[REPLAY] James Aitken – Macro Strategist Extraordinaire (Capital Allocators, EP.58)

28:31Is it any wonder that people have struggled? The point being that we went from a very broad macro environment where things moved to a very constrained macro environment, which made it difficult for people to express what they wanted to express. so what makes a good macro manager today and you know of course what i'm replying from a subjective point of view because i i know a few of these guys firstly it has to be a broad mandate to be able to use single stocks for example to optimize a macro view to be able to trade exchange-traded Korean derivatives if the mood gets you. I mean, it's an enormous, liquid listed derivative market in South Korea of all places.

29:19To express a view on Japan by a particular sector or basket as opposed to, oh, I'm just long topics. Basically, to differentiate yourself from everyone else by taking advantage of things that may not be quite as crowded, the ability to avoid all the macro roach motels is the critical thing secondly in fact it might be the most important point you need the right clients you need the right clients you can't have clients who ring you up every friday saying what have you done this week that is just no way to manage money but i'm afraid that's tended to go hand in hand with a lot of the institutional allocations that macro managers and headshot managers more broadly have changed you know They sit on your shoulder all the time, meaning that you feel you can't lose any money at all.

30:05And if you can't lose any money at all, then you don't feel terribly compelled to take any risk. So it's a pretty nasty circuit. Let's talk about today's markets. Maybe the place to start is the epicenter, the Fed in the US. What's going on in the plumbing? What are you talking about with your clients of things of concern and areas of opportunity? Just we'll come to the Fed in a moment, but you've just reminded me of an important point. It's dangerous when you're considered to be an expert on something. And I think it's still fair to say that people know me as the plumbing guy. But it's dangerous if you come to be known as an expert because it means you might shut your mind off to new ideas, new information.

30:50and the plumbing of the financial system is an extraordinary, complex, dynamic system. It's not a static system. It's dynamic. Of course it is. And yet, there's so many people out there today, Ted, putting out charts with two lines from relationships, you know, these infamous cross-currency basis swaps, or apparently the ebbs and flow of the Treasury General account, the deposits the US Treasury has at the Fed explains everything that's happening in the world today, which I think is just nonsense. And they say, oh, look, here's two lines that vaguely resemble each other. One proves the other. Look out, we're going to hell.

31:28It's like, well, no. And the key point I'd make that far from explaining to people over the past two years, what's going wrong in the plumbing, this notion of dollar shortages and stuff like that, which is a little bit off beam. My job is to be explained to people what's actually going right. what's actually going right. Opportunities arising from being able to lend dollars if you're a reserve manager in a sensible risk control way and earn a few more basis points, very controlled way, or to lend out your treasuries, or how Japanese institutions are lending their dollars in a much greater scale, which is lubricating global money markets and increasing the float of dollars.

32:12It's a change, right? So it's not what's going wrong, but it's explaining to people how relationships have changed. There's an obvious feedback loop between post-crisis regulation and what central banks have been trying to do. In fact, you might argue they're at cross purposes. But it's to try to help people explain how the plumbing is adapting and evolving. And I'm very fortunate to count key men and women in the plumbing as dear friends. So if I don't understand something, I can pick up the phone to my friend who's the treasurer at XYZ and say, am I thinking about this the right way? Or the CP guy, or the swaps guy, or the stir guy, and say, hey, look, have I got this broadly correct?

32:55And I find that immensely helpful. And really, Ted, if people think of me as a plumbing expert, it's not because I know anything about the plumbing, really, seriously. It's not. It's because in my experience, the plumbing of the financial system is so complicated and constantly subject to change and ebbs and flows that nobody can know it in its entirety. So if I do know anything about how this works, it's only because I never stop asking questions. That's the key. And we live in this day and age where everyone seems to be entitled to their own facts and accusation is taken as evidence. and it applies as much as in political discussions as it does to observations about how the financial system works or how the Fed works or how the US economy is evolving.

33:55Oh, here's two charts, and we've all seen this. Here's two lines, one advance six months, we're going to hell. Great. That's fantastic. That's so helpful. I'm sure you and I, if we challenged each other in the next five minutes, we could go onto the Bloomberg and prove that mobile subscriptions in India drive dollar funding markets in Hong Kong, but if we lag it long enough, right, I'm sure there's a link. But you know, that's the danger. So my challenge, in fact, when I reflect on most of the advice I've been trying to impart to my clients over the past couple of years, it's been more of the perspective of that's not right.

34:30Well, that's not quite right. Here's why. Here's a background paper, or here's what this money market fund manager has actually said, or here's what this US corporate treasurer has said or here's how banks are actually responding to US tax changes, et cetera. So it's to give people a broader perspective. And I think there's a phrase one of my clients like to use, which I think applies to investing in general, which is the mindset of constructive paranoia. Constructive paranoia. And you mention that to people, Ted, and they say, oh, you're one of them, you're one of those left-tail people. It's like, actually, no.

