Interest Rates Are Going Up - Is the UK Ready?

0:06Welcome to IG's The Art of Investing. Now, if you're new to this podcast, stop scrolling right now and listen. This is the UK's top financial podcast and the only one to bring you the expert's advice to running an actual model portfolio. Yes, IG took a survey about a year ago and asked their clients, what do you really want from your investing? And the answer clearly was, we want to know what the experts are investing in and why they're doing it. So I was sent out to find two experts. Unfortunately, they're still on their summer holidays. So today, I bring you my equity expert, Mark Spice Holden.

0:48Hi, Rich. And my Bond Supremo, Chris CJ Fellingham. Hello, Richard. Gentlemen, isn't it wonderful to be back? It certainly is. We're back in our home from home office. This is what it's like. We're seeing each other in the flesh after four weeks of summer holidays. Speaking about in the flesh, I think we've got a story to catch up on, don't we, Spice? Yeah, I was at the Fringe last week and recommended by my son. I went to see a comedian called Gary Starr and he's coming to London soon. I highly recommend it. I laughed continuously for an hour. He does the whole show naked except for a pair of flippers.

1:25He's a penguin, basically. And there was a moment where he does some body surfing. And let me tell you, Flesh was pressed on Flesh. And I was four rows back. And that's quite scary, I can tell you. And there wasn't only four rows in the room, was there? I know. There was about 600, 700 people there. So it was a huge venue. Absolutely hilarious. I laughed literally from start to finish. And I highly recommend the show. And he's coming to London, I think, after spelling New York this week. He'll be in London for the Christmas season. Okay, we know our Christmas guest for the podcast then. It makes you think differently of a pantomime, doesn't it?

2:00Right, speaking about that portfolio, let's have a look at exactly how it's performed this week. After that big intro, it's down 0.9%. So a tough week there, particularly for three assets, which we're going to come on to in a short while. But that does still leave us up 12 % year to date and up 24.6 % since inception. So to hear the why and the how of what's been going on this week, we go over to the Spice Market Update. Thanks, Rich. Well, as you alluded to, a lot of assets have had a tough week, and that's because the bombs have started flying in the Middle East again. The oil price has shot up 12%, the highest level for about six or seven weeks.

2:41Brent oil now back up to about$97, which is a little painful. Remember,$100 is quite a big psychological level. So if it tips over there, you may see further wobbles in assets. but it's been a big week. And that's despite people like the US saying that they're now getting about 17 million barrels of oil a day going through the Straits of Humors. Remember, pre the war, there was about 21, 22 million barrels going through there, about 20 % of the world's oil requirements. And they also mentioned that they're absolutely ramping up their production in Venezuela. Remember the subtle takeover of Venezuela that Trump has done?

3:15And their production's up 25 % and exports are up 50%. This week, interestingly, Chevron has said they're going to announce$7 billion of new investment in that Venezuelan oil production. Their shares went up on the back of it, surprisingly. And ENI, the Italian oil company, they're going to invest$1.5 billion. Unfortunately, BP, our homegrown oil company, has decided a couple of weeks ago, which we didn't really talk about, that they're going to leave the North Sea because it's mature, it's too heavily taxed, and there's no incentives to go and drill in the North Sea. So listen out, Burnham and Co.

3:51You want to keep our oil companies drilling, and you want to keep that oil price down. You need to encourage our oil companies. Sounds like how CJ describes himself, mature and taxed too much. I hadn't thought about that, Rich, but perhaps I should call myself BP. Big. Big something, yeah. Let's not go fringe. Big penguin. Oh, dear. Enough jesting. Enough jesting. Enough jesting. You know, on a serious note, unfortunately, this rise in the oil prices led to European gas prices hitting the highest level since 2008. And this is obviously going to hurt some of the European industrial manufacturers.

4:34And, you know, so the European markets have had a tougher week this week. and basically it also sort of put pressure on bond yields. Remember, bond prices go down, the bond yields go up and they're worried about this oil price feeding through into inflation. It hurt other assets. Bitcoin having been very good for the last few weeks, fell 5 % this week. Gold and silver down about 5 % this week. No all new time highs to report in the equity markets and the chip sector down about 3.5%. So that's pretty tough out there. We come right to the end of the reporting season. We've had some of the big hardware providers to the AI boom.

5:13Dell Computers, many of you got Dell Computers sitting at home, but they're also making big AI servers. And their shares are up 5 % after great results. For the fifth quarter in a row, they've upped their guidance, this time by about 25%. And they've got a$25 billion order backlog over and above which they've reported to the market. So that's pretty good. And their margins have nearly doubled. So very good reports from them. I must say, I think that was one of the best earnings report that I read throughout the entire quarter, if not the entire year. They are absolutely smashing it. And I mean, the stock's responding.

5:48I think it's up over 200 % in this year. It is, yeah. But it deserves to be. They've completely transformed the business as to what it was before. Yeah, absolutely. As you say, they've gone from just doing laptops and sort of home PCs and office PCs into this AI server. And it's now half of the business. So that's been a very rapid move. And they've done it, executed it very well. I mean, we've had some other great results. Broadcom had great results. HP Enterprises, all exposed to these big data center growth and the hardware that goes into AI. Those shares didn't respond quite as well, even though Broadcom's revenues are up 86%, I think, and AI is now 50 % of the group.

6:29And they've guided to the fourth quarter to be even higher than that, looking for 94 % growth in revenues in the fourth quarter. HP, very good. The margins doubled, upgrades followed through, but the shares fell about sort of 4%, as I say. Interestingly, there's a company called Snowflake who do a lot of the chat box that you get automated when you go through particularly on HR functions. And their shares were up 20 % last night. They're having fallen about 50 % because everyone, remember, sold the software stocks when everyone said, I think when Claude said, we can do all this software stuff really easily.

7:01And they've recovered quite strongly and they're up another 20 % yesterday. And again, their results were very, very good. They're seeing accelerating demand, 20 % upgrades. It's all pretty good. So the software side is not being written off at all now. And actually, I think investors are beginning to realize that. And that's coming through in cybersecurity as well. Huge rally in the cybersecurity names. Again, this week, Palo Alto, really good numbers. That's the premium name of the sector. But yeah, these soft, I mean, that was an opportunity that we maybe missed, was instead of looking just at the AI names to look at the really beaten up sector of software.

