Odd Lots - Luke Kawa on the Macro Situation Right Now

Episode Date: March 22, 2021

Over the last several weeks, we've seen major developments in the macro situation. The vaccine rollout has accelerated. We've gotten a stimulus. The economic outlook has improved. And rates have risen across the curve significantly. So what does the macro picture look like right now, and what is the best framework for thinking through things? On this episode, we speak with Luke Kawa, an Asset Allocation Strategist at UBS Asset Management, about how to understand the current macro picture.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots, follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing corporation distributor.

Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. So Tracy, you know, every once in a while, I feel like every few months, we have to do like a sort of macro episode. I mean, we talk about topics and macro, but it's also good to just sort of take stock of like where we are right now with the economy, Fed, and markets. Yeah, that's fair enough. I feel like at this moment in time, I mean, I should mention we're recording on March 15th. There is a Fed meeting coming up, so maybe things will change.

But at this moment in time, the macro environment is really interesting because, of course, we've seen this big backup in yields, which has impacted stocks. And now we're watching out to see what the central banks actually do about it. Yeah, this is a very interesting environment for exactly that. In addition to the backup and rates, we've seen this fairly dramatic rotation. the likes of which we haven't seen for a while where we have a lot of like banks and energy companies leading the way and a lot of the tech darlings for the last year, if not the last decade, arguably, pretty severely underperforming. We're seeing this commodity boom ongoing, something that we recently talked about with Jeff Curry. We're seeing expectations continue to get ratcheted up for what growth is going to look like in 2021 and maybe 2022.

too. So we're definitely like at a turning point, which makes a of some sorts, which makes a good time to like take stock of the macro right now. Yeah. And I guess whenever you have these big turning points in markets or when it feels maybe like you're seeing a turning point in market, the question always comes up about how you should actually position for it. And it does seem in this particular environment, I don't know how you feel about it, but like I feel that it's more difficult than normal, I guess, because bonds are selling off because people are positioning for growth. And at the same time, all the stock market winners that we've seen for the past couple of years are also selling off. So I don't know, it feels a little bit tricky at the moment

if you're in charge of allocating assets. Yeah, I mean, you know, I think for the last, for a long time, you could have had a real like sort of set it and forget it portfolio, like a 6040 type thing. We have a bunch of stocks. You have a bunch of treasuries. and you just don't worry about it. But A, there's a lot of talk that maybe the Treasury component isn't going to work that well, especially in an environment that's reflationary, higher rates. That has impact on the stock. So there is a broad reckoning or at least questioning of whether a lot of the strategies that have worked well for a very long time,

longer than a decade really, are just going to continue to be so easy. Anyway, the good news for us is that we're just journalists. And so we don't actually have to answer these questions ourselves because it's not our job to get it right. That's true. But our guest is a very special episode today. So our guest not only used to be a journalist, but actually used to work for me and you, Tracy. This episode makes me very happy because we're going to have one of our old colleagues on. And not only was he an excellent journalist, but he's gone on, I think, to be an excellent strategist at a real bank.

And it's really nice when you see someone who. has, who has expertise in markets who sort of translates that expertise into, I guess, something other than writing about it and actually takes an active role or position in it, putting theory into practice. Right. So we just write about it. We just talk about it. But our guest today used to do that.

And now he actually has to make these calls. So we're going to be speaking with Luke Kawa, our longtime colleague. He is asset allocation strategist at UBS asset. asset management. We reference his work a lot. We talk about his business week cover ones, which will probably come up today. Luke, thank you very much for joining us. Guys, it's my pleasure and the warm, fuzzy feelings are very much mutual here. So is this a tough time? Like, as Tracy set out, like, does this seem like a particularly sort of tricky moment for thinking through problems in the question of asset allocation?

I mean, this is the thing about uncertainty, right? It's always. supposed to be above average. But at the risk, at the risk of, you know, contradicting Tracy, which I guess I'm allowed to do now, it's, it almost seems that one of the, one of the more difficult parts right now dealing with this environment is, is letting it fully play out. We know that we have, you know, some incredible fiscal stimulus in the pipeline. We're pretty sure we have, you know, sustained monetary support over a reasonable enough forecast horizon. So now it's a lot about just making sure the fundamentals are still aligned with your thesis coming into this year. And so far, I think that's been the key.