35:04Constructive paranoia when you're thinking about markets and asset allocation and investing is as much about, oh my gosh, am I overexposed to something that might go wrong, as it is about, oh my gosh, am I underexposed to this particular opportunity that people haven't re-rated yet? So it works both ways. The paranoia, the left tail, starts with US rates. Sure does. And there's a simple case that we went from private debt to public debt in the US since the financial crisis, rates have been incredibly low. A very large asset swap effectively, right? Yeah. Should rates normalize? Can we afford this?

35:45And what happens? Take me through your thoughts. 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.

36:45And 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 criticised 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.

37:33I mean, you had this extraordinary event in March 2017, where Janet Yellen thinks that her Federal Open Markets Committee have made it abundantly clear they're going to hike in March. And yet, the Fed funds market was not willing to price it in. And they all went, the key board members, into the financial media to say, no, no, we're actually going to do it. It was like an out-of-meeting rate hike, because Mark was like, no, it's the Fed, the nincompoops. They don't know what they're doing. Oh, it's the Fed. They're always wrong, which is, I think is a little bit unfair. I mean, they're not stupid people.

38:06They just move to the beat of a different drum to the rest of us. And they've managed four hikes in 2017. But let's go back a little bit to September last year and how people were able to do very well simply by paying attention to the Fed. You had the grand total of 0.2, i.e. no, rate hikes priced in to the US short-term rates market in all of 2018 and all of 2019. Now, you don't need to be a genius to think to yourself, that's probably a bit pessimistic. So people who understand how the Fed's thinking and looking at the economy with a broad perspective and estimating, guesstimating the probability of Republican tax cuts, said that's just silly prices.

38:57So they start tapping out a few euro dollars, putting on various curve trades, getting stuck into mid-curve futures, stuff like that. And then you get to the end of the year, and contrary to expectations, the Republicans have delivered a tax cut. And then, I know this is a tiny bit in the weeds, but it's very important, I think, to understanding where the Fed's going. And then you get to January the 11th of this year. Now, by the way, just as we entered the start of the year, something different started happening in financial markets, right? Now, we've been used to years of asset prices levitating and implied volatility across all asset classes coming down.

39:34But as we came through the first couple of weeks of January, asset prices are still going up. And guess what? Implied volatility stopped going down. Now, that's interesting. So you just write that down in the notebook and go, okay, something's changing here. Don't know what. But equity index implied volatility is no longer reacting the same way as it did previously. January the 11th, Bill Dudley, who's the outgoing head of the New York Fed, very important man, for a long time the world's favourite dove. But as the data evolves and the economy evolves, so too does Bill Dudley evolve, as you and I would if we were him.

40:08We're responding to new information. He gives a speech. He talks about this rather the nebulous concept of our star, neutral equilibrium, real interest rate, you know, a whole bunch of gobbledygook. But it's going up. And that he thought, you know, three to four hikes in 2018 would be slow and gradual. And basically, you know, the economy is looking pretty robust to say the least. Nothing happens. And I remember picking up the phone to one of my short-term interest rate friends and saying, am I following the wrong economy? And if I misread this speech, and he's like, we're sitting here thinking the same thing.

40:41This is like a really, compared to the baseline, this is a really hawkish speech from Bill Dudley. And basically, the front end of the US term structure has moved about a basis point. He said, look, I think this is wrong. I've sold some more Eurodolts and stuff like that. And then a week later, this is how the games work, right? A week later, Bill Dudley, I'm paraphrasing a bit, rings up the F2 and says, I need to speak to you. grants an interview to Sam Fleming, who does a wonderful job covering the Fed at the FT in Washington, and goes to Sam and basically says, bang, bang, bang. No, I mean it.

41:20And then you start to get a little bit of more pricing in US short-term rates. And then a week after that, we get the high inflation prints. And then two weeks after that, it's on like Donkey Kong. Now, the serious point is, if you look at financial history, it tells you that when realized inflation goes up, not implied, realized actual inflation goes up, guess what? The correlation between stocks and bonds changes. Who knew? And the correlation between stocks and bonds and credit changes, as it should. And yet the world has become accustomed to the idea that the correlation between stocks and bonds is predictable and exactly the sort of amplitude and magnitude where it is today.

42:00And it continues to change. So the point is, if you've been paying even a moderate amount of attention to the Fed from the third, fourth, even all of 2017 onwards, and especially the start of this year, there's been an awful lot of money to be made. And then the challenge was to calibrate what the spillovers might be. Where the Fed's at today is still slow and gradual, working out how to retreat from forward guidance. And what Jay Powell is trying to do is to reactivate the market mechanism. Now, notice I didn't say price discovery. Price discovery to a central banker sounds a bit scary because it might go further than you think.

