capacity employ Americans and uh and build a supply chain that is diversified away from China and perhaps others as well. And that's what it means. Now how would you do that? Well, you could change the tax code. It wouldn't be difficult to change the tax code so that the deduction of interest expense and the computation of corporation tax is no longer available to everyone, but only available to makers. Now, I'm not saying I'm recommending any of that, but you can see the rhetoric which would say here are the makers, they get the tax break. Here are the financial engineers, they don't get the tax break. Now, we know that private equity is very, very politically powerful. Uh but there's something in that national security document which could lead you to think they're maybe not as powerful as they think they are. So yeah, private equity is is kind of running rampant, but debt to GDP is coming down. You know, this is what people forget about the United States. You can it's easy to focus on a little subset of credit, which is private credit, which does seem to be out of control. But credit in the aggregate is private credit in the aggregate is is not as bad uh as it as it has been. So it's not good. Don't get me wrong, it's not good, but it's not as out of control as it is in in in some other countries. So, so let us see. My my forecast for private equity is one day it will live up to its name and it'll be full of equity, not >> it seems that uh part of this process is this re-industrialization, bringing some of the manufacturing back from China to the states. And I think that the policy tool that the administration seems to have chosen for that is tariffs. How effective do you think those will be and what else are they likely planning? >> Well, I think they will be uh pretty successful. We've already got the Koreans building a building well putting more uh capacity into Philadelphia ship building. Yesterday we had the Koreans announcing a big uh zinc and uh base metal smelter coming. I can't remember where that's going to be in the United States of America. So it works you know it works and every nation in the world will be I mean I think Canada is the best example. So we here in Europe we're talking about becoming free or reducing our reliance on China and that's been underway for a while much like America but none of here in Canada you want to reduce your reliance on Canada on China and America. Can you imagine how much investment Canada might have to do to to do that? So this is not a uh a a phenomenon of the United States of America. But why the security national security strategy document is so interesting is that America is not seeking to bring all productive capacity back to America. It is very happy if you read that document to align with its allies to see that productive capacity moved to its allies. So the Vietnam deal perhaps being the best and most interesting deal. As long as Vietnam is aligned against China, it can keep producing stuff and selling it to America. Mexico in the last couple of days has moved to put significant tariffs on China. Therefore, plenty of production will still be done in Mexico. The stuff that comes back to the United States of America is more of the strategic in nature stuff. So, what the Trump administration is trying to do and I think relatively successful is to realign the world to be to be an ex-China world. So, this is really really negative for China. I think it's really really positive for Korea, Japan, Taiwan, Thailand, Malaysia, and potentially Latin America. Though Latin America has a a history of opposing US presidents, and there may be, let's call it some volatility along the way in the relationship with Latin America. So, uh, yeah, there's there's lots of beneficiaries of the this, but it's not an American re-industrialization. It is really happening. It's an anti-China industrialization. Therefore, it can happen in lots of places. Therefore, in terms of the stocks you own, they could be absolutely anywhere. They could just as easily be in Japan as America as anywhere else. >> French shoring. >> Brenshing was Janet Yellen. Janet Yellen couldn't bear to say deglobalization. [laughter] >> You know, that's that's the one thing about politicians. If they change their minds uh and do exactly the opposite of what they told you were going to do, they'll give they'll have the good grace to give it a different name. So franchoring it it is but it's accelerated French shoring. But >> is that is that inherently inflationary though? I mean I imagine the cost structures of all of these productive capacity has to be higher than I mean when we went to China and saw some of the things there. It's like gez we have nothing like this here. >> It's inherently inflationary. I mean it's the biggest depending how quickly it happens is potentially the biggest supply shock since 1914. Certainly a bigger supply shock since than 1939. So you've got your supply shock coming in and then if I'm right and we're using lots of bank credit to fund this that's high growth and bank credit means high growth and broad money which if you're of my bent inflation is every word at all times a monetary phenomenon then you add a little bit of monetary inflation to that. So yeah, very inflationary. The politicians will want to assure that that shows