Is France Becoming Europe’s Biggest Market Risk?

0:00On today's Art of Investing, it is the reader question special. So coming up, Spice answers your questions on Nike's latest profit warning. Is it time to pay a higher multiple for those trough earnings? And CJ goes all French on us as European politics hits the headlines again. C 'est la vie.

0:27Welcome to IG's award-winning podcast, The Art of Investing, with myself, Rich McDonald. Donald, Chris CJ Fellingham and Mark Spice Holden. Morning, gents. Hi, Rich. How are you? So, of course, this is the last podcast before we come live at Lourdes. So we thought we would save some of our market discussion for that event coming up next week. So this week, we're going to answer a lot of your questions that we've been receiving via the email. Thank you very much for those. So that's coming up a little bit later. But first of all, to have a look at this week's portfolio performance, we are up 0.6 % on the week.

1:06That takes us back to up 13 % on the year and up 25.5 % since inception. Now, to discuss how that has come about, we're going over to Spice for the Spice Market Update. Well, thanks, Rich. It's been a pretty dull week, actually. Funny enough, the oil price has stayed pretty much around$100. And that's despite the authorities saying that now we're back to 80 % flows back through the Straits of Hormuz, 80 % of where they were before the trouble started. The problem seems to be that the freight rates that it takes to transport this oil have absolutely skyrocketed. So basically, it's costing to hire a supertanker about$1.2 million a day now to use that.

1:51And that's up from less than$300 ,000 a day. So, huge increase there. That may partly explain why the diesel price particularly has stayed higher than it ordinarily should be. But hopefully in the next couple of weeks, that will sort itself out and we'll start to see lower prices and lower inflation expectations, which might well help bonds. Who knows? But they'll certainly help equity markets. Away from the oil market, most things have been pretty flat. So, the chip sector is up about 4%, which is good. That's helped NVIDIA come to a new all-time high. Ho, ho, ho. And a recent purchase of ours, NASDAQ makes an all-time high as well.

2:28And a more established holding that's been a bit of a laggard for a while, but is now sort of making good ground. So the S &P 500, as we talked today, has just taken out its all-time high as well. So those are the main sort of equity sides to look at. We've had another very strong week for the US dollar. That's about four weeks in a row. We've seen it rise nearly sort of 2.5 % over the last four or five weeks. This time it's been at the expense mainly of the euro, and I'm sure we're going to talk about this a little bit later because there is a French budget that's trying to go through their parliament that is not being very well received.

3:01And those eagle-eyed amongst you will know that Spain have had to go and call an election last week because their budgets are failing to get through. So governments are failing to get their spending plans through, markets are punishing them, and we'll look at that in the bond markets. but it's had a big impact on the euro as a currency. It's been much weaker than most others. Sterling's been a bit weak as well, but the euro's been the main target. In the corporate world, we're just a week or so away or a few days away from the big reporting season starting. So next week, we get inundated with a load of US bank reports from Goldman Sachs, JP Morgan, Citigroup, all those sort of guys from next Thursday and Friday onwards.

3:48They're going to be coming thick and fast. And that will then obviously become a big focus for markets in the next few weeks as we go through the third quarter reporting season. Now, historically, companies like to edge their numbers down a little bit, play the game so that they can come up to the year end, beat expectations, get all their big bonuses and share options come out at a nice level when they report their fourth quarter earnings, which come out in January. But for now, the next few weeks, we'll see what they do. Obviously, we've had a fantastic reporting season in the second quarter where earnings were up over 30 % for the S &P 500.

4:20So expectations are very high. And the bar is high. So let's see how they deliver. Before that, though, our friend Nike, and Rich knows it well as a sportsman, have had another terrible profit warning. Now, that's the fourth one in just over two years. And their share prices have completely collapsed over that time. And the earnings are just been absolutely devastated. I think just on last week alone, they fell 10%. But they're down about sort of knocking off a 60%, I think, from where they were before they started those profit warnings. And that's when things like the S &P 500 are hitting an all-time high.

4:55And we've got a question coming up about that later, Spice, as well. So stay tuned for that. Indeed, indeed. Looking forward to that. And China is the big problem there. And we've talked a lot before that China, its domestic economy is really struggling at the moment. And the authorities aren't really that interested in trying to get that going. So all the companies that are manufacturing are exporting to other countries like Europe or the UK or America where they can, because obviously America has pretty big tariffs on some of these. But basically, where they're producing these goods and they can't sell them, they're cutting prices and therefore winning market share and undercutting people like Nike dramatically.