7:38Yeah, well, particularly with all these, the AI being able to break passwords and everything like, I think cybersecurity is going to be very important going forward, clearly. But the big number to watch this week, we've got payrolls on Friday. Remember, this is how we measure the US employment market. And it's going to be key because the week after next, we have the Federal Reserve's rate setting meeting. I think it's on the 16th and 17th of September. we'll be looking tomorrow from this payroll number for an increase of 55 ,000 potential jobs. And that was against a fall, remember, last time at 23 ,000.

8:12That really shot people. And that negative number, first of all, took the pressure off interest rates, saying, oh, the economy's not doing as well as we hoped, or the jobs aren't being created. So, that lessens the need for an interest rate rise to control inflation, because lower jobs should lead to lower employment, lower wages, lower inflation ultimately. So if it does come in with another negative number, I think the pressure will come off again on interest rates. But right now, we've seen that there has been an increase in expectations for interest rates because we had Jackson Hole at the end of last week.

8:41And we highlighted that that was going to be quite an important event. And so it proved to be. So Jackson Hole, got my cup of tea ready, biscuits, had a few positions on. And I really enjoy these things. Watching a Fed interest rate decision press conference is as good for me as watching the premiership match. I really love it and I get into it. Warsh stood up, he spoke for 10 minutes and I felt my head start to nod off and I physically fell asleep. You've got a strange life, Rich. There's no doubt about it. When you sit there with your biscuits and cup of tea and you think that's exciting. I'm on my IG platform already.

9:20It's a tough life, mate. But look, We talked about it as being important to see if there was any highlighted difference between him and the Treasury Secretary Scott Besant. Remember, Besant's trying to manipulate markets. Walsh, the Federal Reserve chairman, wants them to go to wherever they should go to. And also, after the last Fed meeting, in the question and answers afterwards, Walsh wasn't particularly helpful to anybody as to what he thought was going to happen. and I think was broadly criticized, certainly criticized in your favorite podcast here, but other people joined in as well. It's nice to be in a crowd sometimes.

10:01And essentially, he therefore had to do something. So he came out and within the two minutes of starting it, he basically said, I think rates are going to have to go higher because inflation isn't behaving itself. And that shot the market and the market then started pricing in more rate moves. In fact, he started off in a very interesting way that nobody knows for certain whether it's a coincidence. But he said, everybody, welcome. I hope you've had a chance to get out there and hike around the area of Jackson Hole. It's a beautiful place for hiking. And there's two different types of hikes that you can do when you're here.

10:39And he went on to talk about Yellen and a Bernanke hike. Was there anything behind that? I don't know, but I've seen it referenced that he has got a reputation for hiking around there. So he was able to make a nice play on that hiking, but also on what might happen to the Fed funds rate next. But no forward guidance. This is the important point. Here's the guy who says, I'm not going to tell you what I'm going to do. I'm going to let the market make up his mind. By the way, I'm going to raise rates. I mean, you can't make this stuff up. But unfortunately, he had made it up at the last Fed meeting, got pilloried for it.

11:13And so now he was having to mend those fences a bit. So the market is now expecting rates to move higher. But that isn't the only excitement there's been in Bondland. Not only have we had the Jackson Hole statement, but we've continued to see the fallout between those partners of Scott Besson and Stanley Druckenmiller, who we talked about in last week's episode. They've been at it again, haven't they? Now, the argument shows no signs of baiting as the divorcees, as I like to call them now, because they're now not talking. They're still arguing about the outlook for US bonds. On August 31st, Scott Besant gave an interview to CNBC at the G20 meeting, because last week was the G20 meeting.

12:00Well, sorry, the start of this week was the G20 meeting. And he responded to Stanley Druckenmiller's criticism of the Treasury's expanded buyback program. And what he said was, he said, Druckenmiller remains a great investor. It's like that expression when people say, you know, with respect, when you know there's no respect whatsoever, right? With respect, he's a great investor. He said they had a conversation, they discussed things, and it was very amicable. I mean, quite why this was at all relevant is beyond me, but anyway. He said Drucker-Miller frequently changes his market view and dislikes losing money.

12:41No shit, Sherlock. Wow. This is really eye-opening, this interview. But then he said he suspected Drucker-Miller had lost money because of what he had announced, and therefore, that's why Drucker-Miller was upset. Wow. So his defense was essentially that US bonds had performed better than other bond markets, and therefore, that's fine, isn't it? My view is, so what? Stanley was saying bonds should be allowed to move higher in yield, lower in price, and that's exactly what they've done. And I'm afraid, as far as I'm concerned, Besson's talking a load of doo-doo. Technical term. It is. Now, the remark was essentially, he was being disrespectful, in my view, to Stanley Druckenmiller.

13:28And that is a very, very foolish thing to be. In a dogfight, you always back the big dog. And in hedge fund terms, there's not many bigger dogs than Stanley Druckenmiller. And the market sell-off shows he has been more right than Besson has been. So don't pick a fight with him. Just shut up, Scott, and let the market decide where they want to go. Now, I want to contrast this with what's going on in the foreign exchange market at the moment. Because if people will remember, we talked about Besant trying to manipulate the bond market, but also intervening in the FX market, in particular, the Japanese yen.

14:10We would always say, and have always said, that you can't buck the fundamentals. So in bonds, everything points to higher yields. So why is Besant trying to keep them down? It's ridiculous. He can't keep those yields down. But in FX, the yen is cheap. If you look at various things priced around the world and you translate those prices into Japanese yen, a thing called purchasing power parity in the terminology of the city, the yen is clearly very cheap. And so intervening in the yen to buy it is a positive thing and we should respect. And what have we seen today? We've seen a big move today in the yen against the dollar of over 2%, which is a big move.

14:55If anybody is wondering what purchasing power parity is in a real man's sense, it's the Big Mac index. How much does a Big Mac index cost in Hong Kong to Edinburgh to Los Angeles? Yeah, and that's another way of showing whether things look cheap or expensive when you turn them into the same currency. So the Treasury, the US Treasury are doing two things. One, they're trying to manipulate bond prices higher, yields lower. Wrong thing to do. We don't agree with that at all. But they are also trying to drive the yen stronger. And we do agree with that. And I'm sure that will give them great comfort that the best financial podcast in the world is agreeing with one part of their action, but not the other.