up in wage inflation. And if you listen to the American Secretary of the Treasury, you'll hear a lot about that about blue collar America and industrialization and blue collar this and blue collar that. And uh so yeah, it's going to have to show up in wages, but it is inherently inflationary if we start to reverse China's great emergence into the world. You know, there are many many people who don't want to believe this. You know, I could be wrong. Let's put it that way. But most people I meet don't want to believe that because the whole structure of the global monetary system uh global supply chains return on equity everything is you know it's a world turned upside down if the Trump administration achieves this packed against China but it's a world of massive opportunity I guess we should then get to value investing but you know the a lot of the stocks that have been depressed in this long long period I I should have used about five longs there really shouldn't [laughter and clears throat] very long are those who've had to suffer a Chinese competition and of course actually if you've survived it you're probably a pretty good company you know to have survived it or you're getting big public subsidies I mean one of the two uh so if you if you lift the yoke of Chinese competition there are so many opportunities and of course there are basically all of them I would expect outside the S&P 500 because these are now pretty small companies whether they're American or whether you know whatever you look pick an index anywhere in the world the companies that benefit from this are probably not in that index. >> Russell, I've got sort of a twopart question for you, but the first part is if the world follows this um path that you that you believe that it will what are perhaps some of the counterintuitive things that we can expect to see that that deviate a little bit from the mainstream um whoever represents the mainstream. So uh financial repression if it's holding down the the discount rate and pushing up the nominal growth rate you'd say I'd buy equities. It seems you just the most intuitive thing of the word buy equities. There is a problem with that though and it's a big problem which is if I tell you to buy bonds if you're an institutional investor I tell you to buy bonds. The question is what are you going to sell? Now one of the few things you have that's liquid to sell is equities. And if you look at global portfolio investors over the last 35 years, what you notice is a decline in home buyers. But someone had to benefit from that. Well, we all know who benefited from it's a market that's 70% of global market capitalization. It's the S&P 5 >> and and indexation means that many of those investors just bought the index. They didn't bother to try and pick stocks. So perhaps the counterintuitive bit of a low discount rate and a high nominal growth rate is the S&P 500 comes down >> but not in not in a form in a way that most people think. So as you know I run this course in in financial history. We look at the mean reversion of the Schiller PE it doesn't always collapse. If you ask anybody how equities come down they go quickly. But actually it's not true. uh there's two periods 1901 to 1921 1966 to 1982 where they come down slowly and that that that would be this environment a slow grinding liquidation of massive overweight positions in the S&P 500. So I think that's the first place where I think people could be intuitively wrong in this financial repression war. Obviously and and the other thing is at the end of World War II buy equities was a great thing to do but of course the dividend yield on the uh don't think it was the S&P maybe the Dow Jones was 10%. And the Schiller PE was about nine. Well that's not where we are today. You know as we say in Ireland it depends a lot where you start. So equities are not equities in aggregate are the not the place to be at a financial repression. But as we've discussed, there are lots of equities that would would be like that. And then gold is I think sort of counterintuitive because it looks very expensive. You know, inflation adjusted. It's off the top end of the chart. We were teaching the course a few weeks ago. And you know, we have gold prices back to 1297. Uh this is for the United Kingdom. United States not being in existence as a as a republic in 1297. Uh and we have inflation numbers for the United Kingdom to 1297 as well. some very busy financial historians in this country. So we have a lovely chart there of a 300year rolling real return for gold and a 100year rolling and and you know what the real return for gold is over 300 and 100 years it's zero the real return except for the last 30 years where it's been plus six. So, you know, as a financial historian, I should be saying to you, look, it's it's, you know, it's it's gone. It's in the price. But in this world, actually, despite its really superlative real returns relative to history over the past 30 years, it's it's still gold. Because this is not just about negative real rates of interest, this is about a a government that wants to move your money around. And uh despite President Roosevelt's actions in 1933, uh moving around people's gold is is still difficult. And frankly, who cares? I mean, there's so little of it relative to all the financial assets in the