5:30So their margins are being hit, their sales are being hit, their market shares are being hit. It's a horrible, horrible situation. But maybe we're getting to the bottom of it. Remember, we've talked in podcasts in the past about profit warnings don't come in packs of one. They certainly come in packs of three or in this case, four, maybe a five bagger. You never know. But we are probably getting towards the end of that. Who knows? They have put in place new management and we'll see what happens. But there we go. It's a single stock and doesn't make the market move that much. The other big one was really Snyder Electric that some of you may well have heard of.

6:02They make electrical components and parts. And they've made their biggest ever acquisition for$22.6 billion by a company called PTC, who guess what they do? They take software, they use AI, they attach it to electrical components, and they make it work much more efficiently and better. And so AI is now coming into industry. I think that's quite an interesting move. That's one of the reasons I mentioned it, is suddenly that industry is recognizing the power and strength potentially of AI, even in some of those old industrial processes. So we'll see, but it's a big acquisition. That's the point, actually, Spice.

6:38I was in the IG offices this morning and almost got knocked over by a very large robot which goes around cleaning the place. But honestly, it's the size of a Dalek and it looks similar to one as well. Brilliant, brilliant. Well, I was on the golf course yesterday and I saw them cutting the grass, but they've been around for a few years now, the grass cutters, but they're coming everywhere, aren't they? Thick and fast. The only other things I really wanted to mention, we've had quite a lot of economic data at the end of last week, which had been quite influential. Remember, we were looking forward to the ISMs, the Industry Services Index.

7:12And basically, that came out better than expected. So, strength in the economy, that's all positive. But really, the big market mover was the payrolls number in the US, or that's the way that the US look at their employment data and how the job market's going. And that was very weak. So, you would think with a strong economy, there'd be lots of jobs being created of the rest of it. Actually, there was only 29 ,000 jobs created and there was expected to be 90 ,000. And also, layoffs, interestingly, were not increasing. So, there's no job creation, but there's no real big layoffs. So, we're in a bit of a stagnant state in the job market.

7:50Now, that's something the Federal Reserve, remember, they have as part of their remit when they're trying to decide what to do with interest rates. So, they look very closely at what happens to the job market. But doves like me would have taken heart from that and said, oh, look, that's an excuse for them not to put up interest rates. And actually, the market went from thinking there was a sort of 70 % chance of another interest rate rise of a quarter percent in the October meeting in a few weeks' time to just 20 % now. So that's one of the reasons you see the S &P push up. And you'll see later on that the Russell 2000, the US markets have basically had a pretty good week compared to the rest of the world.

8:28And that's pretty much the market update as far as equities and data goes. CJ, do you want to say anything about bonds? We only had a pod three or four days ago, so not much has moved. There's a couple of things I've noticed. We've been warning about these higher bond yields and their effect. There's an article in the FT today that talks about borrowing costs for companies with the lowest credit ratings. So these are the the junk bonds that we talk about often the the triple c or lower have risen to a spread of 12 percent over five percent on yields so they are 17 percent now wow if you're if you're issuing that junk that you've been doing for a number of years and you've been saying well i can do that i don't know perhaps you've been issuing that maybe 10 percent or 11 percent or maybe 12 percent, but I can live with that.

9:24You are now having to borrow at 17%. And it's interesting, Spice mentioned how some of these equities are moving at the moment. Well, clearly some are struggling with this higher costs of borrowing. And there's a lot of refinancing to be done in the next sort of three or four years. So if bond yields stay where they are at the moment, that's going to be a very, very strong tailwind to all the buybacks and all the other things that have been going on over the years. And so that's just something to mark the card. So, A, we are seeing those bond yields pushing up more for the worst quality companies.

10:06And then I noticed today also that we've had a disappointing move in that the five-year UK fixed rate mortgage market went over 6 % today, which is the first time since 2006. If you look at the charts, you're going to start realizing that maybe the last 15 years were the except section, not the rule, for where mortgage rates should be. And it made me think, what sort of a mad world were we in wherever you could borrow at 1 % for five years? What world was that? But anyway, so we've got two signs. I wish we could go back to that world. Well, perhaps in time we might, but not for some time. We're seeing clearly that bond yields are starting to hurt sectors of the market, but it's not relevant for AI equities.

10:56As Spice has said already, they're going to new highs. They're obviously saying, come and have a go if you think you're hard enough to the bond market. So the bond market will have another go, that I have no doubt. So it's going to be interesting to watch this one play out. But so far, AI won, bond nil. so just before we go on to the portfolio can i ask you one last time and i promise it's the last time because the finfluencer awards are next week now we've dropped the link below if you would go on there if you've not done so already of course and if you would vote in the category for best economist then you might find the art of investing in there and feel free to you know vote for whoever you think is the best.