42:44But to be fair, Jay Powell is trying to find a way to reactivate markets while avoiding a rerun of the taper tantrum. It's tricky, but far from being concerned about a further tightening of financial conditions or further increases in realized and implied volatility, to them it would be perfectly logical and expected. And Ted, the whole point of tightening monetary policy is to tighten financial conditions and eventually bring asset prices down. That's the point. And yet the market continues to impose and project its view on the Fed. No, they're wrong. The yield curve's inverting. Believe me, if the Fed wanted to steepen the yield curve, they could.

43:39Oh, they could. They have the power to do it. It might be quite a dramatic thing, but they can do it. But this narrative that things are going wrong, and yet the Fed is like, slow, gradual, slow, gradual. And what the FOMC is trying to articulate to markets who are not willing to listen is that they think that they're going to keep hiking rates for a long time to come. and yet, no, no, no, they're Fed, they're idiots, here we go, global PMIs are rolling over. Well, I need to give it more study, but when I look at global PMIs, the reason they're declining a bit is because of capacity constraints.

44:18And capacity constraints and bottlenecks don't strike me as late economic cycle, they strike me as mid-economic cycle issues. So there's this disconnect. So my challenge is to pay attention to the Fed. They are an important central bank. They put tremendous effort into all their communications. Unsurprisingly, tremendous effort. And they are going to be slow and gradual for a long time to come, barring a tremendous exogenous shock. And the final point I'd make is, look, let's step back a bit. this has been the first occasion since 1964 when a US economy perilously close to full employment has embarked on tax cuts you would think based on that observation the probability is higher that in 2018 and 2019 the US economy will run a bit hotter than it has done over the past several years.

45:18And while I think of it, out of necessity, all these morning calls around the world over the past several years, these global calls have started with ambitious young women and men speaking to their colleagues on a speakerphone. It starts with which central banker said what? Who's up next? What did it mean? And then and only then do you get into discussion of what with Singapore non-oil exports or what's happening in Korea or best of all, what are we learning from our portfolio companies? And these global corporations are as sophisticated in their inventory management, logistics and order books as any hedge fund sitting in front of a Bloomberg.

45:59The investment they've made in logistics infrastructure, whether it be SAP HANA software, these guys have their finger on the pulse of the global economy. And I'm struck by the disconnect between the consensus macro commentary on how the US economy is perilous or global growth is perilous or emerging markets are in dire strait, I find that difficult to reconcile with the commentary that continues to come from global corporations about order books, forward order books and everything else. And my sense is subject to revision that we're looking at late cycle asset price valuations. But shockingly, the US economy might be mid-cycle.

46:45And that might be the opportunity for people who are prepared to take a step back and look at things. And look, to be fair, I wonder whether too many people are caught up by the first White House tweet every day. And that drives, oh, what he said now, oh, the man's done. Oh, you know, they go on and on and on. And therefore, by looking at the world through the prism of the president, people are biased to look for what's going wrong as opposed to what could be going right. I think there's an opportunity to step back from the consensus narrative and focus less on what central bankers are saying because they're reacting to the exact same data that we can see and they're reacting to input from US and global corporations.

47:33And in this age of crowded positions, leveraged exposures, if I'm going to wait for a central banker to give me permission to reprice something, it's too late. If I'm going to wait for Jay Powell to say it's now okay to sell the long bond, it's too late. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead. When it comes to M &A innovation, SRS Aquium has reshaped the way that deals get done, streamlining processes for maximum efficiency and minimum headaches.

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49:11Are there other core assumptions that you think markets are making today that are faulty? I'm sure there's a great number of them. But of course, for me to assert that a market is faulty or the assumptions are faulty is you need to be careful that one is not too arrogant because Mr. Market is not always wrong. Sure. And markets, I think of them as a contest of ideas. So one guy working from a broom cupboard in Wimbledon needs to be careful how he... 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?

49:54I 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, it's all going to hell, you know, deleveraging. And then there'll be the person who's looking at the Chinese technology giants and everything's going to the moon.

50:35And 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 going to 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 dangerous.

51:29When it comes to, for example, shadow banking and spillovers in China, what do we not know? We've had more and more information released. We know the stock. We know the flow. We know the players. We know the crosslinks. We can sign up with a WeChat account and talk to bankers onshore on the mainland. But it's just one part of the puzzle. And you have a man running the show, for as long as he cares to, President Xi, who takes a long-term view. And he's trying to figure out how to rebalance the Chinese economy. It's a toughie. No one's tried to do what he's trying to do. And if we were him, we'd probably take a lot of time to figure it out, which is why I say deleveraging with Chinese characteristics.

52:23What Chinese financial policymakers would like us to focus upon would be that the rate of growth in credit and shadow banking in the Chinese economy has declined abruptly. But the key thing there is that's the flow rate of growth. The stock is still rising. And perhaps I'm being simplistic, but I don't see how you ever deflate what is frankly a gigantic liquidity bubble rolling from asset class to asset class inside China without some pretty stern consequences for Chinese GDP. And that's the downside of being in charge of everything if you're President Xi. If everything goes right, ta-da, I did it.