15:41Yeah, they're doing it in conjunction with the Bank of Japan as well. And they do this thing when they try and spook foreign currency traders. They do what's called a rate check. So they ring up the market makers or the people who make the prices in the currency day to day. And they say, hi there, Rich, can you give me the price, please, in US dollar, Japanese yen, in a billion dollars, please? Oh, 159 choice. There you go, right. The market maker goes, what do you want to deal? and they go, I'm just rate checking. Thank you very much. Puts the phone down. And then the market maker goes, oh, I think they're going to do something.

16:16They're going to do something. So they start moving the price automatically the way they think that's going to happen. And that just shows, I think, if anybody who's watching this on their YouTube will notice two things. First of all, Mark starts talking about prices and so does Rich, and they put their hands like a headset. I mean, it's not the real world, guys. It's now on the screen. What are you guys? I mean, you're so old and you think you call me the dinosaur. It's outrageous. Harsh but fair. When we're trading in the size we do, you've got to call up. Yeah, exactly. Oh, right, exactly. I mean, to be fair, the Bank of Japan also, one of the main members of the Bank of Japan rate-setting committee basically said, there's a meeting coming up just after the Fed meeting in two weeks' time, said that they should maybe not nibble interest rate rises but think more than that.

17:07and that implied at the moment everyone thinks they're going to put rate rises up about quarter percent every six months so from what he said it implied that you could get more than a quarter percent rate rise in the next meeting maybe a half percent or even three quarters of a percent sort of front try and get ahead of what everyone is thinking and maybe do it not just every six months but maybe every meeting or every other meeting or something similar to that so that combined as you said and chris said that strengthened the japanese yen by about two percent in the last couple of days purely from those actions.

17:36But it's a concerted effort between the US and Japan itself. But the fundamentals point that way. The key I want to leave people with is if the fundamentals are your way, it's a lot easier to get things going than if you're trying to fight and stand there, like putting your finger in the dike, a bit like the UK did when George Soros was breaking the Bank of England. And they're saying, we're never going to devalue, we're never going to devalue, we're never going to devalue. He just says, I'll sell you another billion. I'll sell you another billion. See, I'm doing it now, Spice. And I'm going, oh my goodness.

18:08I'll buy that. I'll buy that. We're finished. We're finished. But anyway, at the end of the day, go with the fundamentals. When they're in your favor, it works. It's not just a concerted effort as well. Besant is trying everything he can to manipulate markets. So he's tried intimidation, saying in the press conference, guys, it's asymmetric information. I know more than you. And I'm doing this. So why aren't you doing it? And then he was caught on camera this week in a small group Q &A, and there wasn't meant to be any cameras. And he said, guys, just remember, for 40 years, I've been in the investment world, but now I'm the house.

18:47And you know, comments like that, is he getting too big for his boots? I've got a bit of a problem here. I've got to make sure I don't start ranting. But over the many years that I've been in the markets, when I first started, there were no laws against inside information. And then very quickly, we came up with inside information. And for those who don't know what inside information is, it's information that is not in the public domain, which is affecting a particular share price or a particular product, right? And it's illegal within the stock exchange. But because FX and bonds are traded outside of the stock exchange, it is not illegal, but it must be frowned upon.

19:24When someone is saying to you, when the Treasury is actually saying, I'm doing this because I know something you don't know, why is that okay? And it's really, really naughty, in my opinion. Absolutely. It shouldn't be allowed and it's something that we are going to regret seeing happen because the market wins in the end. The market will win. And so the bigger you make it, as I said, if it's against fundamentals, the bigger you make the bet, the more money you're going to lose. Your capital is at risk. The value of your shares, ETFs and ETCs can fall as well as rise, which could mean getting back less than you originally put in.

20:00This content is for information purposes only and is not investment advice. Past performance is not an indication of future results. Well, talking about the market winning, it certainly beat us this week because looking at this portfolio, like I said, down 0.9 % on the week. Spice, give us the good news first. Come on, what were our winners? Thanks, Rich. I'll do that. Our old friend NASDAQ, which is heavily exposed, as we know, to the AI trade, was up 0.6%, our best performer this week. And that was actually led by the fact that NVIDIA had a halo effect from their results a couple of weeks ago that we talked on and said they were fantastic.

20:34Their shares were up 8 % this week. That certainly has its, you know, one of NASDAQ's biggest stocks and 8 % of the S &P 500. 8 % move in NVIDIA. It's a big move. And the Magnificent Seven were up 3 % as a whole as well. So a big chunk of that was driven by AI. Emerging markets helped by this AI halo did better as well, up 0.4%. And India actually arrived in the top three this week, despite AI doing well. And we found recently that India's done badly when AI has done better. And actually this week, they had very good gross domestic product or growth numbers out of their economy. Their economy is growing at 7 % at the moment, which is very good.

21:11God, would we love to have 7 % growth in the UK? Andy Burnham would love that. Just think of the money he could spend. It's coming. Wouldn't we all? And remember, that's over and above inflation. So, you know, the US might be growing at 6.5%, 7%, but that's, you know, including inflation of about 3%, 3.5%. So, very good news from India at last, a sort of nice positive there. And I mentioned the S &P 500, which we hedge back into sterling, so we don't take that currency risk. They're just up 0.1%, again, helped by those tech names. A good time to bring up a viewer question. So, I had a question come in from Maturin, or Paul Cooper, as he's otherwise known.

21:46and he said, CJ, I don't really understand why you've got these short-term gilts. As you can see on screen, there's zero to five year. They haven't done anything for the whole time you've had them. What's the point? Wouldn't that money be better used elsewhere? Yes.

22:05Guilty as charged. In fairness, we're trying to have a balance within the portfolio of risk assets and sort of safe assets. And we put those in right at the start. I can't remember Spice who wanted to buy those rides at Stark. Can you remember? Who was it? Yeah. Look, we take collective responsibility here. We do. I'm going to say we all took that decision. At the end of the day, they've done nothing, but they're effectively cash. So you'd expect them to do nothing. So to me, we're balancing within the portfolio the risky assets with the safer assets. we have had a more much more risky assets in our portfolio which is why our portfolio has done very well in hindsight would we be better to put it all in the best returning asset over the last year of course that is what we should do maturing thank you for pointing out that with hindsight we were wrong but at the end of the day it's that balance we're looking at but the real time to have these and why they're in the portfolio at all is if this economy suddenly starts to go south you'll actually get quite a nice return from those as equities are most likely going lower.