world. You just go after the lowhanging fruit. So, I'm sure I've missed a couple of the sort of or things that are intuitively not quite right. But gold can keep going and the S&P 500 can come come down despite only, you know, if you do a Gordon's dividend discount model, you get a low discount rate and a high growth rate, you got to go buy equities and suddenly see the grind and grind and grind. But fundamentally, nominal corporate earnings growth probably goes up, but the valuation slowly over a long period of time comes down. That's more like 66 to 82. It's a chart that I look at occasionally that compares the S&P 500 to the price of gold and it doesn't run it back 300 years. It probably only goes back it might it might go back 70 or 80. I think it's it is kind of interesting that we do seem to be in a period of time where and I I've Jake and I have discussed this offline where as much as gold has run it still looks reasonably cheap relative to the S&P 500 compared to the other extremes on that chart there have been periods of time where gold has been very very expensive and the S&P 500 has been very cheap and we're clearly not in one of those periods right now where the S&P 500's is expensive and it looks to me on that chart that if it follows this long one uh pattern that it seems to have followed that we're more likely to get more expensive gold and cheaper S&P 500 on a relative basis. I'm not necessarily picking one or the other. I'm just saying that relationship seems to be as you've described stretched. >> Yeah. I mean gold is nobody's liability which is kind of important in a world swaved in debt particularly as I say Japan, China and uh and France. So having an asset which is no one's liability may be quite useful in this in this world. Um I I this is a value investing podcast and I didn't mean to necessarily direct you that way, but it does seem to me like you're describing a scenario where uh the higher growth longer duration equities that have been dominant over the last 15 years are the ones that suffer a little bit more under that regime and the stuff that has closer to commodities and more tangible assets seem to do a little bit better. Is that is that a >> Yep. Please tell me that that's what what you're saying. No [laughter] motor. >> I just want some clarity. I just want to clarify that >> very fair summary. Let's give some numbers back to the 66 to82 period where if you go into the S&P 500, you obviously do very badly in real terms. But we have the French and FAMA data for that period and and they divide up into value. So you got, you know, we've got value series going back a long time. Let's say in ' 66 you bought midcap value in the US. Now you got this dreadful performance from the S&P 500 in real terms. In real terms, you hold your value in uh midcap value. That's pretty impressive given what was going on in the S&P 500. In 77, Buffett writes his famous article for Fortune called how inflation swindles the equity investor. The lots of bits of that, but clearly points out that one of the things is that you you you did get a march higher in the nominal rate and the discount rate and the valuations came down. So if so part of the reason that equities performed so badly relative to inflation from 66 to 82 was you bought them at very high valuation. So if you can buy them at a very low valuation it's not clear to me that actually inflation is that negative. Now Buffett I think he lists six other characteristics there and at the margin I think they're probably negative but there are lots of positives going on at the same time. As I said nominal earnings growth from 66 to 82 for corporations is pretty strong. I keep stressing the word nominal not real but anyway uh you so for value stocks that was a good time pretty good time to buy. So if we're in the same situation we are and that and that is not a situation where we were aggressively moving supply chains away from Russia in a cold war because we've done that already. You know we were aggressively building uh armaments. We were aggressively building uh machinery to get us into space but we weren't aggressively moving our supply chains around the world. to butter, wasn't it? >> Yeah. There's an added impetus now to to to help those uh sort of midcap value stocks. So, I I I I look at this as a man who's written the book about bare markets and generally seen as being quite gloomy and and really get quite excited about where we are. And when I started my career, the book that we all read was one up in Wall Street by Peter Lynch, published, I'm going to say, in the mid 80s. And he talked about the excitement of going to the Midwest and going to the Rusfeld and finding all these companies that nobody had visited for 20 years seeing how cheap they were. And I think on a global basis that's true again because those companies have been so depressed by Chinese competition. So they may be in Korea or Japan or America. So I think it's an exciting time to be a value manager, an exciting time to be a a [clears throat] stock picker, but as you know a lonely time to be a value manager. the chilip um received some criticism for for lots of reasons that I don't want to really go into, but it's you can find any other Tobin's queue or any other there are lots of other uh metrics that basically line up