53:10But on the other hand, if you're all powerful and in charge and anything goes wrong, it must be your fault. I don't think the Chinese economy can afford too much deleveraging. Now, it doesn't mean there won't be mistakes from time to time, but you look at the new leadership of the People's Bank of China, they're very sophisticated when it comes to the plumbing. And while the People's Bank of China's balance sheet has been coming down, which I think has been underreported from my trip to China last year, number one takeaway is I will never understand this. I just can't. I just can't get my head around the enormity of it.

53:47I just want to be less wrong. So we're told for years that all these Chinese property companies and Chinese corporations are borrowed in dollars. If the dollar goes up and the Fed tightens policy, they're in a world of pain. And this young man managing a Chinese bank balance sheet in Beijing casually mentions, Ted, that, oh, we've got our$300 billion offshore balance sheet. I'm like, stop, what? Oh, yeah, we've got$300 billion in our offshore balance sheet. Oh, what do you own? Oh, well, there's a few treasuries. And guess what? Dollar paper issued by Chinese corporations. I'm like, wait a minute.

54:24You mean all these dollar bonds are stuffed into the Chinese banks in their offshore bounces? Yeah. And then I triangulate it. I call a couple of large fixed income clients in the Far East. I say, look, you've expressed an interest from time to time in owning dollar bonds issued by Asian and Chinese corporates. How many have you been able to buy? None. Why not? Oh, it all goes into the Chinese banks. Ah. So you've got to think differently, right? And suffice to say, the Chinese like to support the home team. That's never going to change. Then there's another angle to this that I think is important, Ted.

55:00And rather than getting caught up in the game of predicting Chinese policy or economics or tariffs or trade or predicting what the PBAC is going to do with interest rates or the RMNB or whatever, is there anything happening that is a structural change that is not about predicting but is structural and the answer is of course yes and we're just at the start of chinese onshore financial markets being plugged into global capital markets and over a long period of time i think that's going to change correlations everywhere i really do in what way well global asset allocators, out of necessity, will have an increasing amount allocated to onshore REMNIMB assets.

55:53Now, of course, it is easier, and it's taken a while, to plug Chinese equities into the MSCI indices. Plugging in onshore credit and fixed income, which is a gigantic market, into global bond indices is much trickier. You've got to think about custody. You've got to think about, can I hedge onshore? You've got to think about repo. And of course, plugging in onshore Chinese credit and fixed income requires further opening of the capital account because you and I are not going to commit X billion to Chinese government bonds if we can't get it out. That's just not going to happen. So the fixed income and credit bit is going to take time, but it's coming.

56:37Meanwhile, the MSCI inclusion has started. And over the past several years, the ebbs and flows of Chinese onshore equities have seen more about the rotation of the Chinese liquidity bubble. So this gigantic liquidity bubble inside China rotates from housing to bonds to commodities to stocks and round and round it goes, whatever's hot next month until the authorities say, don't do that anymore. So for a long time, Chinese equities have nothing to do with fundamentals and everything to do with liquidity and speculation. But what's interesting over the past, say, three to six months is to observe and to work with clients who are picking Chinese stocks onshore and to notice how Chinese equities seem to be slowly more aligned to what we in the West might call fundamentals.

57:29So responding more to earnings results, better calibrated with multiples. Now, this is an iteration. There's a wonderful friend of mine told me the other day that some of the best performing external fund managers he's had since the early 2000s have been onshore Chinese longshore equity hedge funds. There's a structural shift occurring. We can be as sceptical as we like about Chinese policy in economics. In fact, we should be. We should be. But is there something that's structural that's changing? I don't recall any country being included in the MSCI indices to be subsequently excluded. But I'm afraid the facts are that whether it be passive money or active money, over the next several years, there will be increasing allocations to Chinese onshore equities, and that's not going to go away.

58:24I know that this is going to be a powerful change for global capital markets, so I need to find a way to calibrate it. I need to find a way to think about this structural shift and how there's probably a great opportunity for stock pickers in the mainland, if I can find some. And I need to calibrate that structural change against the deleveraging, the complexity of deleveraging, the way China's trying to come to grips with this extraordinary stock of debt and shadow banking and trying to calibrate the trade-offs and most of all trying to be proportionate about an immensely complex, gigantic economy about which, by design, Westerners will never know much.

59:10So let's turn to something that's been more stagnant and always seems on the cusp of change, which is Japan. It seems every few years there's an anecdote. there you know people still in the graveyard from shorting jgbs there's structural reform in the corporate sector what are you seeing in japan i'm seeing a lot of opportunity because it's boring i love boring boring compared to everyone being an expert on why abe's three arrows were going to drive dolly into infinity and you know all that kind of stuff right and all these people projecting that oh this is the greatest macro opportunity of all time it's quite striking how few of them actually made any money out of that but look japan's still ticking away, a little bit of a setback in the economy in the first quarter, but by and large, it's looking pretty good.