23:15You're opening a bigger question here, which Mark and I have talked about a number of times here. Mark, I think, has explained it extremely well, which is that in the old days, when the... In the old days? When you used things. When I used to look like I was putting something in my ear, the bond market would move inversely to the equity market. So, you know, you thought, well, if equities come off, bonds will do well because they're going to be cutting interest rates. And that's what happened for the last 15, 20 years, let's say, the 2010s, the 2015s. That's what people remember. Bond prices go up, yields go down.

23:58When that happened, equities might fall and they would therefore be a balance. But, of course, it really depends upon what's driving the setback in the market. And we talked in this podcast on many occasions that if what's driving it is inflation expectations are picking up, that's not good initially for equities, but it's also not good for bonds. So, actually, these things move together. So, it is good, it is right to say that it's a diversifier having these short guilts in there. But if the prices are moving because generally inflation is moving upwards, they're not going to help you. And I suppose realistically, we've had them in there as a sort of a balance, as I've said.

24:45But at the same time, inflation has pushed up. So they haven't really done anything for the portfolio. Well, we've tried to avoid it for as long as possible. But yes, these negative Nancy's. The Russell 2000 down 2%. The FTSE 250, a tough week, also down over 2%. The BlackRock World Mining Trust down 2.2%. But that XLI Industrials ETF down over 4%. Spice, what are the reasons for those in particular having such a negative week? We said Nasdaq's great because of Nvidia, but is there a particular reason? I think the simple trend is the oil price up 12%, right? If you're an industrial company, a big amount of your costs are, you know, fuel, diesel, if you're running engines or machines.

25:33And as I mentioned, the gas price in Europe's hit a big high now, the high since 2008. And that's really sort of pressurizing the cost of these companies. Even in miners, mining companies, about a third of their costs are actually things like diesel and oil. And so it has a spillover into these other industries. But industrials are particularly badly hit and miners as well. And that explains that. And, you know, the other area that's moved, and, you know, we've just been talking about the pressure on interest rates potentially going up. Next week, we actually have the European Central Bank set their interest rates ahead of the Federal Reserve, the Bank of England and the Bank of Japan the week after.

26:11So next week, it's now a 97 % probability that Europeans will put their interest rates up by a quarter of a percent. And that's because they had inflation of 3.3 % this week. came out and it was expected to be 2.9. So it's much worse than expected. Yes, it was all to do with energy and oil, but nevertheless, it's there and it's factually. And they're probably not going to say it's transient. In other words, it will just go away and everything will revert to normal. And that's the pressure that Kevin Walsh and the Governor Bailey will face at the Bank of England. How long will this high oil price last?

26:41Because when it comes off, yes, the pressure will come off. But right now, it's pressurized and it's hurting those mid and small size companies, which we're exposed to in the FTSE 250 and the Russell 2000 because those companies are more interest rate sensitive than other bigger companies because they tend to borrow more money through the banks. So if the interest rates go up, the banks put the rate up. So your overdraft facility will pay more on, you know, personally you pay more on your credit card or your mortgage. And those companies that are not as big as the super, you know, Magnificent Seven and NVIDIAs of this world are affected by that pretty quickly.

27:13You're trying to tell us you've got a credit card. Yeah, just a few. Okay, then. So as I said, that gives us negative 0.9 % on the week, up 12 % year to date. But CJ, where does that leave you thinking as we're seeing some of our assets move lower by two to 4 % in a week? Are you starting to get nervous? Because it does feel like the market is, you're potentially talking about higher inflation and a lower jobs number coming through. I think we're in a really tricky time at the moment. And the question that I want to ask over the next sort of 10, 15 minutes is, is the investment theme dynamic changing?

27:58We have been of the view that growth's fine, interest rates will stay quite low, and that will help equity markets do very well. And we're seeing a bit of a challenge to that. But let me explain why I say that. You know me, I like to get into my bond speak. So for those of you who are thinking going off to make a cup, see, don't, because you'll miss the best part of this podcast, which is about the bond market. So look, let's look at the UK and the US bonds in detail because they are giving us a different story. Thematically, quite similar, but a different story. The US 30-year currently trades at 5.3%.

28:41So you've got a 30-year bond with a yield of 5.3%. And remember last week I introduced, or maybe the week before, about inflation-linked bonds. And what inflation-linked bonds do is they say they'll pay you return over and above inflation. And that's called a real yield. So the real yield in the US is 3%. Now, if I take the 5.3 minus the 3, that gives me an estimate as to what the market thinks inflation will be over the next 30 years. And in the US, that's 2.3%. So I would argue there is no risk really priced into the US on inflation. People think inflation will remain well controlled. Mark's talked about this many times, how the AI, the benefits of AI may be deflationary, bringing inflation down.

29:37The growth is strong, but we've got deflationary pressures. So the market looks to agree with that and say inflation is going to be well-behaved, not a problem. And it did almost get there last year on the PCE. Yes, so it's fine. Now let's look at the UK. Now the UK example is slightly different. UK 30-year yields are at 5.9%. 30-year index linked in the UK, this inflation-adjusted returns, are 2.5%. Now, 5.9 minus 2.5 is approximately 3.5%, 3.4%, 3.5%. So, what we're saying in the UK is, remember in the US, inflation is going to be well controlled at 2.3%. In the UK, the estimate is that inflation will be 3.4 % over the next 30 years.

30:31Now, call me old-fashioned. Old-fashioned. Thank you. Call me old-fashioned, but the Bank of England is sitting there with a target of inflation of 2%. So the market is telling you that it has no belief in the credibility of the Bank of England to keep inflation low or the government to get control of spending and break down inflation from the fiscal side. That, to me, is very worrying because it's something we can do something about. There are things in life you can't do something about, but the Bank of England is there to get inflation at two. And they only have one job. They only have one job.

31:17In America, they have to look after employment and growth as well. So if you think about that, the Bank of England are saying, we want to get inflation at two. We'll keep inflation at two. We'll keep inflation at two. The market says it's going to be 3.4. What's the Bank of England going to do? And everybody, including myself, will say the last thing we need in this country is an interest rate rise. And I will tell you, you are definitely getting them now. because of where these numbers are now, because we are losing credibility. But we can win it back by doing that. Now, the other way of winning it back, of course, is to cut public spending.