And if you look at kind of the current environment we're in something that it reminds me of a lot, not in macro implications, but in terms of just letting it play out, would be the kind of the mid-2014 oil shock whose ramifications in terms of what it did for bond yields, what it did for commodities generally. commodities currencies, that essentially lasted for like an 18 month period in which it was a chief catalyst for performance across the board. Right now, that's kind of how I'm envisioning the degree of fiscal that's in the system right now and the kind of earnings rotation that it's supporting underlying markets. So I have a ton of questions just based on that. But I think maybe

to begin with, we have to start with your, or at least talk about it a little bit, your transition to the real world, you know, moving away from journalism, actually putting what you write about in practice. Like, what made you want to do that to start with? And obviously, obviously you can avoid saying bad things about Bloomberg, but, you know, why were you interested in making that switch? Yeah, and nothing but love on my end for former and current employers on that front. But yeah, I think it just, there was time in my, in my career where I wanted to definitely

take a, take a learning step and, you know, figure out whether kind of my ideas and the way I thought about things could, you know, could translate into the real world, but also to, you know, to start fresh again and be the, definitely be the dumbest guy in the room. And that's, that's a position I relish and I enjoy and I'm in in every meeting I'm in. So just the ability to really to learn, to rewire my brain, and to, you know, to solve problems on a, on a more prolonged basis. Because I think, you know, one of the things with journalism that's fun and exciting, and what I loved about it when I was doing it is that when you go in every day, you have really no clue what you're doing. The market is going to dictate what you're doing and, you know, whether you're covering commodities that day or options or bonds, et cetera, et cetera. I do like the idea of a little more structure and working to solve problems where, you know, the half-life and the payoff period is going to be longer than that one day, where we're going to have some staying power, where we're going to be building results for our clients together over a prolonged period of time.

So that's something that really appealed to me. And, you know, I love the people I work with when I was at Bloomberg and I love the team I'm on here. So talk through a little bit more of the process. I mean, it's one thing. to like have calls, right? It's like, okay, rates are going to rise or commodities are going to continue to rally or whatever. But obviously to make a call like that, you have to have some sort of like deeper, you know, something has to precede that, some sort of like process for incorporating new information into a call. Talk to us about how you and your colleagues begin to think through these problems, translating inputs in the markets, in the economy, and policy, and turning them into the question of, you know, decisions on asset allocation, basically.

Yeah, so I think there's a really actually good tie-in to journalism here, because I think Bloomberg, the interview question you're always asked, I think there is one of the most important things as a journalist, and its accuracy and accuracy are the two most important, is I think what you're supposed to answer. And then when it comes to investing, I think the answer there would be accuracy and asymmetry. So, you know, essentially what we're trying to doing is,

is trying to identify convex opportunities that are based on underlying macro themes we expect to play out. Now, what is something that provides the convexity or the outsized return or the best expression of a thesis, so to speak? It's probably going to be a combination of both valuation and catalyst. list. So it's really working, working through and doing the work to identify assets that do appear undervalued and that we do believe have like a reasonable macro case to expect these valuation gaps to remedy based on an improvement in the underlying fundamentals. And I think that's key. It's not just hoping that this valuation gap will close. If you have that, but you don't have the here's how part. And that's what we spend a lot of our time doing. It's easy to, it's easy to,

kind of identify and just know where the valuation gaps are, how you avoid value traps, is really finding that catalyst and making sure it'll be there within a reasonable period of time. So you have your margin of safety built on evaluation, and you have your catalyst that provides for meaningful upside exposure. The catalyst point is interesting, because I always thought that this is probably one of the things that I would certainly struggle with if I made the switch. you know, it's one thing to write, you think rates are too low or that the dollar is mispriced or something, but it's a whole other thing to actually come up with an actionable trade based on that idea. And the other thing I've been thinking about is you could argue that, you know,

markets get stuff wrong, although I guess some people would take issue with that. But you could argue that markets, you know, stay irrational longer than you can say solvent. Things like that. That's probably why the catalyst becomes so important. But how do you sort of deal with that aspect of it, especially in recent months or years, we have seen this frothiness in markets. And you can say that valuations are way too high, but they can just keep going up and up and up without, you know, a catalyst on the horizon. I think this is something that plays in very well to the kind of the biggest debate that you alluded to in the preamble, which is essentially the growth versus. value trade right now because I think that you know that essentially is a good parallel for for you know what underlies your question there and for the longest time you could say well you know these these