11:44But, you know, we want a high number of votes in there to make sure that the contest is fairly won. We'd appreciate that very much. And as I said, the link is in the show notes below. 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. This content is for information purposes only and is not investment advice. Past performance is not an indication of future results. So going on to the portfolio, it is one of the starkest contrasts we've seen for a long time of the rest of the world performing and UK and Europe disappointing.

12:21So if we take you through the top three, we've got the Nikkei 225 up 3.5 % on the week. Then we've got emerging markets up 3.1 % on the week. Then over to the US with the NASDAQ and Russell 2000, both at 1.7 % and 1.2 % respectively. So really strong performance spice there from the rest of the world and from US especially. Yes, as you say, Rich, it's been a very stark week with the rest of the world, ex-Europe and ex-UK doing well. And you can see our losers this week are actually centered around Europe and the UK with the FTSE 250 down 1.8%, the Eurostox 600 down 1.1 % and the FTSE 100 down 1.1%.

13:06Our worst performer, though, was BlackRock World Mining, which is down 1.9%. And we've talked before that actually this strong dollar that we're seeing, mainly as a result of things like the euro being particularly weak because of their own politics, then BlackRock World Mining and commodity companies were hit down 1.9 % this week, and that was our worst performer. And Spice, do you just want to remind everybody why a strong dollar is negative for commodities? Yes, well, there are two reasons. One is that all commodity prices are priced in US dollars. So for a country where their currency is weaker against the dollar, that effectively means that they have to pay more to get exactly the same amount of commodity, whether it be an ounce of gold or a barrel of oil, it's the same problem.

13:51So if their currency goes down, the dollar goes up, that makes it more expensive for them. And that's particularly so at the moment where you've got an elevated oil price. Now, the other reason is with this elevated oil price, mining companies particularly can get hit quite hard with the combination of this strong dollar, but also the fact that about a third of their costs come from having to use diesel because a lot of their processes use are quite energy intensive and particularly diesel use. And with diesel, I don't know if you, I've driven down the motorway from Scotland today, I saw a diesel price of£2.22 a litre just as I left Scotland.

14:32And so that's pretty eye-watering, frankly. And as we talked about in the last couple of weeks, the US have been grappling with all-time record high diesel prices. So clearly that hasn't helped. Okay, great. So as I said, that leaves us up 0.6 % on the week, which over two weeks basically were flat. But it will be really interesting over the coming nine days until we record again, as we see US markets going higher, what will the performance be this time next week? So as promised at the start of the show, we're going to answer some of your questions. So gents, if you're ready, we shall start with our first question and our first ever international question.

15:14It is coming in from Jean-Pierre in Paris. and he is asking, I think this is for you, CJ. And his question is, la politique en France, c 'est la catastrophe. C 'est le moment d 'acheteur d 'action français. If you'd like me to translate that, CJ, for you, it means... Sorry, I think I've got problems with my earpieces. I thought for a minute we were on a French podcast. I think it translates as what on earth is going on in France at the moment? Is it time to buy stocks? Is it time to buy bonds? Yeah, it's been a really interesting start actually to the quarter. Because if we think back to when we last recorded, it was on the Thursday morning, and we had put on our marks for Wednesday night, and we were recording on how equities and bonds had performed up to that point.

16:11Things had all looked pretty calm. And then on Thursday morning, the markets suddenly decided they were going to focus on the French fine fiscal situation and treat Europe all together as one, as a bit of a basket case, if truth be told. What happened? Well, you know, it's really this high bonds, high bond yields, low bond prices, high bond yields everywhere. And as they go higher, they unsettle various things. There was an old expression, I think it was by Warren Buffett, which said that when the tide goes out, you see who's swimming without their swimming trunks. And so when bond yields are low, Everybody's fine.

16:50They can finance everything. But when bond yields get higher and higher and higher, it costs more and more money. So we have a situation in France where they've not had a government with a majority since 2024. So essentially, their fiscal position has just drifted and drifted and got worse and worse. And in France, their budget deficit, the percentage of GDP is 5.4%. Now, in UK, remember, we're 3.9%. France is 5.4%. And their gross debt, the percentage of GDP is 118%. Whereas here, it's just over 100%. So France is worse in both those measures. And what makes it even worse for France is that the euro area is meant to be working to a limit of 3 % as budget deficits.