31:53If we cut public spending, the central bank's pressure to raise rates will disappear because demand has come back. So we have a very different situation between the US and the UK. The US, real yields are higher. Real yields are higher means there's a shortage of capital which needs to fund the data centers. In the UK, we've got an inflation problem and a credibility problem. And the only way you can sort that out is someone's going to have to do something tough. And if the government won't do it, the Bank of England will have to do it. And if the Bank of If England won't do it, the markets will do it for them.

32:36And that's where the risk is at the moment in the UK. A big issue behind all of that is that the US are going for energy independence. Now, they've got some very high, they've got very high oil production domestically in the US, but they're also going to Venezuela. They're trying to secure oil deals in the Middle East, wherever they can. They're getting oil deals. Europe and the UK are sitting on the sidelines going, well, we're just waiting to see what happens. You know, yes, we depended on Russia. Look what happened there. And like I say, with BP pulling out the North Sea, what are we doing about it?

33:08We've got the Falkland Islands, they've just started producing. That should be somewhere that the UK is tapping into and saying, yeah, we want to have some of your barrels and get it here first before you sell it to anyone else. Keep talking about the Falkland Islands, Spice. For those people on this podcast, they'll know that me and Spice have got positions in the Falkland Islands from many, many years ago. So keep talking about it, Spice, and see what we do. But my point is the UK has got a problem, but we can sort that out. Well, you can sort it out in two ways, but if you sort it out via the Bank of England route and you increase interest rates, that's going to hit growth.

33:43And when you hit growth, then that messes up the budget even more so. So then the politics has to then do what they need to do. But the only thing the Bank of England is going to do is tighten rates. they are judged by keeping inflation at two. They have missed it for the last X years. They have to raise rates. The people who say they're not going to raise rates, they are going to have to raise rates if this carries on. There's no doubt about it. It's the wrong thing to do without a shadow of a doubt, but it's the only tool in their toolbox. So they're going to have to do it if the government don't do something.

34:18And this is the problem with an independent central bank in that sense. They only have one thing. What should be happening is the government should be saying, the reason we have inflation in this economy, and we won't talk about pay rises for train drivers to Manchester, which was announced in the weekend press. We won't go there because that will really get me going. That sort of thing creates inflation. More spending creates inflation. We need to get that spending lower. But we can do it. We can do it. The big problem to me is the US, which is there's a shortage of capital for AI. You can't make capital.

34:55So what has to happen is that capital has to come out of other assets to go into the funding for AI. So what then happens is you get this, what Stuart Thompson has called, when we've talked about it before, we get this competition for capital where somebody suddenly says, how high do these yields have to go to encourage me to go into them? And where am I going to get it from? Well, in the States, everyone's in the equity market. So the only place this stuff can come from is either from overseas, where the money comes in, in which case markets come down anyway, or it's coming down in the US. And so to me, that's a circular argument around to where are we at the moment.

35:39I am concerned that we are in an environment where bond yields are going up, generally around the world on real yields going up. We have a particular problem here, which we can sort out. But real yields generally are going up because there's a shortage of capital. And that is not good news for asset prices. And another area where we see a safety valve come into effect when you have these big different differentials is in the currencies. So we're seeing a lot of it in Japan at the moment. But in the UK, let's say the Bank of England are stubborn. They don't put interest rates up because they're worried about the economy.

36:13That's not their job, by the way. Their job is to sort out inflation, not the economy, because they're hoping the politicians do the right thing. the politicians doing the right thing, and the burden keeps spending, keeps spending, keeps spending, the pound will go down, right? Which means actually, ironically, any goods we buy from overseas become more expensive because we get less, you know, purchasing power from our pound. So that adds to the inflation. The whole thing spirals and spirals and spirals until eventually it breaks and someone has to do something, whether the government have to cut the costs, or the Bank of England have to put up rates much more than expected.

36:42And that's the fear that's beginning to gather in the UK. Now, obviously, we've got a budget coming up in just over a month, That will be absolutely key. And I think that international investors particularly will watch that very carefully and we'll have to watch what happens to the pound immediately after that. And then talking about international investors, you've also got the situation in Japan that Spice mentioned. It's internationally bond yields are going higher. So that's making that more attractive for domestic Japanese funds. So when you say that capital could come from abroad to help the situation in the US where they're short of capital, could actually go the other direction.

37:21Without a doubt, Rich. I mean, if people are convinced that the yen is going to strengthen, as I've said, the yen is cheap. We should not be fighting that battle. We should be with Besant on that battle. If the yen starts to go up and people start saying, yeah, I like that. I think that's a good trade. Then all those investments the Japanese have made over the years in other markets start to be eroded by the fact that their currency is going up. So the net effect of that currency is bad for them. So they bring those assets home. They take them out of those overseas markets and bring them home.

37:56And the other issue you've got, of course, is there aren't a lot of people who want to put money in the US. So at the end of the day, I think the US is going to have to solve its own problem. And the only way it can solve that problem is by putting yields up further. Now, we've talked before on this podcast as to how you think about bonds in a framework. and we've sort of said before there's a real yield. And let's say the real yield is correlated to the growth rate of the economy. And then there's an inflation rate you add on top and then there's a bit of risk proving. Well, it doesn't take a rocket scientist, it might take Spice, but it doesn't take a rocket scientist to work out that if you believe that growth is going to be around about three and a half, which I think Spice would say is what he thinks in the States, maybe living a little bigger, but they say three and a half, and inflation is going to be three to three and a half, why aren't bond yields seven?

38:46Why aren't they seven and a half? And they get there. If I can pick up seven and a half on a US government bond, and I only ever think I'm going to get seven on equities with a risk, why the hell am I going to own those? This is where we get to in my book at some stage. I think we're on that trajectory. It's when and how do we get there? And that's what we need to think about. Are we on this trajectory to high yields overall? I'm not hearing any of us complaining that's not going to happen, but if you don't agree, tell me. So this is now a question of timing. This is a question of when does it get painful enough to say, time to run for the exit.

39:29And I'm going to say one thing here, and then please, guys, you tell me what you think. There's an old city expression, which is, don't be a dick for a ting. What that means is, don't lose sight of the big picture and be too cute about execution levels. You know, if you think the thing's going down, sell it. Don't wait, oh, I'm another quarter percent. I'm sorry, but I have a reputation for being a bit of a dick for a tick. I've been trading the bond market my whole life. Two ticks failing. And people, exactly, as JP said that time, but they're probably right in this occasion because we are now trying to fine-tune when this is going to really count.