valuations are getting to the most stretched since the dot-com bubble et cetera et cetera at certain point this is going to snap back the the situation we have here and people can people can point to the rates market as a you know as a catalyst for this rotation or as accentuating this rotation when you really look at this under the hood, it's just the fact that the earnings, the bottom line for value stocks, are expected to grow at a faster pace than growth stocks for the first time in quite a while. So if you look at finally getting the catalyst to realize some of that outperformance, and that's unlocked by vaccinations, that's unlocked by fiscal stimulus. So right now, I view that as much more fundamental to the cause of value versus growth performance than the,

on the rates market, if you're going to run like correlations for three month rolling performance of NASDAQ versus S&P 500 versus the movement and tenure rates or real rates, you're not going to get incredibly strong signals. It's a bit of a quasi myth. So it's really looking into what's been driving the outperformance. Is it the earnings growth? And do we expect that's reversed? And that's our view that based on just the the amount of fiscal stimulus in the system, a given vaccinations, laying the groundwork for return to economic normality, that that's going to happen. And so that's the kind of scenario that I'm talking about, just letting it play out, because the earnings in this case are the catalyst. And you come late this year, midpoint of this year,

we'll be talking about, okay, how can this be sustained? Do we have the policy action to sustain this? Or are we going to migrate back into the regime we have before? And that's when you return to monitoring your policy milestones. And Todd, to attempt to discern the tea leaves here? I mean, you basically anticipated my next question. So 2021 expected to be blistering fast growth. I mean, we might get, I think I've seen estimates for like potential GDP growth of like 8% for the year.

It's like going to be something nuts because the reopening, the vaccine, the stimulus. I think 2022 will probably have some of that and also be pretty decent. But then there's a question about what's next. So how do you start thinking about, as you say, those policy milestones and the degree to which they'll sort of like continue to affect the like what's next, the weather value continues to outperform. What are you like getting what are you going to be thinking about or thinking ahead? What are you going to be thinking about for the end of 2021 in terms of that what's next? I think the important part is not to not to think ahead too much, not to not to think too fast. Like the kind of the biggest mistake that could be made in the in the coming months is essentially saying,

okay, we've had peak policy support. What's next? The kind of show me story and using that as a reason to get, you know, bearish when, you know, we know it's a popular, to quote another of our former colleague, Sam Rowe, you know, stocks usually go up. That's the thing. So I think importantly, kind of anchoring on that and realize, that as long as we're still expected to get earnings growth, it's just a matter of making sure you're on the right side of the rotation.

But in terms of things to watch, I think an encouraging development lately has been the degree of Chinese policy support that hasn't really contracted as significantly as some may have feared coming into the year. That's removed a pretty key downside risk. Second would be the continuation of U.S. fiscal support not only through the end of the anticipated infrastructure bill that we think Congress will begin to work on soon and hash out over the course of the year, but also whether some of the provisions and the most recently passed $1.9 trillion stimulus are actually extended and made more permanent. Those kind of

things they do add up and they just do show that the policy boat is continuing to move in the right direction. And that allows kind of the more cyclical traits to continue to have the wind at their back. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day.

But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing

corporation distributor. You mentioned China there, and I do want to get into that, but before we do, maybe if I just ask a bonds question, that would be a good segue into it. We're talking about how stocks in the long run tend to go up. But I'm curious how you feel about bonds at the moment. Because I imagine, you know, if you're in the business of asset allocation, I just don't think selling, you know, a big position in U.S. Treasuries is that, I don't know, it can't get people that excited at the moment, right? Like, it doesn't really, it doesn't really work to, to offset losses in stocks anymore, or at least it hasn't this year. The yields are incredibly low. It's just very, very, hard to see the attraction in U.S. debt at the moment. So how are you feeling about the role of,

you know, U.S. treasuries in a portfolio? Well, I think bonds full stop do still play an important role in portfolios in U.S. treasuries due to, like, think, think about the nature of the quote-unquote shock. And I'm using air quotes on that because we're still pretty much even at all-time highs after this rate shock. And it's the thing about bonds is that they aren't intended to hedge the shock. They're intended to hedge the downside shock to growth. And that's something that, you know, we were, we were able to overcome and deal with last year. And bonds, you know, performed pretty well throughout that. I think you can say, especially after the liquidity crisis stages of the COVID shock has passed. But right now from from our point of view at UBS,