59:55The Bank of Japan sort of waffles from time to time about exiting their asset purchases. I don't see how they can. I really don't. And I could get myself into a lather about what it eventually means for the JGB market and everything else. Or I can step back and say, are there Japanese corporations that are absolutely the best in the world at what they do? And the answer is of course yes and it's not just about robotics it's about a whole range of things there's even activists getting involved in japanese equities by the way under our base patronage he's like look if i can't convince my countrymen to do it can you come in and give it a kick and you know it's it's been a good opportunity so far for people with a mandate to do that you know whether they be here in new york or elsewhere and it makes sense but there's still these companies out there, I think it's quite cliched these days to say own Japanese banks, but I've liked them for a long time and I like to stick with them because I know how much they've invested in their risk management technology.

1:00:58I know how much they've upgraded their personnel. I know how keen they are to understand how they run their balance sheets and stuff like that. So I think they're in pretty good shape and there's further re-rating. So I think of Japan as I need to keep an open mind. I need to keep an open mind. I think there's less excitement surrounding Japanese equities broadly. And my suspicion is that I need to retain a core minimum allocation to Japanese equities more broadly. And if in doubt, I'll just stick it in an index fund. And actually, that's what we have. And I just want to sit it over there and just ride it out.

1:01:30So let's go from boring to exciting. Yes. Get back home for you so you don't have to talk about being a guy from Wimbledon thinking about China. Yeah, yeah. How about Europe? Oh, it's all good, Ted. It's all good. Look, what is it about these people that they always want to play chicken with their own financial system? What is it? There's been this obsession with the Draghi wizard as I think of him for the past several years which is fair. who's an extraordinarily accomplished, fiendishly market-savvy man. But look, people have sweated and obsessed over everything he's said, which is important, about short-term interest rates, about quantitative easing, about lending, about everything he's done, which is important if I'm trying to duck and weave through FX trading, trading Uribe or trading various curves in the Eurozone.

1:02:27But I took a step back from all of that the other day and I just read through the transcripts of the opening statement he has made at every governing council meeting since whatever it takes. And when you step back from all the what's he saying now, you realise that he opens every governing council press conference with a plea for structural reform and nothing's happened. He basically says, well, he's saying two things. A, if it goes wrong, it can't be our fault because the ECB has done things that it was never designed to do, which is true. And then he also says that, look, you really need to follow up, please, Mr.

1:03:07Politician, follow up on structural reforms, but you keep promising but never delivering. There's no banking union, there's no capital markets union. And arguably, given the setbacks, the self-inflicted setbacks that Merkel has had, the probability that we're going to get widespread structural reform is going down by the minute. And then we have this extraordinary episode over the past few days. And I'm afraid I was not nearly as astute as some of my clients were in March when you had this election. And a couple of them said, hey, this doesn't smell good. And I was like, okay, I was more focused on US rates, which was a mistake.

1:03:45And then you get this Mattarella not denying that Italy can't have a referendum at some point on the euro, but basically denying these two guys who wanted to form a government come charging in and saying, right, you know, this is what we're going to do before they put it to the Italian electorate. So guess what? We had some pretty spectacular price discovery. And I'll say straight up, I'm not sure what this all means yet, but at a minimum, it's refocused people on unfinished business in economic and monetary union and perhaps permanently unfinished business. And how the heck can the ECB, which is the only game in town, ever step away from asset purchases?

1:04:31How can they? And we sometimes forget that we're talking about global growth being X or realized inflation being why. And the Fed's balance sheet is still$4 trillion plus. The ECB is still buying assets. And the ECB's policy rate is minus 40 basis points. What on earth might be the market clearing price of risk with regards to Eurozone peripheral credit were it not for minus 40 basis points and a certain amount of ECB asset purchases? So when I look at what's happened the past couple of days, people are already stepping in to buy the dip. And I'm not sure that's right. I'm really not sure that's right.

1:05:17Now, as a tactical opportunity, go for it. If I can scoop up a few BTPs at 300 over Bunz, great. But at 300 over Bunz, effectively, that is implying, I mean, this is subjective, but effectively implying a 30 % probability of some kind of redenomination or tactical default in Italy. 30 %? My word, that's not good. So the tactical trade, go for it. But the structural problem, not going away. But there's a bigger lesson, Ted, if I may. Central banks, with the exception of the Bank of Japan, have been signaling for a year or more that they are trying to reactivate financial markets. And financial markets don't want to hear it.