40:06It started to count this week, but my view is it's not quite time yet, but I'm nervous. Yeah. Is that right? He was called a dog for two ticks, not a dog. He was my boss. I wouldn't call him anything. I think this is a great time for us to go to Gibson's question, because it's very much related. If you've got a situation in the bond market, could potentially lead to money being taken out of equities in the US. Gibson asked on YouTube this week, have the moves in bond yields changed Spicer's view in the Russell 2000? Because originally he said you wanted down in the dirt cyclical exposure. What are you thinking now with bond yields and here in CJ's view?

40:56I think that I still have the opinion that with such strong growth in the US, gross domestic product in the whole economy, that that is plenty of growth to be able to weather a sort of a three or four, maybe two or three certainly, interest rate rises. So half or three quarters of a percent. If it goes to 1%, yes, it begins to get a bit more sort of, you know, delicate. But the market is now looking for two to three interest rate rises after Jackson Hole and it was a bit more hawkish, whereas the week before it was looking for one to two. So that's why Russell has probably had a bit of a tougher week this week.

41:30And there's no doubt that the people, the big macro investors will say, oh, that's bad, therefore I should sell some Russell, et cetera. But if this economy, the US economy grows at 4 % real, so 4 % over inflation, 7 % on the top of that, then the companies in the Russell 2000 are going to be doing very well. And now about 40 % of the companies in those 2000 in the Russell 2000 don't make any money. But if the economy picks up strongly enough, they will start to make money. And going from losses to even a small amount of profit has a big impact on the earnings. So, if you look at the earnings expectations for the Russell 2000 for this year, for the whole of calendar, you know, 2026, well, we're looking at 55 % earnings growth out of the Russell.

42:14And that's because a lot of these loss-making companies are going into profit. Next year, we're looking for nearly 30%. On top of 55%. On top of 55%. So, you know, and this is not a particularly expensive market. It's trading the year forward on about 22, 23 times earnings. The S &P 500 is expected to now deliver about 30 % earnings growth this year, which is fantastic. That's one of the reasons I'm not worried about these real yields being so high. Because if the growth was going to be 6 % or 7%, those real yields would be really, really painful. And I would probably be saying, let's sell equities and sort of go and hide in the bunkers somewhere.

42:49But with 30 % earnings growth this year and still 15 % expected next year, you know, that is fantastic growth and can weather some interest rate rises. The big question will be what is, you know, enough and what's not enough. And I think, you know, the market's reasonably efficient when it comes to bonds. You know, these guys are pretty smart when it comes to investing. You've got to look at me there. I tell you, I've got a compliment. It must be just after some holidays. I think you said pretty and smart. Yeah, pretty. Yeah, pretty answer. So, look, I think that in all seriousness, the market's currently looking for two to three interest rate rises of a quarter percent interest rate over the next 12 months in the US.

43:28So, that would take, add half to three quarters percent to a three and a half to three and three quarters percent interest rate now. With that sort of growth, I think you can weather it. And I still think the Russell 2000, with the domestic economy growing as strongly as it is, can weather it. If you're looking at the UK, it's quite a different decision. And we've got to be very careful because the mid-250 is exposed to some of those things. Now, the mid-250 in the UK is expected to grow at about 15 % this year, about 13 % next year. So, nowhere near as strong as the US, and yet we've got higher rates to deal with in the UK.

43:59And that's a balance there. So, if I had to own one of these mid - and small-cap areas, I'd buy the American one because the domestic growth in the economy is very strong. You know, the UK is going to grow at 1%, which after inflation is going to be about 4%, right? So, its magnitude is different. Yeah, but it's not rated. It's raised it 12 times. Exactly. Whereas Russell's raised it on absolutely enormous. And the issue to me with all these things is all brokers, I mean, if we made our money, if we survived by listening to brokers' forecasts, it would be the easiest thing in the world. We'd just never be short of any equity.

44:35We'd be long of them forever. The fact is they get it wrong. They think you're going to get one rate rise. You get five, their numbers are going to be wrong. Their forwards' forecasts are going to be wrong. So my question back is, forget the one or two rate rises. Let's say Bonniel's a 7%. Where's Russell? It ain't going to be up from here. All right, well, unless growth is 10%, right? But I'm not saying it. If it goes 10, there'll be 10. Again, it's chicken and egg. What goes first, as you said, right? So at the end of the day, that's what it's all about. I don't think you and I disagree in terms of, if you only get a little bit of a change in the short term, There's so much growth, it's fine.

45:16The problem is if suddenly this is a turning point, what's going on in the bond markets? And they suddenly say, right, until we see some action, proper action, we're just going to keep starting off because of all the demand for capital from the hyperscopers. Yeah, it sounds like a bit of a timing issue. You're on amber alert, it sounds like to me, whereas Spice is still happy to go on. But you both agree at some point in the future, we could get to a level if they're on the trajectory like you promised us there is some point in the future whether that's six weeks or six months away where you would start to be less risk tolerant but is there new highs in the u.s markets before we see that i think so because the big unknown and where i probably just differ a bit from cj is i think that i'm a firm believe, and I've said this for over a year now, that the AI benefits will ultimately be disinflationary, will impact jobs.

46:15And we're seeing that already. I mean, I think Goldman Sachs have got some facts that basically think that monthly there's 16 ,000 jobs being lost in the US every month because of AI adoption. And that's quite powerful. We'll see the figures tomorrow. My point is that those impacts are quite disinflationary. So the inflation expectations in those real yields could fall quite markedly. If that coincided with the Straits of Humas opening properly, some sort of end of the Straits of Humas war with Iran and the US, the oil price could be $20 lower than here, 20%, 25 % lower than here. And guess what?

46:56No one will be looking at 3.5 % inflation next year. They'll be looking at 2.5%. Well, that would be fantastic for equities. That It wouldn't make a difference for the US equities because the US equities are saying it's going to be 213 anyway. That's not why the benefit is going to come. The benefit will come if that happens outside America from all the people who are actually discounting much higher levels of inflation. You've answered that by talking about inflation. Inflation is irrelevant to this at the moment. To the US. Because the US hasn't said there's an inflation problem. It doesn't say there is an inflation problem.

47:27It says there's a shortage of capital. There's an enormous demand for capital and there isn't enough capital in the country. Yeah, so it's coming from other countries. But it hasn't come from other countries, which is why yields are going higher. The point is, if it doesn't come, it has to be provided in the US. You have a problem with this level of AI spend. And your figure for US GDP is very reliant on capital because it's only open AI and Anthropic, which is then leading to NVIDIA. And that is all coming from debt. and we see Google raising money. We see Meta talked about that they were about to raise cash as well.