we're under we're underweight global duration and that's just based on the view that you know we're getting a recovery and bond yields haven't fully priced in the magnitude of the recovery or the about or the amount of growth we're we're about to get that's in the pipeline but you know being underway bonds doesn't mean kind of abandoning them completely so that's that's the kind of the rule we see that the give and take it's certainly not a time in our view to be to be overweighting bonds we prefer equities to bonds. We prefer credit to bonds. So that's, that kind of gives you a sense of of where we are positionally. So just on the idea of bonds as a diversification play and the fact that you mentioned the Chinese economic performance recently and the fact that monetary policy hasn't

been as tight as maybe some people were worried that it could be, how do you see Chinese bonds at the moment? Because I got to say, like one of the things that we've been watching out here in Asia is the enormous inflows that we've seen into Chinese government debt in 2020 and 2021. It's just such a step change in China's position in investment portfolios and also in the global financial system because it's getting very close to moving from an exporter of capital to an importer of capital. And that's just really interesting to see. So I'm curious from an investment strategy perspective, what's going on with Chinese debt? Like, what is the attraction right now? I think the attraction starts with just the most simple component, and that's the

yield premium relative to the rest of the world. So essentially, coming into this, coming into this year, you had the Chinese tenure at a near record premium to G3 yield. So that in itself is going to drive attention, especially with central banks signaling at the time that, you know, we, nobody was anticipating the kind of the results we got in Georgia or for yields to move the way they had. So that's something that just off the hop is going to naturally lead people to gravitate towards a, you know, a higher yielding solution. But I think a deeper part of this, and this is something that it's part of a collection that me and my colleagues have written called Upgrade Your Asset Allocation. And the second paper in this series deals with

enhancing diversification in the context of a low-yield world. So how are you going to make sure your portfolios are well buffered in an environment where bonds might be at an effective lower bound, which still an interesting part of the COVID shock is that no central bank took rates more negative to deal from it. So it seems like the appreciation of that policy tool might be fading in its role going forward. And so when we looked across the spectrum of different fixed income instruments, We just believe that Chinese bonds, because of the yield premium and because of the economic maturity, the People's Bank of China has now a reasonable history of being able to move countercyclically. So, you know, unable to, you know, ease when conditions are bad and tighten when conditions are getting better.

That kind of supports the stock bond correlation you would like to see and helps you have faith, that it will be there in the future. But I think what's more important is what Tracy just mentioned, the fact that you Chinese bonds are getting all of these inflows and receiving all of this, you know, all this more institutional adoption and appreciation is something that itself will perpetuate and kind of reinforce this, this negative correlation between stocks and Chinese bonds in particular. Because if you look at also the, you know, if you go through the growth shocks or the, you know, any reasonable pullbacks we've had in the past few years, it's, you know, China, the 2015-16,

and China deval. Obviously, Chinese component yields go down during this and global stocks go down. Early 2018, the Volmageddon experience, clearly not a China matter, but yields down materially. For 2018, not really a China story. You can argue it might be about trade, maybe not, but yields down a lot during that. COVID is certainly a story that China was first into from an economic and risk market perspective and yes, yields down. So if you're trying to tell any story about the global economy and macroeconomic cycles and ebts and flows, it's very likely that China's going to be a mover and shaker in that story. So it's, you know, it's very likely that beyond the yield premium of the offer, that the negative correlation will still be there. That's super interesting.

So you mentioned something early on in that answer I want to go back to, which is we didn't see any major central banks go deep into negative rates during. this crisis. And what we have seen, at least in the U.S. context, is that, you know, in lieu of perhaps more monetary using, we've had this something of a handoff to fiscal that people have been talking about for a long time. A, are negative rates as a policy tool likely done, like sort of discredited or not likely to be pursued again? And B, more broadly, does it change the business of asset allocation to think about a world in which there is this policy asymmetry and we're more likely to get a fiscal impulse as opposed to just a monetary one when there's a downturn.

So on the negative rates question, I guess, I mean, the only thing that keeps me from, you know, in my view, saying that it's definitely going the way of the Wully Mammoth is the Bank of England. That would be kind of the only thing that gives me pause because they do seem to be at least laying the groundwork in the financial system to do that if needed. And it's a real consideration. But that could also be part of the, you know, the Ben Bernanke, constructive ambiguity when it comes to negative rates, even talking about them as a form of forward guidance. That can kind of help keep the front of the curve well anchored and well behaved.