17:44As part of the rules of the Eurozone, you're meant to be trying to get your budget deficit to 3%. And of course, it's nowhere near that level. And so the Prime Minister, remember, hasn't got a majority. He has put forward some budget cuts, public spending cuts, 54 billion euros to reduce debt to 5%. And there is a crunch vote coming up on the 20th of October. If it doesn't pass, then they'll have to go back to the drawing board again. Then everyone will worry about it all and drive things forward. Now, there's nothing different here in France than there is in the UK, there is in the US and everywhere else.

18:22Everybody wants to spend more and nobody wants to put taxes up. And what do they end up doing? In the end, they're going to put taxes up and spend less. And that's what's going to happen. We all know that's what's going to happen, but it isn't going to happen without more pain and more discomfort. Now, for people who say, well, you know, this is all very interesting. Let's just talk a little bit about what's relevant for Europe, which is really the spread of French bonds over German bonds. So given they're all members of the European Union, given we're not, this is where we have an issue. Some people will argue we have many benefits from not being part of the single currency.

19:05This is one area where we have an issue, is that they're effectively all guaranteed by the German taxpayer, everybody in Europe. So everything trades off the German bond market. So you have a French bond yield, let's say, let's call it four, and the German bond yield at three, there'd be 100 basis points spread. Okay? now that spread has varied between 150 and zero when people have been really happy with europe french bonds have traded at the same level as german bonds but now with all the uncertainty about this fiscal situation they have gone up to a spread of 130 base points 1.3 percent which is higher than really they were after the crisis in 2012-2013.

19:54So this is the highest level since then. And this reflects the uncertainty that is going on in the French bond market. And so just like here as well, the government needs to do something about the deficit. Just like here, great games are talked. But is it going to actually happen? and that's why the French bond market is doing what the French bond market is doing. And it's traditional that when you panic in the city about the French, you dump the euro. The hedge funds have been doing that for years. I spent my whole career watching people in the city of London trying to say, I'm really glad the euro is getting stuffed.

20:31I'm going to sell euros. And, you know, once again, you know, we look at them today, the euro is rallying nice and strongly. Everyone's getting caught short. At the end of the day, though, it's a proper problem, this. we need to see determination from fiscal authorities to solve it. Remember, it was Jean-Claude Juncker, the former president of the European Commission and prime minister of Luxembourg, who said in 2007, we all know what to do, but we don't know how to get re-elected once we've done it. And that is a perfect example of what's going on here. Everyone knows they've got to cut, but people are reluctant to do so.

21:10They're kicking the can down the road, aren't they? Exactly. The bond market has to do the hard work for everybody because they don't want to do it themselves. Yeah. And it's a bit scary. I was looking at the bond spread, the 10-year bond spread between the UK and Germany, and we're up to nearly 2%. The British government has to pay 2 % more than the German government does for 10 years at the moment. So yeah, it's not just France or Italy even. Italy's doing better than France, interestingly. Well, that's a really critical point you make there, Spice. If we go back to 2012, I know I appreciate a lot of people on this call can't remember the financial markets of 2012.

21:46I'm not sure Rich was born at that stage. Rich joking, of course. But if you look at how Italy traded relative to Germany, in the financial crisis of 2012, you're talking about sort of 8 % the spread, 800 basis points. now italy trades closer to germany than france does which says the market is saying italian bond market risk is less than french bond market risk shows you how far the french situation has deteriorated as i say i'm not concerned as long as you don't believe the european project is going to break, then I'm sure that we'll sort this out. But it does say pressures are there. You've got to do something about it.

22:33Now, everybody just reminds you at Lords next week, if you hear CJ calling anybody a pig, then he's not being rude. Spice, what does that term pig mean? And where did that come from? That's a left field question. I think it's Portugal, Italy, Germany and Spain. Greece and Spain. Not Germany, wow. Not Germany, no, no, no. Yes, Portugal, Italy, Greece and Spain. Pigs, the anachronism. That's where Greece were going bust, basically. And what happened to European equities through those years? I think it was 2011, really, it started, wasn't it? Yeah, I mean, they performed worse than other markets, a bit like they're doing this week.

23:16They underperformed the US markets, but they didn't really suffer too badly. And part of that is that, you know, if your currency goes down, if you can, like when the UK came out of the European Union, Brexit, the pound plummeted. Actually, the FTSE 100 went up quite a lot because the pound plummeted over 10%, which meant that when FTSE 100 companies earn over 85 % of their earnings from overseas, the value of those earnings went up by nearly 10 % when the currency went down. and therefore the UK market looked quite attractive. And you had a similar sort of dynamic happening in the rest of Europe.