with chilip. So I I don't know how good those arguments are, but one of the one of the for that chilip chart that that I look at for the US, it stands out that 66 is a cyclical peak and 82 is a cyclical trough. And in between those two in over that 16-year period, the S&P 500 sort of went sideways. Not really. Yeah. Just sort of chopped around. There were lots of >> There was >> 7374 was obviously a terrible bare market and that was both bonds and equities. So I was just wondering if you apply your framework, your sort of bare market framework, does that does that period feature at all? >> Yeah, just just a quick aside. This will sound unconnected, but it isn't. In 1967, Elmer Bernstein, the man who wrote the soundtrack for uh The Great Escape and The Magnificent 7, wrote a musical 1967 called How Now D Jones. And the premise of the musical is that the uh this woman had a fiance and the fiance would only marry her when the Dow Jones went through a thousand. Pretty pathetic uh thing. But anyway, as you probably know, it kept it go through a thousand and then came down. So it spent this entire time just bargely hitting through a thousand. Whether the poor woman ever gets married in the musical, I don't know. It's not one that gets it's it's star song, by the way. U maybe a sign of the times was called step away from the ledge. So yeah, look, when people ask me to pick a period of of what the equity market's most likely to look like, I say it is 66 to 82. And uh I you know maybe we'd be better looking at that in the context of a non-American market because America wasn't really running much of a financial repression post World War II. It it does get into that as the uh Bretonwoods agreement comes under strain as American gold r begins to drain and that is one of the features of that period from ' 66 to 71 obviously is is the attempt to stop capital outflow. Uh President Kennedy introduced the interest equalization tax of 1963. uh presidents uh Johnson and Nixon would often get corporates into the White House and say stop investing overseas. So there's an there's an element of rising financial repression even in America. Uh but for other countries that have been underway for a long period of time. So I think we can learn an awful lot from that from that period. That's the one I would like to pick out particularly because you can't if you pick 45 to 66 you're picking low equity valuations going to high equity valuations. But we're starting with high equity valuations. So why not focus on 66 to 82 is you know that's a period of war. America's at war. It almost but didn't quite impeach a president because he resigned first. Uh New York the city of New York not the state went bankrupt. Uh we had a bankrupt bank Franklin National Savings Bank which I think was the 12th biggest bank uh in the United States of America. If you look at any movies made in New York in the mid1 1970s it looks like Berlin 1945. You know, this was pretty awful period of financial history and value stocks produced positive real returns. You know, not big ones, but they they did. >> Is there any AI plus robots uh you know, technological advancements that can pull a rabbit out of the hat and and save us from from all of this? >> Well, that must be true actually because the one thing that you can predict through history is surges in productivity growth. surges in productivity growth are usually associated with technological breakthrough whether it's the canals, the railroads, electrification, the internal combustion engine. So I think one of the startling things in my career is you know I I know how productive I am today and all the technology I have today and I'm speaking to you on this and yet the evidence for quite a long period of time now certainly over here in Europe is it didn't produce any productivity growth is quite astounding and it leads one to think that the data must actually be wrong because given how productive we we all now are. So the problem with AI and and any technological revolution is you just don't know how big that can be. Now, if we can elevate real GDP growth by, you know, let's take it from two to four. Clearly, we're, you know, this is pulling rabbits out of a out of a hat. But I don't think any of us can predict that. I just don't think it can be can be done. I've never known it happened in the past. And just because you do that doesn't mean to say that the returns from that occurred to the people who made the investment either. >> Not right. >> Not they they overinvest. they get poor returns but somebody else gets to use the capacity at very cheap and economical rates. Uh but even so it doesn't really matter if it elevates productivity growth. So uh yeah there is there can be look the number one thing that will get everybody out of a mess is really cheap energy they'll stop. >> Look at why would why were the canals and the railroads successful because the price of coal collapsed because you could suddenly get coal around it quite quickly. So, if there's something out there that brings the oil price back to $8, then then we have to have a more optimistic outlook on real growth and we don't need as much as much inflation and we don't need uh as much financial repression and uh I don't think it's forecastable. But if I had to forecast it, it wouldn't be AI I'd be looking