When it comes to the policy asymmetry point, I think it plays out in two important ways. One is again, you reasonably might not be able to expect bonds to deliver the same degree of performance during risk off that they have in the past just because of the lower starting point. So that's a mathematical kind of construct there. When you move to the handoff to fiscal, I think that that's where it moves more into the realm of equity rotation and equity risk premium. So if we're moving into an environment where policymakers have say, hey, we're, we're, we're

we've discovered the real solution to countercyclical policy. It's giving people money. It's giving businesses money. It's making sure that liquidity crises don't morph into solvency crises. And actually, we do that role better than central banks do it. We're going to continue this playbook going forward. What does that do to the cyclicality of earnings for cyclical companies? And in my view, this is something that would make them less cyclical.

if we're going to constantly underwrite the business cycle using fiscal policy. So the valuation gap that we talked about earlier between value and growth, if you also kind of just reframe that as cyclical versus defensive, if you're less worried about the cyclicality of earnings for cyclical companies because of fiscal policy taking a more muscular role, that's something that can act as a conduit to over time that valuation discrepancy narrowing. Sorry, so just on that point, I mean, you mentioned the 19th, 1970s oil crisis. So I'm just curious, as this shift from monetary policy to fiscal stimulus gets underway, how are you thinking about this is such an obvious question, but how are you thinking about inflation? So there's, inflation is a show me story still, right? Like, the Fed has essentially told us that 2021 inflation is not, is not something they're going to react to. It's, you know, the Fed, Jerome Powell is the 2011 Fed, Ben Bernanke, looking.

through inflation, not the 2013 fed of the kind of, you know, preemptive setting off a taper tantrum. So that's, so the reactivity of financial markets to near-term inflation outcomes. I think we've been, we've been well prepared for that, and you see that already in the, in the backup in yields we've had. Looking forward over a long period of time, and I know Joe loves to post charts of essentially a bunch of core inflation measures that are just hanging out close to, but not above 2%. So that's the history we're fighting. But that was a history that we had in the context of monetary policy doing all the lifting. So it's, you know, Sisyphus posting the boulder up the hill. Monetary policy can't do it on its own, boulder back down. We try it again. This time it's different because, you know, Hercules is pushing the boulder to. You have fiscal policy much more on board. So it's it's a wait and see and monitor because, you know, at this point, we can't judge the degree of fiscal stimulus and how long it'll be there. What we can do, is look at, okay, what kinds of realized inflation outcomes would really cause us to reexamine

the stock bond correlation and the potential negative effect on portfolios? And so a couple of my colleagues, McKellie Gamberra and Louis Finney, have done some great work on this. And what they found is that the point where the correlation flips, where you should be very, very worried or at least concerned or taking steps to monitor that the bond part of your portfolio isn't providing the protection you might think it is, is when core CPI has averaged 2.5% for a 36-month period. So if you think about that in the context of average inflation targeting, that's that's almost what we're looking for. So we're almost targeting,

basically getting back to us to the point where bonds might not be providing good protection, but you know, still might also be. So we're going to be flirting with that line under a policy success regime. This is super interesting and super important. I also want to note again, we are recording this Monday, March 15th. By the time you'll have listened to this, we will have had a Fed meeting, the context of which is partly this backup in rates, growing economic optimism, but this general sense that this doesn't change much yet for the Fed.

How confident are you generally that this really is, as you put it, the 2011 Fed, right now, or certainly not the 2018 Fed, in its willingness to tolerate a level of inflation and tolerate a drop in the unemployment rate that doesn't make them nervous in a way

that we didn't see with the Fed pre-crisis. I can tell you things that will make me more confident in that going forward. I think just on a basic level for the inflation point, it's almost as if all this, the policy

review was for naught unless it produces some kind of concrete change and the Fed's reaction function. So that in itself, there's some sunk costs into this new framework that does suggest that yes, it will continue to be an operable one that produces different results than the previous economic cycle. So I think from a starting point, that's a good place to anchor to. Going forward, I think what would increase my confidence that this is really really a different Fed. And you hear Fed members talk about this fairly often. They're talking about

more economic metrics outside of the unemployment rate that's in the summary of economic projections. They're talking about the employment to population ratio. They're talking about how labor market outcomes are unequal based on race. And that is something that over the fullness of time, a hot labor market can start to correct. If the Fed gave us in their dashboard and their summary of economic projections, the outlook for how some of those variables are expected to unfold and suggested that those are what's moving into being targeted as measures of full employment. I think that would very much increase my confidence that there won't be kind of the, there won't be as much of a preemptive tightening, and we won't be, you know, we won't be tightening