23:55But this week, yeah, I mean, the first thing they do is they run for the hills and they sell everything to do with France and everything to do with Spain and just batting down the hatches. Normally take it back to the US because 70 % of the world's assets are driven by US investors. So when they get scared, they take money home. I had a great story. So, of course, I was working in emerging markets at that point And Greece was one of our markets that we traded. So there was a Greek bank that had to do a recapitalization. So they decided, right, we'll raise some money from international investors and we'll raise some money locally in Greece from Greece citizens.

24:35And we heard that there was a great amount being raised locally in Greece. So that helped us with the international book. And it was quite an easy sale. And we recapitalized the bank. However, it came out a year later, there was an investigation because what had happened is that this bank that was being recapitalized had lent money to investors to buy shares in them. And so it was, you know, I would hate to call something a Ponzi scheme, but if the shares had gone down, these investors were in real trouble because the bad loans would have been from the bank that had been failing. So yeah, good old classic European recapitalizations.

25:17You also remember what happened at that stage was that there was a lot of uncertainty as whether the Euro project would hold together. And everybody was pushing very hard. And then the president of the European Central Bank came out, Mario Draghi, and basically said, we will do whatever it takes. We will support the bond market. And from that moment onwards, there wasn't a problem anymore. and we saw a wonderful bull market for most of these assets as it all drove forward. So really, this is a question of, will the ECB be forced to come in and make some sort of protective noises towards France?

25:56Or will they say, you know, let's just leave it for a bit and see what happens? My suspicion is they'll say, let's leave it for a bit, see what happens, because there's no reason why they should rush in now. But as I've said before, I have no doubt they will rush in and save the day if there's a problem. So you should probably be looking at this as an opportunity rather than a risk. Right, CJ. Second question is from Howard. And he is asking you to just discuss the difference between buying an ETF with a mix of gilts in it, such as GLTL, and the difference between that and buying an underlying gilt itself.

26:31it's a a good question because um those people who are investors will realize they have two choices if they want to buy bombs they can buy or they actually got three choices they can buy a mutual fund uh run by an investment management company investing in guilt or they can buy an etf of the guilt market or they could buy that individual um guilt themselves now there are some benefits, some significant benefits to buying individual gilts. The first one is, for those who are not aware, this is something that's quite well known, or if it isn't, will be after this podcast, that gilts do not attract capital gains tax.

27:14You have to pay income on the coupon, but you do not have to pay capital gains tax on the amount you get redeemed. So if you can buy a gilt at 80 and you get 100 back at the end, 20 points, that 20 points is not subject to any tax. So that's one attraction. Clearly, only if you're paying tax, if you've got it in a retirement account, then it won't matter. But if you're a private individual, private wealth looking after your own money outside a tax wrapper, it's not a bad idea to buy some gilts then individually. The other advantage they have is if you buy a 15-year gilt today, in a year's time, it's a 14-year gilt.

28:05And in years after that, it's a 13-year gilt. And after that, et cetera, Even you can work this one out, Rich. After 15 years, you get repaid your money. Whereas if you buy an ETF and it's a, let's say it's trying to match the return of the over 15 year guilt index, when a guilt comes below over 15 years in maturity, it will be replaced and more longer dated guilts will go in there. So you never get closer to redemption. You're always buying the return of that index, not of that individual bond. and you may have decided to buy that bond because you've got a liability in 15 years or 17 years time and you bought that bond to match that liability.

28:47So that's, again, why it might be useful. The final thing that I think to bring in mind when you look at these things are the transaction fees. And for the transaction fees, the ETF wins. So the ETF is a very low fee for managing it, and you deal at the single price point of the ETF. If you go along to your stock broker and you say, I'd like to buy the 15-year gilt, he might make you a really wide price and charge you quite a lot of money to do it. So you have to think carefully about that. So my answer to the question, long-winded, I know, is if you're buying into a taxed account, i.e. you're paying taxes, capital gains, and income, not a retirement account in any way, I would probably buy the individual bond because it's well worthwhile doing to get that capital gains tax uplift.

29:38If I'm in a tax-free structure like an ISA, I would buy the ETF because it's a simpler way of doing it. So CJ, you said some people are interested in buying low coupon gilts there. And that became popular during the Liz Truss episode. And it's happening again now. Why is that? All right, look, here's a simple example. I'm going to get my numbers a little bit wrong, but give me that flexibility. The bond yields at the moment about 6%. So if I buy a 6 % 10-year bond, it's going to be priced close to par, meaning every year I get 6 % return from the income, which is the overall yield on the fund.