1:06:04There's a very fine fellow called Jeremy Stein, who was at the Board of Governors until 2014. And in his last speech, before departing the board, he reflected upon the taper tantrum in 2013. And I've reflected a lot about that too. It's popularly believed that the taper tantrum was a colossal communication error by Ben Bernanke. I'm not so sure about that. He was telling people via his speeches from February 2013 onwards that he thought US long-term interest rates were too low and people just refused to listen. And in reflecting upon that period, Jeremy Stein delivered this tremendous speech and he talked of leveraged quantitative easing optimists.

1:06:56In other words, people who were fully invested in the idea yeah, that central banks would have their back forever. And I think that pretty much describes where we are right now. The last 10 years, that's been the winning strategy. That assumption has been the winning strategy. You are dead right. But from time to time, we get attempted regime shifts by central bankers. Attempted. And that's when we need to be on guard. And when central bankers privately and publicly tell you over and over again that we're trying to reactivate markets, and when they go on and on about, oh, geez, implied volatility is too low, they're actually saying that our tolerance for some kind of market correction is higher, which makes sense when in some parts of the world, and particularly here, you're trying to tighten policy.

1:07:48As you look around the world to asset markets as opposed to rate markets or currency markets, where do you see risk? 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 300 billion spending that they shoved into the budget in January at this stage of the cycle, well, there'll be some consequences.

1:08:36But 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. So where the institutions have been piling their money are in these long duration assets. More and more in private equity, you hear about private credit.

1:09:12Yeah. And on the one hand, from an investment perspective, That's nice because they get out of their own way. For sure. They own an asset for a long period of time. On the other hand, the longer the duration, the more the risk that they're going to get hit if rates do eventually move up. Of course you're correct. Let's think about incentives. And this is where central bankers get muddled. And many of them say to me, James, we're trying to tell people that we'll tolerate more volatility and we're not interested in holding the market's hand anymore and it's time for people to think for themselves.

1:09:43I'm like, yeah, that's great. I get that. People appreciate that. They just don't believe you. But then from an asset allocation perspective, think of it this way. If central bankers keep saying over and over and over again that when they're done hiking this cycle, they'll end up at a number much less than previous cycles, which seems reasonable, frankly. So Fed funds doesn't get to 525 basis points like it did in 06. It gets to something like, or let's say 300, which I think would surprise some people if we got there, but that's where I think it's the minimum. And if you, Mr. and Mrs. Central Banker, say that when we're done, terminal policy rates this cycle will be much lower, you're advertising to every long-term asset allocator, nearly all of whom are chafing under heroic, if not absurd, return targets, mid to high single digits.

1:10:36You are telling them that if terminal and nominal policy rates are going to peak out at a much lower number, then the nominal return on risk assets is going to be lower. And the only way I am going to meet these absurd return targets is by remaining fully invested and owning duration, which is great right up until the point you made. Because if I'm assuming a steady state discount rate, great. Yeah, no problem. But then I sort of add 100 basis points to it. Oh, if you're in front of the chief investment officer of a pension fund or an endowment, different liability structures, how do you take and synthesize the information that you have and advise someone on how to shift or think about their portfolio differently for this period of time coming up?

1:11:31I start by trying to understand if there's been any changes in their process or any changes in key personnel or are they under pressure you know try to understand their incentives i've had this conversation with one very large pool of money and he was actually saying this is a great example actually it was during the eurozone crisis and we got into a great discussion about what was going wrong and he said james you know i get all of that but i'm sitting on top of a hundred billion dollars and given my mandate i just have to bull through it. And I thought that was a great lesson. He said, I've just got to stay in the game.

1:12:11I can't duck and weave. I can't flip. I can't hedge. I just got to suck it up. And that's important. It's often overlooked. Frankly, I don't want my pension fund clients and endowment clients and family office clients to be in and out of stuff and trading. That's really counterproductive. But my number one challenge is to explain some of the things we've discussed about the Fed in a simple, understandable way to be able to condense it into this is what's material to you. And some of the things we talked about, like one of the topics that comes up a lot is how should I think about my exposure to onshore Chinese assets?

1:12:53The other thing is a lesson on liquidity and what markets are like today is in nearly every discussion. If you're waiting, as we said earlier, for Mr. and Mrs. Central Banker to tell you it's okay to rebalance, it's too late. You've got to have a strategy. You've got to have a plan. So it's a whole range of things. But also, Ted, the most interesting part of the discussion with a pension fund or endowment or family office is, what are people not talking about? And that's where you learn so much. Hey, what are people not talking about that you think is really interesting? And what's the answer to that question today?

1:13:27India. India. And here's what I'm wondering about. It's a big place. It's a complicated place. It's a bureaucratic place. It's not going away. And in the not too distant future, it'll have more people than China. And some of the conversations that are starting to come up, I find fascinating because it forces me to broaden my knowledge and get outside of my comfort zone. So here's this country that is probably a structural opportunity. So take one example. We're all experts on Chinese technology giants. My gosh, these things are juggernauts. I mean, just juggernauts. And we all know the valuations.