even as soon as we see the whites of inflation's eyes, but we can see a little more than that. We can see the iris and the pupil. So you've talked, or you've mentioned a couple of times now, this idea of waiting and seeing how durable the fiscal policy response actually is. And this is something that I've thought about at various times throughout the years. But how difficult is it as an investment strategist or, you know, as an analyst or something like that to be gauging policy and to be looking at economic policies. through a political lens. And I remember the first time this came up was in the context of the European Union and the Eurozone debt crisis.

There, you know, everything hinged on what the EU would actually do and what sort of political will there was for burden sharing or fiscal austerity and that sort of thing. And it just seemed really, really difficult if you were a strategist who was basing their decisions on, you know, actual fundamentals to suddenly switch to trying to figure out. what a certain politician was thinking and how they were playing to their base and what political calculations they were making. So I'm curious, like, how difficult or easy is it to incorporate political motivations and mechanations into your investment thesis? I think it's incredibly difficult because, as you got alluded to, your biases will tend to

creep in and in fact the process. And I think that's where, you know, being a, being a global bank and I'm on a global team, this is where that that really comes in handy because you do have more kind of boots on the ground, closer to home, domestic knowledge in pretty much every market. So I think as a starting point, that's very helpful. And beyond that, it's recognizing your, limitations, recognizing that I'm not, I'm not a congressional analyst. I'm not a political analyst, but I talk to people who are. It's still doing that research, doing that work. And that's where there's so much symbiosis, I think, between news and asset management. We rely on the, we rely on good reporting. We're around the desk. We're sharing Tracy Alloway or Stephen Spratt

or occasionally Joe Wisenthall articles and discussing the information in this and whether it's, whether it's changing our priors, whether it's changing our views, whether it's changing our thesis. So I think it's a lot of humility. It's knowing what you don't know. It's knowing that there's someone around you who has a better idea than you do, deferring to them and then continuing to seek out corroborating evidence from actual experts on the subject. Eating well shouldn't be complicated, but somehow it turns into recipes, prep, cleanup, and half your Sunday gone.

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So, this might be a good time to pivot a little bit to journalism. We mentioned in the beginning we sometimes cite your work here at Bloomberg, and I think just over a year ago, I think it was last February right before the crisis hit. You kind of had this legendary business week cover when the bull market gets weird about what was then the sort of nascent thing, which has grown way

bigger, about the role of sort of Robin Hood and Wall Street bets and this thing that's really taken on a life of its own. Talk to us about when you think about impact on portfolio, thinking about portfolios and impact on the markets, how the introduction of this new phenomenon of this really intense retail participation, call buying, meme stocks, all kinds of stuff like that that has become very mainstream in the last year. How it intersects with your broader thinking about portfolios and how markets behave. Yeah, I've got to say it was this, this was the moment in time where I think my brain had been successfully rewired when you, when you see some of this activity and then you immediately don't go, okay, I need to check this or that

forum, it's okay, like, how is this going to affect the broader market ecosystem? So kind of from the highest, highest possible level of view, if we're going to have a new material source of funds generally entering the market, this is going to put downward pressure on the equity risk premium. This is going to be kind of positive for asset valuations. So from that high level perspective, that's the first order from which I would view is that this increased, these increased flows from this cohort is positive for equities, full stuff. The increased kind of footprint of this cohort, the higher turnover, and I think what we saw at the end of January, it's a reminder to me about how a lot of the pullbacks we've gotten in recent years are, you know, they really do have a

liquidity, accelerant kicker here. And so from an asset management perspective, if we're able to identify a situation where sharply swinging flows are what's essentially driving the move in headline markets and the fundamentals haven't changed a bit, well, then there's a pretty good opportunity for us. That's the valuation and the catalyst that's opened up thanks to these flows. We can expect that to remedy and therefore that that's an opportunity. I think another element that's really unique to retail participation is the time. the fact that this came about during a period in which buybacks obviously fell tremendously

because of profitability and because of, you know, regulatory rules. And it was a time when, you know, the macro economy was not doing well. So I think this leads to a bit of, you know, an overfocus on retail, which certainly you can, you can see the visible footprint, but it's important like not to be doing partial equilibrium analysis here. We also do have to consider how flows are going to improve from buybacks, how flows might improve for more autopilot flows as employment does grow. And so that's something in a wholesome manner.