30:21Now, if I buy that gilt, I have to pay income tax on it. And a 50 % taxpayer, let us say, means I take 3 % home and I don't get the other 3 % that goes to the tax man. If I buy a 0 % 10-year bond, it must give me 6 % annualized per year in capital gain to give me the same return. So it will be priced at, let us suggest, 40. Wow. So you'll get 100 back, but you've got then 60 points over 10 years, which is, funnily enough, 6%. It doesn't work like this. Please don't all phone in and tell me I've got my numbers wrong. I'm doing it to keep it simple. And that would all be tax-free. So on one of those gilts, I get 6 % return.

31:15And on the other one, I get three. So you will find low coupon gilts trade quite expensively because a lot of high rate taxpayers will buy low coupon gilts. Excellent. Right. Back to equities then for those of you that find bonds very boring. And that includes me as well. Right. We've got a question from Phil and Phil is especially interested in the Nike share price. it might be Phil Knight for all we know. But the question from Phil asked that he's read a lot about the potential for Nike to now be on trough earnings. So the question is, what are trough earnings? And how do you think differently about a share price when it comes to that?

32:03So before we go on to that spice, let me just give people an example of PE ratios in Nike over the past few years. And I'll use round numbers. So these aren't accurate. Again, this is just for an example. But let's say Nike used to earn$1 earnings per quarter. So they make$4 in a year. And the market, you know, trust them. They still think their earnings are going to grow. It's a good company, great brand. They put it on 25 times earnings. So all that means is that we take$4 of earnings multiplied by 25 and the share price is$100. But the next year, oh no, no, we get our first profit warning from Nike and they now expect only to make$3 of earnings that year.

32:52Now, the market doesn't like profit warnings. So it might cut the PE multiple that Nike is now rated by the market. Okay, and this is where the art of investing comes in. because again, reputation's kind of gone a little bit because they didn't grow earnings and maybe the management hadn't warned well enough about what was about to happen and people are worried about future growth. So earnings are now three and they put that on a 22 times multiple. So it's been slashed from 25 times to 22. That gives you a share price of$66. Now, fast forward, another profit warning, exactly what's happened in Nike.

33:35and this time it's down to$2 a share per year. And this time the market is not happy at all. So they put them on 20 times earnings. The share price drops to$40 and that's where you saw the Nike share price going into earnings last week. Now, another warning, yet another. As Spice says, these things happen not usually in ones, sometimes in threes. so this time the EPS is expected to be$1.60 so it's come all the way down from$4 to$1.60 what do you do then Spice? Well that's that is as you say is the art bit and let me just explain probably a little bit why companies have more than one profit warning at a time and I used to quite closely with corporate financiers and they would they would have their takers inside this company's having problems you know they're going to miss their numbers what do we do about it we're going to put a statement out to the market to say we're going to miss our earnings expectations by 10%, let's say.

34:38What they've done, though, is in their business has probably been going up nice, nice slope, and it suddenly has dipped and started to fall quite heavily. The analyst forecast it was going up here. But instead of cutting your forecast straight to the worst point where you are now and follow that trajectory down, they just slope it sort of at a less of a sort of a steep angle. And it takes them two or three times to eventually go, God, we just give up on this. There's a saying, let's kitchen sink it, which means you just put everything, all the rubbish you can, all the washing in there, and you just go for broke.

35:12So trough earnings are what you would normally call unusually low earnings, very unusually low earnings, exceptional. And they normally come during recession. We see this across the whole market often during recessions because the economy is doing badly, companies are having to lower their expectations, there's no growth out there for them to lift their earnings. They have to do cost-cutting to protect those earnings. And that means job losses, that makes the economy worse, and that's why the central government, central banks, want to cut interest rates to support the economy and that sort of thing is happening.

35:46So it actually looks that the price-earnings ratio at the bottom of a cycle, at the bottom of these big downgrades, and you've had four big ones from Nike over the past two years, look very high. So it looks like it's on a really high P.E. ratio. It's like 25 times P.E. Why would you buy that when actually the earnings have been going down to sideways when you can buy the whole of the S &P 500 on just 19 times P.E. ratio? So you're paying a 25 % premium to buy Nike over and above something that's really good like the S &P, which is not going to have these big profits. warning. So it's not going to be damaged in the same way as Nike has been.