48:11So if you do get higher yields, you don't get GDP. GDP collapses. I disagree with that. I think about... So it's not all AI, as you're saying. No, about half of the US growth is estimated to be... I mean, full-time economists estimate that's about what's happening. So about half of that growth is coming from AI spend. And that feeds into other... It feeds into contractors. It feeds into architects. It feeds into energy companies. It feeds into all of these other areas of the economy. Now, you know, that might slow up because there's a bit of nimbyism. We talked about earlier on, actually, at breakfast this morning.

48:41Yeah, we did. There's nimbyism. People don't want a big data center, which is basically a huge block, you know, of humming energy sitting in your backyard, right? And people don't want it in their backyard. And that is potentially a risk to the speed of the U.S. growth. But interestingly, the companies that have already been ahead of this, and that's maybe why the Magnificent Seven are going for a hell for leather, they are in there. They're building the data. They're there. They've got the planning permissions. They are there. And so actually, they'll be able to reap the rewards of this investment probably sooner than people think.

49:12If NIMBYism really takes hold and they say, we're not building any more data centers for six months in this area, then that could lead to some of these bigger profits in those companies that already have it. And you remember that the Magnificent Seven are about a third of the S &P 500. That's pretty punchy. But do you get slower growth if bond yields continue higher? I don't believe that the longer term rates impact that growth. I think if the interest rate, the short term interest rates between now and the two years start to go up, then it could impact it. But I think, as I said, at the crux of it, I believe there's such strong growth that the US companies and the US economy can certainly live with another half to three quarters of percent interest rate rise, which is what's being predicted at the moment over the next 12 months or so.

49:56It's not really short-term interest. The companies happen to pay 9 % on the corporate debt. If they're borrowing from the corporate market, yeah. But that's what's funding data centers. Yeah, but if you're a smaller company, they don't borrow money from the bond market in the same way that the big companies do. They go to the banks. The banks actually probably do very well out of this. And by the way, Russell's got a lot of banks and financials in it. And that's one of the things that's one of their best performing sectors this year. And that's helped some of the performance. So, I mean, there's a fine balance, and I totally agree it's a fine balance.

50:28But as I sit here now and what I can see, I'm happy to sit in that position. In the US, you know, I think I am still nervous about what happens in the UK and other small companies around the world because they have different dynamics. It seems right to say it this time, Rich, it's different this time. Well, I didn't say that. I think you did say that. I think you did say that. I didn't, I didn't. I said it's different in the US. Rewind the take. So this conversation, actually, it wasn't even set up this way. It takes us perfectly on to the next topic. And the final question for the day is, what warning signs and dangers is there to becoming emotionally attached to a position?

51:14Has this happened in your chap's careers? I've seen it come through in some of our comments, right? This isn't just becoming emotionally attached about a stock. It can be a whole asset class. These Bitcoin lifers are attached to gold in the way that they'll only ever be adding to gold position. Is that dangerous? It very much depends upon how much you're investing and your time horizon and all these things, right? You know, you can be in love with something and invest nothing really in it. So who cares? It doesn't matter. But, you know, if we assume that everyone's being professional, they're investing decent sums of money in things that they believe in, There is a real danger about being in love with anything or falling out of love with anything.

51:58It's like the real world. There's a huge danger there. And there isn't an investor I know who hasn't experienced something which gives them a lesson in this area. And, of course, the successful investors listen to that lesson and they make adjustments to their process. I don't ever believe anybody who says, I'll change my process completely because I've learned now and I'm brilliant because that's bullshit. At the end of the day, everyone makes the same mistakes again, but if they can learn how to minimize the losses on those mistakes, they become a better investor than they were in the first place.

52:35I mean, I've got a perfect example for myself. If only I had one, I'd be very happy. I've got many examples, but my own example, which was very expensive, it took 20 years to come right. I mean, this is real. It must be a bomb. It's a real time. Yeah, yeah, yeah. It was the UK index link market. We talked about real yields before, and they've got a correlation to growth rates above inflation. And they used to trade in the UK in a range 1.5 % to 4%. You know, if it was 4%, real yields were 4%. That was tough for people. If it was 1.5%, it was quite easy for people. And they used to vary around, and that was great.

53:11In 2005, the index link market in the UK, 2005, 20 years ago, in 2005, the index link market went mad. and yields in index link went from 2 % real to minus 2.5%. Wow. Now, let's be clear what I mean by that, minus 2.5%. If you think inflation was going to be 2 % over the period, you were locking in minus a half a percent return for that bond you bought. I mean, why the hell would you ever do that? absolutely ridiculous, stupid, and idiotic. Anyway, that's how I justified it to myself, for being short of them anyway. Why did they fall? The damage was done by the reckless move, I'm going to say, by pension funds into bonds, out of equities, which was brought about by the move from defined benefit pensions, the old pensions we used to have in this country, where your company guaranteed your pension, into the DC, the defined contribution seems, which almost everybody has now.

54:17Oh, sorry, if you're not in the civil service and you're not an MP, and I'm going to start ranting in a moment. The first yellow card of the season. The first yellow card of the season. So people used to have DB pensions. Almost everybody's been pushed into DC pensions after the legislative changes by Tony Blair and Gordon Brown in the late 90s. We single-handedly destroyed the best funded pension scheme in the world, which was the UK pensions fund market. And we made it the mess it is now where we have less than 3 % in UK equities and a small amount in equities overall and a load in bonds. But you weren't emotionally attached to this idea at all, were you?

55:00So as you can see, the passion is still there. So I sold index linked. I said, I know what's going on here. I'm a superstar. I moved underway to the asset class. And by the time it worked, I'd retired. I lost clients tens of millions of pounds in the process. Fortunately, I made it in other things, but it would have been a lot better had I not had those. If I could go back to the day where I'd sold it and said it's right to be sought, and I just said, no, I won't bother. I'll go out for a long lunch. I normally did that. Maybe I'd had a long lunch. But I fell in love with the position, ignored the waste of money moving into the asset class.