That's kind of how we think about it. Sorry, I got to ask this as a slightly flipping question, but one thing that I've said about the GameStop phenomenon and Wall Street bets is this idea of flows before pro. So that idea that money can sort of, I guess, trump the economic fundamentals and at some point, you know, asset prices that used to be self-limiting because at some point valuations would just be excessive now can kind of keep going forever because it's the momentum that really matters to investors. People are just trying to catch the next wave. I'm very curious or sorry, let me rephrase that. I'm wondering, now that you're a pro at UBS, How do you feel about the flows? Like, what's it like internally at UBS when you see something like, you know, GameStop rising to $400? This is where kind of the, we're very top-down oriented and don't do kind of anything related

to single stocks. And that's where this is where it helps here is that you can see that clearly in late January you're having dislocations and you're having headline indexes decline because of flows related to retail trading and associated de-leveraging. Nothing about the fundamentals change for the better or worse. And very soon thereafter, all-time highs again. So thinking about it from the index level perspective, it doesn't seem that these flows are kind of overpowering the fundamentals at any point in time. Might that be true at the single stock level? That's mercifully something I don't have to have an opinion on anymore.

Okay, so we're talking a lot about flows and how you actually pitch investment strategies once you become a professional strategist. So another thing that's been really hot this year is, or in recent years, really, is ESG and, you know, environmentally and socially friendly investments. And I have to admit that I've become very cynical about it, probably because I receive at least eight emails a day. you know, 10 other press releases about someone starting an ESG fund or how a particular bank is doing something new in ESG, whatever. It seems like the thing, the bandwagon that everyone really wants to hop on. How is that playing out at UBS or, you know, how are you approaching it? Like, is it something that you're pitching because clients are demanding it? Or is it something that you're pitching because it feels like the right thing to do or that I don't know how to

phrase this. I guess I'm just curious how you all are thinking about ESG at the moment and how much of it is a trend for better or worse. When I think about ESG and this is what I'm primarily going to kind of focus on is that there's a paper again. I'll give Michaela again, I'll another shout out because he's in the process of review, but another paper that I'll try not to cannibalize or preempt too much. It's about how do we think about and incorporate ESG into the asset allocation process? Because I think the, a big underlying question to this is, is there a tradeoff? If you think this is a, if you think this is a fad, if you think this, you know, doesn't

produce optimal return results, what are the, what are the associated costs? Are there any? And there's precious few academic studies or work on this. and Michaela is among the first in this field. And so how we're viewing it is that the traditional kind of investment process, you're balancing risk and return. With ESG, you're adding a time dimension and you're also adding preferences that are going to, the preferences are going to guide the investment universe.

And that could be by kind of regulatory fiat or that could be because of the values of, you know, of certain boards, firms, endowments, et cetera. And the time dimension is, I think, something interesting. It's the idea that more and more ESG is much less a, you know, here's something we would like to encourage by, kind of by rules, by flows, et cetera. And it's going to become much more something that drives bottom line activity. It's not, it's not just kind of regulation saying, you must do this, you must do that. it's government's making steps beyond that using fiscal policy to support ESG goals and particularly related to E. So that's what provides a lot of opportunity on the on the time dimension side of things

is that, you know, I'll give you the, the Cole's note punchline of the forthcoming paper. And it's essentially that we believe through our research is that there's, there will not be a tradeoff between risk and return, any negative tradeoff by adopting ESG. and that you can make essentially a lot of portfolios that have the same factor components as the parent index, the non-ESG index, you know, pretty easily even using some more, some brute exclusion techniques. So it's something that, you know, regulators seem to be demanding. It's something that, you know, clearly, if you look across the industry, there's interest in. And it's something that's going to be affecting bottom line results for corporates more and more. I have a, sorry, I have one more question, but this is also something I've always wondered.