36:23So the judgment then is, have they kitchen-sinked it? Is it all in there? If it is, and Nike have said, for example, they're going to try and get$2.5 billion of cost savings over the next five years. Now, they've failed to deliver on those before. It's going to cost them a billion dollars to get those because they've got to make people redundant. They've got to pay them off and do all the things you have to do, sadly. And they may dispose of other businesses. So that is entrenched now in the expectations for Nike. So people at the next set of results or next update will be looking whether those cost savings are starting to come through.

36:59If they are starting to come through, do you know what? Those low trough earnings will start to nudge up instead of down. And then you'll go, actually, I don't mind paying 25 times P ratio for this thing, because if they get these$2.5 billion of cost savings, suddenly it's going to be on 15 times earnings because they will have delivered such big cost savings against a very low profit base and the profits will therefore unusually jump high. And therefore, sometimes it's right to buy companies on trough earnings, but you have to be sure in your own mind, this is where doing your own research is important, that the profit warnings are finished.

37:38you know and nine times out of ten you know after the third one you're getting close to the average most people don't know only had more than three or four so so spice just for for me being a simple bond man what you're really saying is that if you see a company that's been giving out profit warnings like you know confetti and it's suddenly on a very high p e multiple what really the market's saying is we think the low of earnings is in and the next set of earnings will be substantially higher than the last one which will then by mathematics reduce the p multiple going forward is that correct right exactly right so if they deliver those cost cut that cost cutting then the earnings will come will be much bigger and actually instead of being on 25 times it might be on 15 times going forward and therefore even though you think you're buying and paying 25 times for it.

38:33If you believe that, you actually think you're buying on 15 times, so it's worth doing. Because in time, it should go back to the same sort of valuation as the rest of the S &P 500, for example, on, let's say, 20 times. And the chances are, by that point, you've got a really lean business and you've taken all the costs out on necessary costs. You've taken your staff numbers down low and the amount of leverage on the business at that point, if they do start getting product right is much bigger than it was before you even went through the warnings. The other thing to consider there is when a company like Nike, that is a great brand, let's face it.

39:13I mean, look, it's still a great brand. It's having massive problems with dealing with China and the overcapacity that's going on in China. But what it is, is still a great brand. And there might be sharks circling out there. And I wouldn't be at all surprised if you see at some point someone say, oh, I wonder if Nike is going to get a takeover approach. And, you know, the shares will go racing up. Because when companies that have such a strong brand are doing this badly, they become very vulnerable to takeovers. And that's why it becomes attractive for people like value investors, what you call value investors, to maybe come in and buy these situations and think, okay, I'll just hold it.

39:51If I'm willing to hold it through, maybe another profit warning, another one. If I hold it long enough, someone will come in and take you over. and that you'll get a massive premium or they will deliver on the cost cutting and China problems will start to die away and the earnings will start going up again. And I, yes, I think I've paid 25 times. I probably only paid 15 for it and then therefore it will look cheap. But that is a matter of judgment and it's very difficult to work out, frankly. Now, Spice, what about the other end of the spectrum and what every new investor completely forgets and disregards?

40:25What about peak earnings? And there's a chance we might be seeing peak earnings in micron over the next two years. And that's why the stock's only trading on seven times earnings. But what if we're seeing peak earnings on something like NVIDIA? What do you do to the P multiple then? Well, normally you would derate it. So you would say that if it is peak earnings, then the chances of the growth rate continuing at the same pace as you're seeing already will start to diminish. and therefore you will want to pay less for it. And those earnings, therefore, you expect to sort of come down relative to the rest of the stock market.

41:03Now, you see peak earnings when you get unusually high growth in business. It's like you're seeing, as you say, in NVIDIA or Micron because of the demand for memory. And you normally see them when there's a boom going on or, you know, a big economic growth period. And it can happen in individual sectors, like you say it might happen in micron or not but the p often appears very very like it's like low like you say micron is on seven times but if they do deliver this year and next year then they the people will believe it and you bought it on seven times it might trade on 10 times and you made you know 40 extra money by holding it through that period where people are skeptical they say it can't get any better than this i'm going to sell it now because you know it just can't get any better.

41:53How often does the market get it wrong? You know, when a market puts something on a trough or trough, as Rich would say, when someone puts it on trough earnings or peak earnings, how often does the market get it wrong? Should you believe essentially that the general view is right or does it often get it wrong? Is there an opportunity for money making? I think if you swallowed a textbook on how to invest, you would believe that the market is efficient in the sense that your share price reflects all of the news that is currently available to mankind that has happened in the past. Now, clearly, the art then becomes predicting what happens next.