at. It' be low energy prices. And what is AI likely to do? It's likely to push up energy prices. >> Right. Well, the only there is a possibility there that it brings attention to how much energy AI consumes and that does seem to be a little bit of a push among some of the mag 7 to build their own nuclear reactors or to invest in sort of nuclear in some capacity. So, it is possible that that does spur some some cheaper energy in that area, but that's not necessarily oil is still inextricably tied up with the global economy. So I think that oil investors would say that where wherever we are today, 56 or 55 bucks is pretty cheap. I think that I don't think the suppliers like it at that level. >> Well, we have these little mini nuclear reactors as well. And I'm not an energy economist, so I'm not going to sit here and pontificate about that. But uh you know, as I said, you cannot forecast them, but there could easily be something out there. Not easily, but there could be something out there which brings us cheap energy. That would be much more powerful than AI. And you know there only five ways to get out of a high debt GDP position. Default, austerity, hyperinflation, financial repression, or high real growth. And wouldn't we love it if it was high real growth? So if there's anybody watching this who's can guarantee elevated productivity growth, then we don't need the first four and we can just buy equities indiscriminately and hope to get richer even at whatever we are 40 times sharper PE. I'm I'm betting against that obviously, but I don't rule it out. >> Yeah. What are the prospects for high real growth? >> I don't I don't think they're good because of the gearing situation that one of the ways you unleash high growth is to get the public and private sector to gear up. And if you're starting in a situation where they're already highly geared, then you've got a problem. So, if we go to the end of World War II, it's true that, you know, inflate away the debt, but private sector death in GDP was exceptionally low. We'd had a depression where people paid back their debt or defaulted. We'd had a world war where credit went to the government rather than the private sector. So, you know, given that both the public and private sectors are quite highly geared, I wouldn't hold my breath that we can have have that. Also, look, a lot of the investment we're going to do now is investment of a very different kind. It's going to replicate existing capacity. I we have we concluded that strategically we can't rely on Chinese capacity. Well, replicating an existing capacity is not really very good for productivity, is it? So, I'm not banking on it. But, as I say, I kind of rule it out because that is the get out of geofree car. Yeah. Doesn't it matter what you put the money into? Also, I mean, if you're building dams that are still going to be around in a hundred years, like early development, Keynesianism maybe works better there, but maybe there's some point down the line where you're kind of pushing on a string with all of this. >> Yeah. I mean that's the that's the story of financial repression. I think it's interesting that the word stagflation isn't invented. I think it's 1966. It's a British chancellor of the exjector called Ian Mloud. It's in the House of Commons and he uses this word and no one's ever heard of this word before but he's reflecting something that the world had never seen. And it wasn't low growth and high inflation. It was high unemployment and high inflation. These two things weren't supposed to go together. And but that I think was the was the consequence of financial repression. If the clunking fist of the state is involved in capital allocation, guess what? You're going to build the you're ultimately going to build the wrong capacity in the wrong place at the wrong time. In other words, the supply side does not adjust based on the price mechanism and therefore you can get sort of redundant investment with, you know, lack of supply, high inflation and high unemployment. The question is how long does it take and it can take quite a long time before we realize that that is true. So I think that is where we probably end up. But as we begin with, you know, we have to build all this capacity that China has. It could take a long time to get there, but of course we'll we'll get there to the misallocation of capital through government subsidies through the use of government carrots or the use of government sticks. I'd say it'll take 10 to 12 years, maybe longer. >> I mean, how long did Russia go just building left shoes only for, you know, before it finally stopped working? >> Yeah, it has to be said they were able to keep it going for a long time, but not while paying dividends to investors. So, >> yeah, true. What about uh demographics, Russell? Because we seem to be we've got the an aging population in the US, aging population in many countries in the western world. That would seem to exacerbate the problems that we have the challenge we face. >> Yeah. I mean, if your if your labor force isn't growing, you need particularly strong growth and productivity. So, it just makes it more difficult. So, yeah, we need really strong growth and productivity. But the the the the story of the of of mankind is just when you're about to give up, it happens. And you