55:35And no matter how stupid it was, it was a lesson. I just want to give one example. There's a bond in the UK, we're so boring, called the Index Link 2068. There's not a person in the bond market who doesn't know this story. But as you're not in the bond market, I'm giving you the benefit of this. The 2068 Index Link bond hits a peak price of£340 per£100 nominal. So you paid£340 for this bond. To get back£100. No, no,£100 in real terms. Don't get complicated. We'll say it's 340. There's a formula about what you get back. Just say 340. That bond trades at 48 today. So you bought that bond to protect yourself against inflation at the highs, and you've lost 87.5 % of your money, even though inflation has been high over the last few years.

56:30That's how stupid the market got. I still believe that. I'm going in my grave thinking that. So in summary, getting emotionally attached to a position, the problem there was you went against the flows and the flows going into that. Yeah, the message to everybody is really fundamentals are really important, but you need to identify what the catalyst is for why they can be relevant today. Where I make my mistakes is I say, I don't know, FTSE 250 is cheap, I'm going to buy it. Well, it can stay cheap for 10 years and has done, right? It's not giving me a terrible return, but I could have made a lot more money putting my money elsewhere.

57:14So you need to identify what the catalyst is or what the price action is, which is going to show why your idea is going to work now. And that's the problem here. I'd identified it was expensive, but I ignored all the money that was flowing into the sector from these pension funds moving into index-linked bonds. at ridiculous levels, but they were not price-sensitive buyers. They were doing it to protect their liability, so they didn't care what price they paid. I would also add something to that is if you have gone into the position and it's worked very, very well, I'll give Rolls-Royce as an example, right?

57:53Now, the amount of retail investors that have done incredibly well on Rolls-Royce because they bought it at£1.50 and now it's up near£15, right? So, the profit in their app or their investment account is huge. And every day they look at it, they get a little kick. I'm an eye smart. I'm an eye, a fantastic investor. Now, that is part of their ego that is in that position. So they won't let it go. Even if it gets up to a price that doesn't really make sense. And I'm not giving any view on Rolls-Royce. I don't know what the valuation is right now. But that's another, they're emotionally invested in that.

58:33And I would say, get rid of it. Even if you buy it back, you don't want the profit influencing your mind. Yeah, absolutely right. Absolutely right. Each day is another day. Don't remember too much history because you should review every position each day and make sure you're happy with it still. But it's that important thing. Watch the price action. Get involved with the price action. And when it's telling you something you don't want to hear, don't go, not listening, not listening, not listening. I'm right. The market's wrong. The market is never wrong. So what about example number 42 from you?

59:07Just one thing I was going to say on that Rolls-Royce example. One of the biggest mistakes private investors make is they don't sell something, they will realize a profit and they will have to pay capital gains tax on it. And they don't want to pay capital gains. I mean, what a nice problem to have, right? If you've made enough money to pay capital gains, you should be very pleased. But not making a decision because of a tax impact is a really bad decision. I tell you that for nothing. I've seen so many people fail, wait, and then ultimately lose money on a position. Well, you put the good ones in your SIP and ISA and the bad ones in your stock and shares account.

59:39Exactly. For me, look. Yeah, that's why I've tried to do it, so I didn't pretend to go the other way. I agree. For me, I mean, you've heard about my borders of summer story, so I won't bother you with that. But back in 2002, 2003, I started buying shares in a company called Lonmin, or it's called Lonro Mining. It's one of the biggest platinum producers in the world, mainly based in South Africa. And at that time, China joined the World Trade Organization. So, we're stimulating their economy, putting massive infrastructure spending. As we talked before, China buying over 50 % of the world's commodities.

1:00:13So, the platinum price was shooting up. At the same time, car companies started having to put catalytic converters onto their cars, which required a lot of platinum and palladium, what are called platinum group metals, that had to go into these catalytic converters. So, the demand for platinum was shooting up. The price went roaring up, as did Longmin shares. And I started buying them about three or four pounds. They went to eight pounds. And I was like, I'm doing brilliantly here. I'm doing brilliant here. And then the South African government stood up and said, we are now going to impose what are called black empowerment rules.

1:00:41And that meant that each company had to give away, literally give away, not sell it, a big chunk of the equity in their company to the local people, in this case, in the South Africans. And so about 35 % of the company had to go to sort of African people in South Africa and had to impose, you know, put in black management and all the rest. All great worthy causes. But what it did to the share price was it damaged the share price for about sort of nine months, six, nine months. And having made literally double my money, I then languished and lost about 35%, 40 % for the next year. But I held on to them.

1:01:17And this is one example where I got it wrong, but then got it right because I was patient enough, because then it started to come through that. and the shares ultimately taken over for three times the price I ultimately held on to. So, you know, sometimes it's right to hold on. It's not always right to be a rabbit as we've talked before, but that's one way it went right for me. But I had to be very patient. I should know Spice had come up with an example which showed he did well in the end. Me, I was a prat, but, you know, nothing changes. I very well remember that takeover because it got me out of a really sticky situation.

1:01:51So I was long Aquarius Platinum and it was dreadful and it was going lower and lower and lower. And it must have been 2008. And Lawmen got bid for and Lawmen were up 35 % on the day. Aquarius Platinum was so much short interest, people betting against it. Aquarius was up 49%. Boom, so you're sold. Thank you very much. Anyway, look at that. We could go on for days. And we often do. Yes. But thank you very much, gents. That's very worthwhile. And a really interesting subject is that falling in love with one asset class doesn't always do the best for the diversification of the portfolio, doesn't it?

1:02:36And the portfolio that we show is very much the idea is to have a diversified return just in case we might be wrong. Yeah, it happened. I can't remember when. Well, that's when I was wrong. I mean, clearly, other people around the state are often wrong. But no, at the end of the day, the whole point is diversification across the portfolio. But if you feel yourself emotionally involved in things, do something about it. Cut it out. Start again. Revisit it all. Whatever you need to do, freshen your mind up. Because it's when your mind switches off to that logic, that's when the danger signs and the bad results come.

1:03:15And it goes the same for positions that are going against you, because that can cause so much stress. You're not thinking clearly about your other investments or other opportunities. One quick question for you before we go. There's a possibility we might host a live event before the end of this year in London. So if that would be something of interest, please comment live event in the YouTube comments below and we shall keep you up with details. Thank you very much for joining us as ever. Drop us comments below. a huge amount of comments in the YouTube last week and we very much enjoyed those.

1:03:49And as I say, a couple of questions have come from them. So any questions, drop us a line at theartofinvesting at ig.com or in the comments section down on the YouTube. We shall see you next week.