42:37And that's where certain value investors, as they're called, will look at these companies and go, oh, yes, I think these are trough earnings. If they get this, if they get it right, and they make an assumption. Well, it's not anything you're predicting. There's probably a 50-50 chance you're going to get it right or wrong. So I think that there are a lot of value investors out there. But when I started in the market 40 years ago, there were a hell of a lot of... And that is because as a art of investing, it's actually very, very difficult. And, you know, there's been some brilliant people out there who have lost their reputation, their companies have gone bust.

43:19The great Tony Dye at Phillips and Drew back in, you know, those of you who are old enough will remember him back in the 90s. You know, he was a perennial bear at the US equity market. He retired six months later. The US equity market collapsed 25%. But by then, he'd lost his job and his company had been taken over. So in a long roundabout way, what I'm saying is I'd rather be a growth investor, in other words, buying the ones that I think will keep growing rather than trying to pick the bottom because picking bottoms is a smelly thing. So really, what you're trying to tell us or trying to say to us is, who is the Tony Dye next this time?

44:01Well, exactly. Yeah. And, you know, like I say, there are some people who make, you still, to be fair, make a living at that, but their investors, the people who give them money to invest, understand what they're trying to do. Yeah. And so they will survive. So they're looking for people to take that contrarian view. And as you say, over time, you find that the market is pretty right most of the time. but if you're really good at what you do, you can spot those opportunities. Yeah, I mean, look, you know, I know the way I invest and the way I invest is not trying to pick the bottom and be a value investor.

44:38I'm a growth momentum investor, but the minute what I try and discipline myself at is if I see the growth dipping off more than I expect or you expect it to go up and it goes down, I'm run for the hills, I'm out of it. And that's what I think, you know, I'm good at as a growth investor, a value investor may go, I'll just buy some more because now's the time to, you know, it'll just be a short-term dip and then it'll start going up again. Great. So just before we go on to the last question, just if anybody is currently paying these levels for the S &P 500, just go back and watch the last five minutes because you are paying 22 times earnings that have gone up 50 % in the last three years.

45:20But, you know, nobody would ever say that was peak earnings. Okay, so you're drawing that out. So I was keeping quiet because this is a perfect example, not saying who's right and who's wrong, of exactly what we're talking about here. The market is trying to say we've had peak earnings, so I'm derating the PE. and that is one of the big arguments here between the bulls and the bears. And I'm sure we'll be talking about this a lot more at Lord's next week, but it'll be very interesting to listen to people's questions around this subject. Right. The last question of the day is from Doug. Actually, we've had two questions on the same topic, but Doug watches the portfolio very closely each week.

46:10Are the weights on the weekly slides the target weights or the actual current weights of the portfolio? Do you rebalance holdings you haven't changed back to their targets? And if so, how often? Before we answer the individual questions, let's think about what we were trying to do when we set up the portfolio as such. We decided that we would set the portfolio up to give you, our listeners, an idea of what we felt strongly about and where we felt we should be putting money if this was a live portfolio. And we took the decision then that we wouldn't adjust for market moves or dividends coming in.

46:49It just makes it too complicated. It's fine if it's an actual portfolio, but if it's a paper portfolio, essentially, then it's very difficult to do all these things and get them in there correctly. We are hoping soon to launch a portfolio, which will be a live portfolio. In this case, we would not need to rebalance as the weights we'd be looking at would be our actual weightings each week. And so if we disagreed with them, then we would change them by definition. Performance then each week would be based on the weights within the portfolio. And so everything would be absolutely live and easy to follow.

47:27one other thing i would say is we've probably understated our performance in this paper portfolio by not more accurately reflecting market moves because we haven't had that pleasurable you know drift up in a percentage when the market's moved up a long way and we've said we've still got five when if it had gone up by 10 we'd have five and a half or if we think back So the very early days, when we had the Vanek and the Vanek went up 50%, we had 5%, we'd have had 7.5%, which would have made a substantial difference to our portfolio performance. But we wanted to keep it simple, so we ignored those dividends.

48:08And that is where we decided to position ourselves for this first year, first year and a bit of our resistance. Thank you very much, CJ. So that is the answers for the questions this week. If you've got a question, please write to us at theartofinvesting at ig.com. Also, you should have your emails in your inbox by now for the live event at Lords next week. If you just send us an answer back, it's going to really help us to work out the numbers and make sure we've got canopies for everybody. And if for some reason you haven't received that email, but you did sign up, then please drop us an email at theartofinvesting at ig.com as well thanks everybody so if you're coming along to lords we'll see you next week but if you're not don't worry we are still doing the normal podcast as well which will come out usual time on friday afternoon have a fantastic week