know, I wish we could all forecast it, but it doesn't seem forecastable, but it it has happened. It can happen, but I you know, as I said earlier, the one that would really do it would be cheap energy, even more than AI. So, you know, we can't rule it out. >> Can we talk a little bit about the library of mistakes? >> Yeah, sure. Sure. So we have three libraries of mistakes and we have them kind of for the reason we we began with which is economics, finance and investment has got diverted into a mathematical sport pursuit if I'm being more charitable to those who who do it. Uh which is a bit like distillation. So we do we're pretty big on distillation here in Scotland. I'm quite a fan of it personally. >> Distill the whole point of distillation is to throw things away. So that to get to the purity of the equation, we've thrown away sociology, psychology, philosophy, and all that stuff. So, so when you read financial history, you're just bringing all that stuff back in again. And frankly, it's easier than doing a degree in psychology or philosophy or politics. And secondly, it's more entertaining. So, we have the libraries to try and get people engaged and to popularize the study of financial history. We have one in Edinburgh. We have one on Luzan in Switzerland. We have one in uh in Punea in India. Next year we will open in Singapore. We've we've announced that. >> Uh we have a team trying to open one in Montreal and there are three other locations, two other locations which I can't mention uh because we haven't sort of signed that bit of paper yet, but really confident they'll happen. So we should have four more open next year and u you know it's just a small thing but it's a thing to try and get people refocused on financial history and the blood and guts of economics. And I think I say that literally because I used to be a butcher. My father was a butcher and I you know I I worked in a butcher shop and I saw that economics and then I read an economics textbook and I'm going >> what's going on here? But it turned out economics textbook was really about the skeleton. But it was the skeleton. It wasn't really the blood and guts muscle or even the behavior of the beast. Uh so the the textbook went so far but in my experience didn't really explain all the all the interesting bits. So that's why we have a library of mistakes to try and it's a charitable venture. It's not a commercial venture. It's all supported by by donors and uh and our course it's we're kind of here at Edinburgh we're kind of a social enterprise and sales of the course helped to support the uh the library mistakes. >> And so the library has physical books in it like a like a library. >> Yeah. Yeah. Yeah. No, it's don't don't laugh that the number one question I get asked about lively mistakes is, is it a room full of books? Uh it's a it's a legitimate question these days, isn't it? So, yes, it is a room full of books. Uh there are 5,000 of them here in Edinburgh and that's roughly what we hope to replicate across the world in the in the rest liies. I've just been uh in the library recording my Christmas message. I am the keeper of the library mistakes. And I was able to pick up a book and draw upon some forecast made in the September 1932 contemporaneous opinion about the future. Whether right or wrong has value because you know my in my first book I I looked at the four great bare market bottoms and concluded the way you find the bottom of a bare market is when everybody makes the same mistakes. Not that there are some people who are incredibly right and you follow them. It is consistent errors of opinion about the future. So there's so much going on in financial history that we can uh that we can learn from and that's what we're that's why we that's why we do it. >> Can I ask you in real time 2009 valuations didn't really ever get incredibly cheap on a Schiller PE basis? I think we got back to the long run average maybe a fraction under the long run average. How are you forecasting a bottom in that in that scenario? >> I'm glad you asked me the question because of course I did. So that's fortunate >> I'm aware [laughter] >> be a very answer it would be very embarrassing to say I spent two years writing that book and then to get the wrong answer after two years of research. So the conclusion of the book is that equities get cheap obviously as you say not as cheap as they did because the world believes in deflation and when you believe in deflation it's not actually clear whether equity that fine sliver of hope between assets and liabilities whether it survives at all and fundamentally what changes is that there's a reflation which changes it and that invariably means change in the structure of the monetary system so leaving the gold standard in 32 uh moving to Breton which turned out to be a more inflationary thing in 40 49 and 82 abandoning money supply targeting. So you get these big structural shifts in money supply which means the deflation isn't going to come. But I remember on the not quite the bottom 17th of March is St. Patrick's Day I was standing in the grocerers hall in London with the sun shining through the windows trying to persuade everybody in the room to buy equities on this basic argument. And the the way that format works is the organizers pay me to go and speak and then