1:14:10Let's say, simplistically, that the market cap of the Chinese technology giants is a trillion dollars, subject to what the next tweet from the White House says. What's the total market cap of Indian technology companies? Now, it's not a big number. Now, if we include Tata or not, Infosys and so forth, let's say for simplicity it's$20 billion. What? And again, we can debate whether we include Flipkart or not, and private placement. Put it this way, it's a very low number. And yet you have these immensely talented Indian men and women doing extraordinary things in technology all around the world, not to mention running important companies in the Bay Area.

1:14:53I'm like, yeah, that doesn't make sense. Now, it's not as if the Indians are about to allow foreigners to throw money into the Indian equities. And it's not as if Indian authorities are about to let foreigners jump into, you know, Indian credit and fixed income. In fact, it's often awkward to do so. It's like, wait a second. I'm not thinking about India properly. I'm not. But that's one dimension. Here's another. China, China, China, China, China, China, China, China, every conversation, China, China, China, China. One belt, one road, one belt, one road, one belt, one road. Yeah, it's important.

1:15:25And the reason we hear about it all the time is because China is the master of propaganda. Yes, of course they are. So we're inundated with commentary about one belt, one road, one belt, one road. But look, it's big, it's real, and it's China getting people to buy into the China dream. We know that. Why is nobody talking about the Delhi-Mumbai industrial corridor? and I'm ashamed to admit it was not until I had lunch with a great friend who lives on the same street in Wimbledon he's this great emerging market equity investor he's so enthusiastic and he put up a slide DMIC I'm like what he's like yeah Delhi Mumbai industrial corridor I was there last week here are all the companies developing it unsurprisingly Ted you know Delhi to Mumbai captures an awful lot of humanity and here's what they're doing the roads here's what they're doing with the railways here's what they're doing with the infrastructure india's getting it right and it's not getting much coverage i'm like and he's like it's investable and i'm loving it because it's investable today no one's talking about it i allocate my capital patiently and if i've done my homework correctly and modi's backing it and the whole government apparatus in india is backing it i feel comfortable with that and then i'll come back in a few years and so forth and i've started reading about this and it comes back to the china narrative oh look how many people we've lifted out of poverty.

1:16:47We have lifted hundreds of millions of Chinese out of poverty. Yes, you have. How many million people is Modi going to lift out of poverty? Right? I reckon it might be more than the Chinese have, but just whisper it. But then there's another dimension to this. Now, because it's India, and because it's happily a democracy. It's going to take longer to do things than the Chinese, where it's just like, hey, do that, or you're on the next bus to Mongolia. So there's going to be frustrations. There's going to be bureaucracy, but it's happening. But here is the next observation. What if India today is at the same point of its commodity demand cycle as China was in 2003?

1:17:39Now, that could be big. And my suspicion is that that hunch could explain part of why global commodity markets and energy markets remain fairly well supported. And I need to do more homework on that. But you recall in years gone by, we used to reflect on what the filling of the Strategic Petroleum Reserve in Louisiana salt caverns meant for the energy markets. when they were topping that up. Then we were experts on China topping up their strategic patrolling reserve. And you look at India's strategic patrolling reserve, they've got a long way to go. So I'm trying to learn as much as I can about India because like China, it's not going away.

1:18:27It seems to be undercovered. From my perspective, it seems to be under-discussed. and yet structurally I feel like I need to know much more about it and I'm encouraging my clients to think about it. It's not to trade it. It's not to sort of punt it. It's to think about where India is in its cycle and what could go right in a day and age where every conversation is dominated by China. I want to ask you about your time. You know you mentioned that Warren Buffett has an empty calendar, you sent me a book list of books that you clearly have read that were, let's just say it's a long list. And in this day and age, there's so much happening on social media, which is the opposite of a book.

1:19:20So how do you spend your time and how do you think about what's important and what distracts you? We are in a world that preferences the reactive over the reflective. and I would have thought if one is hoping to succeed as an investor, an allocator of capital over a long period of time, you must preference the reflective over the reactive. So you invert what too many people are doing today. And as Shane and other people and Mr. Buffett and others advise, the most precious asset all of us own is not some stock or bond or private equity investment or whatever it's our time and since i've been working for myself one of the things i've had to learn is to say no that's the most important thing and my dream week is to open the calendar and other than family commitments, there's nothing in it.

1:20:23That's my dream work. I'm not always able to do that. There's always someone interesting to speak with or talk to. But I find that all the mistakes I make are either because I pretend or I get caught up in a narrative that I don't understand and I haven't adequately reflected upon, or heaven forbid, I get caught up in the groupthink, or I go down some ridiculous rabbit hole on Twitter, which is apparently insight, although I do have my doubts. So it's a battle, but it starts with discipline, and I continue to work on that. And when I started working for myself, I really ramped up my reading. Why?