So in journalism, as you know, we get a lot of feedback on our work. Like, I think it's one of the few jobs where you publish to a relatively large audience and you can get feedback almost instantaneously, either through comments on your stories or through social media or people emailing you or whatever. What sort of feedback do you get as an investment strategist? what sort of what oh consequences yes

okay so what sort of consequences happen like if you get something wrong or right like do clients come come back to you and say like this call was incorrect why did you think that or you know does anything happen if you actually get something wrong I know Joe and I were

joking earlier about how when you're a journalist you don't always have to be right but presumably when you're doing this professionally you want to be reasonably, well, you said it earlier, you want to be reasonably accurate in your thinking. What gives you feedback is the market kind of instantaneously and always is giving you feedback on whether you're right or wrong. And that'll play out over time. But for us, it's very important. You know, this is a result-oriented business, but it's very important to keep process in mind at all times. And that's why it's important to build a lot of consensus for new positions and new trades

and have them thoroughly vetted, battered around. So the consequence is everyone having buy-in, everyone having understanding of the factors, of the milestones that could affect a trade when you go into it and being able to monitor it. So you know when the conditions are shifting. You know when there's been a thesis violation. Or you know when things have gone according to plan, but the price just hasn't. So the way to avoid or to kind of mitigate quote unquote consequences is the dissemination of information in a manner that allows a lot of these priors or these questions to be challenged

before you actually do it. And then it's just, you know, then it's just a matter of monitoring and figuring out are things going according to plan? Are they not? And why? And if you've done the work beforehand, you know, you have a pretty good base to go up there. Well, Luke, thank you so much for joining us. It's great to be reunited. And hopefully we'll see you again one day in person. But congratulations. And we miss you. And this was a fantastic and fascinating discussion. Real pleasure, guys. Thanks for having me on. Luke, we're all so proud of you. Yeah, seriously.

Thank you guys very much. It's so great to be speaking to you guys again. And hopefully, you know, a karaoke at some time when Tracy's back in New York. Yeah, we'll definitely do it. Take care, Liz. Tracy, I thought that was great. Catching up with Luke had been way too long, obviously. I really liked everything. That last answer to your question, I thought, was like super interesting, like how they think about, like, feedback and anticipating. Just everything related to, like, process was super interesting to me. Yeah, I've always wondered, I guess, how you're evaluated in a position as an investment strategist. Like, is it how good your research and your thinking was around a certain investment decision, or is it based on absolute returns?

Like, even if you had the smartest thesis in the world, could you get a really bad year because the market just goes against you and you're considered unlucky? Like, you know all those perma bears? I'm not saying Luke is a perma bear at all. But you know, the perma bears who for the past 10 years have been, you know, talking about how stocks are going to crash and things like that. They're very, very popular. They have a huge following among by side and journalists.

But if you actually did what they were telling you for the past 10 years, you probably would have missed out on a lot. Well, you would have made money for about five minutes last March. So, you know, that's true. That's something, I guess. No, I totally agree. I also thought, like, Luke did a really good job, like, clarifying a couple of really interesting thoughts in my mind. One is that discussion of Chinese bonds, which I didn't. I think we should probably do an episode on soon, just like the Chinese government bond market and how it's become this big international asset class.

His explanation of why the money is rushing in, how it sort of is serving as this sort of countercyclical anchor. Super interesting topic and very well explained. And also this idea of like the value versus growth valuation gap. And this idea that like in a world of more fiscal activism, maybe you could put it in a world where politics. policymakers react more aggressively to cap downside, that that then sort of like cuts off the left tail of value company's earnings and you potentially get this sort of valuation re-rating. Super interesting topic. And I think that'll be something like keep watching going forward to see if like what we call

value stocks meaningfully reprice on changes in expected policy in exchanges, changes in the expected fiscal policy stand. Yeah. But just on that point, the way Luke framed it, this idea of not trying to call the tipping point or the big change in markets, but actually waiting and seeing how durable the shift towards fiscal actually is. I thought that was a really important point. And I know markets are always racing ahead to identify significant turning points. But maybe this is, in fact, a moment where you sort of step back and say, okay, we've had the big stimulus. bill, now we actually see whether it translates into growth and whether or not it might translate into inflation. Do you think a journalist could get away with that? It's like, what do you have coming today?

And it's like, just relax. I'm just waiting to see how this all plays out. I'm not rushing the next narrative. Just let's just see how this plays out. I don't think that would work. I don't think that would fly. I think we're in danger of getting into a conversation about the pros of short-term horizons versus long-term horizons.

So we better step away quickly. Maybe we should leave it there. Yeah, let's leave it there. Okay, this has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart.

Follow Luke Kawa on Twitter. He's at LJ Kawa. Follow our producer, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesco Levy, at Francesca Today. And check out all of our podcasts at Bloomberg. under the handle and podcasts. Thanks for listening.

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