two other people pay to come and sell their funds. And as I walked up and down demanding everyone buy equities, I turned around to realize the two guys behind me uh were selling bond funds. So this was experience for them. But yeah, so that's it. I mean, if you can see that the deflation isn't going to come, those equities were not at their all-time low valuations, but they were discounting. And I obviously I know that because I go out and I speak to the market. They're my clients. They're the people I advise. If you could see people saying it's all deflation, it's all deflation. But see the structural changes in monetary policy, particularly obviously the invention reinvention of quantitative easing, then you could say this isn't going to continue. And society can't bear it to continue. So we'll do something about it. That's not true in every situation. If you don't have a flexible monetary standard and you can change and you can't change it, you got a bigger problem like Greece at the same period of time. But uh for uh for the United States of America that was the uh the bull signal. And I know no one believes me but I actually wrote down the minute of bottom that was sitting in my study and I think it was 666. And maybe it was that number that drew my attention. I wrote on a piece of paper this is the bottom of the market. Sadly I didn't publish it but anyway I believe me I did write it down. So I think there were plenty of signals from financial history that that was going to be one of the great bottoms for the stock market. >> Russell we're we're coming up on time. you um you have an offer for a course uh we have a code for the course can you just uh explain what that is >> yeah so as I said the library is a kind of a social enterprise and we have a course called the practical history of financial markets has a slightly different name in the online version advanced valuation in financial markets but it's the same course there's about 18 hours of video material in that course uh we also do an in-person course but you've got to come to London to do that not everybody's cup of tea will be in London in June and September next year if you want to do that. Uh but otherwise if you go to library ofmistakes.com uh you'll find tab at the top course uh we have a promotional code you'll get a 20% discount on tab 20 tap 20 for listeners to your podcast uh and what is it about it's really about finding the best measures of value actually interestingly you mentioned one of them docu cycllically adjusted PE but then we look at why these things mean revert and I think you'll be very aware they don't always mean revert in a time frame that can keep you within in business. >> They take their sweet time, don't they? >> They take their time. So, the rest of the course really focuses on these other factors and and what plays into that mean reversion and and hopefully helps a little bit on the timing. And of course, timing is more easy at extremes like it was in the the spring early in early 2009 uh or it was in 19 summer of 1932. But that's what the course is about. So it's a it's it's not a chronological history of financial markets. It is you know we're using data going back. You can you know we were joking about how long you could get a moving average for equity returns. Well we have American data from 1800s. So you can get an 1800 to 2025 very soon 2025 number 225 years of data. So we use as much data as we can to try and see which measures of value work which ones don't then why they mean revert. So that's uh lovely a lovely Christmas present for somebody who likes to know a lot more about investment. >> The code is tap20. Russell, thank you very much for spending some time with us today. We really do appreciate it. We've been listeners for a long time. I just want to say uh this is going to be the final episode for the year. Uh so I wish Jake and I both Jake may say his own piece but uh wish happy holidays merry Christmas um to everybody particularly everybody who who let me know uh from Boisee Toronto St. Julian's Malta that's I think that might be a first Breenidge London Lousan Eastam Tallahassee Belleview Kennaur Georgia Tomb Texas Boisey Milton Kees Misil Austria Dubai Seattle Mossman Australia good for you San Jose San Diego Valareeso India Indiana Gurnie Scotland Snomish Cincinnati we got a good spread thanks everybody JT any final No, just happy holidays to everybody and uh you know, take this time, disconnect, spend some time with your family, leave all this market alone for a while. You'll come back to it fresh with new insights. Like, you can't think about it all the time. Uh and uh yeah, be good to each other. And if you've been lucky in life, you probably owe it to make someone else feel a little lucky. So, do something to to raise up your fellow man. >> John Battle gave us a tip, too. Thanks, John. We very much appreciate it. Russell, thank you so much for spending time with us. We are genuinely uh very grateful uh particularly because you said that Vatt's going to outperform [laughter] >> which is not why not why you invited me. >> That's not at all. That's not at all. That was a >> that was a bonus. >> That's a Christmas present for Toby. >> That's [laughter] right. That's right. All right. Thanks, folks. We'll uh we'll see a same bat time, same bat