1:21:06Because I could. If you're sitting on an investment bank sales desk, you can't sit there with a book in your hand. You'll be out in the street. I really ramped up my reading, and it's humbling. Every day I walk into my library and I look at the shelf of unread books. My wife often asks why I've not been invited to join the board of Amazon. Goodness knows I'll give him a bit of support. But I look at all these books and I think, my gosh, how could I not read that? How could I have not known that? How could I, oh my God, I've not heard of her or him or that or that event. This is terrible, right?

1:21:40I'll say delicately, you know, midlife-ish. And I benefited from a wonderful education in Sydney. Thanks to mum and dad, I went to the University of Sydney. But I got to say, I feel that my education truly began when I started working for myself. And I started carving out huge chunks of time just to read and think and reflect. and it's a journey. And look, I'm not saying that I've got it sorted out. I'm not saying that I've figured it out. Far from that. All I know is that the more disciplined I am with my time, the better I seem to understand issues of the day. And I say to my clients that related to your question, I'm just trying to be less wrong.

1:22:32I'm trying to be less wrong. And if I can come to grips with that and I'm patient and I read, then from time to time, I'm hopeful there will be opportunities that I can steer my clients toward, whether they be being sensible after Brexit, whether they mean the investing opportunities in January 2016 when you had certain Asian equities trading at Asian crisis lows. I mean, that's just absurd. You know, well-run businesses with good balance sheets. The opportunity in US short-term interest rates. Sometimes you have to wait a while, but the more you step back and create the space to reflect, my hunch would be you're more likely to be less wrong.

1:23:15And that's the challenge. All right. I think we could go on and on, but we probably should turn to these closing questions before everybody stops tuning in. So here we go. What was your favorite achievement from your youth? What age does youth go up to? 40 good now i uh i'm gonna say getting a single figure golf handicap nice yeah all right my handicap today is three children under 13 exactly who i love dearly keep that in what's your biggest investment pet peeve that from time to time i've pretended to know something that I don't understand. That's my number one pet peeve is that for too long, I was impulsive and reactive.

1:24:11And so I'm calling myself out as opposed to what other people do. If I'm thinking about what other people do, one of my pet peeves is people that jump up and down and up and down, up and down, up and down, up and down. And they say, I told you so. Now, maybe I'm old fashioned. And if I was providing independent research to people sitting on top of prodigious piles of capital, I could think of no better way than to antagonize them, let alone upset them, by when something I've been predicting for years suddenly happens. And then I say, I told you so, or we nailed it. So there's two angles to your peeve question.

1:24:57What teaching from your parents has most stayed with you? Being present for your family, number one. I think about the heroic effort that our dear late mother put in to the point of exhaustion most days to feed three very hungry sons in Sydney. The shopping involved and the cooking involved. I mean, she was magnificent. And then dad, who had a very busy job, he was always, I know it sounds cliched, but he was always there for us. And I think that's the number one lesson, being present for your family, not just in the room, but being present. And that goes back to being disciplined when it comes to technology.

1:25:41You can't lecture two preteen girls about the evils of the iPhone, which I sometimes do. if you're walking around your living area with an iPhone in your pocket. It just doesn't work. So the number one lesson for mum and dad was being present. And there's nothing more important. What information do you read that you get a lot out of that other people might not know about? 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.

1:26:39In 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.

1:27:32And 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, the self-indictment that you can read in these transcripts, the disconnect is appalling. What life lesson have you learned that you wish you knew a lot earlier in your life? That as much as I liked to read from a very young age, I should have done even more. That's the number one. Yeah, that's the number one. I could have done so much better. I could have been so much smarter related to which with the way I approach things.

1:28:13I could have been so much smarter with process, discipline. Things as seemingly mundane as getting up the same time every day, doing the same thing over and over again. And I'm glad we kind of almost by accident got into this. But the common thread across all the most successful investors I have the great, great fortune to work with is their absolute obsession with process. Absolute obsession. if they've got three offices around the world good for them but they're identical and having that comfort knowing your process doing the same thing every day for decades the pen's in the same spot the mouse is identical i mean it sounds inane but it helps you be anticipatory and remain in control in what remains a very very emotional and often hyperventilating world so two things ted I wish I'd done even more reading across all sorts of topics and I wish I'd paid greater attention and been more disciplined with how I allocate my time every single day.

1:29:18James, fantastic. Thanks so much for the time. What a treat, Ted. I mean, who would have imagined that you and I'd be doing this even six months ago? Amen to that. Look, it's such a pleasure and such a treat and I can't thank you enough for inviting me on. Hey, before you take off, I've started sending out a monthly email that shares a small selection of what caught my eye over the month. I get a lot of emails like this, and I'm sure you do too, so I'm only going to send no more than a handful of the very best things that caught my eye. If you'd like to receive that email, hop on my website at capitalallocatorspodcast.com and join the mailing list.

1:30:02Thank you.