We Study Billionaires - The Investor’s Podcast Network - TIP307: Cullen Roche on Stocks, Inflation, & COVID-19 (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we have our good friend Colin Roach with us. Colin has managed hundreds of millions of dollars for the past two decades, and he always comes with unique insights. During the 2008 financial crash, Colin's private investment partnership was up 15% for the year. Colin is the founder of pragmatic capitalism and the author of multiple investing books and a regular guest on Bloomberg and major financial news outlets.

Starting point is 00:00:24 On the show today, we talk about the current market conditions and various trade ideas for navigating this landscape. So with that, let's go ahead and get started. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to today's show. I'm your host, Dick Broterson, and as always, I'm here with my co-host, Preston Pish. On today's show, we'll be talking about equities, inflation, and what to expect in the financial markets. Therefore, we're also excited to bring back one of my favorite guest, Colin Roach. Colin, thank you so much for joining us today.

Starting point is 00:01:18 Hey, guys. Thanks for having me. So, Colin, we talked a lot about the potential of a new monetary system here on our show. We discussed the scenario of Fiat-based system with the US dollar as the most important global reserve currency and the probability of having that system for at least a few more decades. And I mean, that's basically the system we have today. And then at the other side of the spectrum, we also discussed the opposite scenario with a new monetary system that might come sooner than most people expect. And I guess you can even say for listeners that they would say that for 300 episodes,

Starting point is 00:01:54 we talked of everything in between. But we're real curious to hear how you see this. How do you expect the monetary system to look like in, call it five years or 20 years from now? I've thought about this a lot, especially with the rise of Bitcoin and the whole concept of decentralized money. My view, basically, is that it's never going to be an either-or sort of scenario that plays out. My thinking is that people want something that is more decentralized, that they have a little more control over, they have a little more anonymity over, and something that is really more convenient

Starting point is 00:02:34 for online and peer-to-peer transactions. But here's the big kicker. And here's the big thing that I have trouble with something like any decentralized form of money is that the reason we use centralized forms of money, like we know, US dollar to a large degree. This is one of the big drivers is it's backed by a government that enforces it. I don't mean men with guns. I mean people are able to take other people to court, basically. So from the beginning of time, all money is credit. And what I mean by that is that all money is basically an agreement between two parties. I mean, in the ancient times, the monetary

Starting point is 00:03:19 system was basically developed from agrarian agreements where a farmer, for instance, would agree to lend a certain amount of seed to somebody else who needed to grow some crops. And they would have this financial agreement between the two of them to next season deliver a certain amount of seed back to the farmer. So, for instance, you needed 100 acres of corn grown. You would lend the amount of seed to make that doable. And the agreement, would be that in the future, that other farmer has to deliver even more corn seed in the future or something like that. And you'd have this unwritten agreement back then that over time essentially evolved into written contracts. And the thing that makes a government somewhat essential

Starting point is 00:04:08 in all of this is that if those two parties ever have a disagreement, Farmer A can take Farmer B to court and he can enforce that contract. And it makes sense. the money more credible. So the debt contracts that we all create between each other, they're enforceable. And that creates an inherent amount of trust inside of the money that we use because you know that it's good. It's good because it's enforceable. You know that the value of it is something that you can recoup in the future if the other party just, you know, tries to nullify the contract for some reason. And so that's the thing that I have troubled with. A lot of decentralized money, they don't have that inherent degree of trust in them because there is no

Starting point is 00:04:55 real way to enforce the contracts if there's ever a problem. That's the thing that I think somewhat hard to decipher with something like Bitcoin is that ultimately is very hard to create debt contracts from because A, it's not very stable and B, it's somewhat hard to enforce. So I think what will ultimately happen is that there's still going to be demand for these other forms of decentralized money. But I think that it's very hard to see a future where something like the U.S. dollar or the centralized based types of money goes away just because I think that the legal system and the enforceability of these contracts is such an important part of the structure in any modern economy. And it's hard for me to see that going away in the future.

Starting point is 00:05:48 So I could see the two systems kind of running parallel to each other, but neither one necessarily going away or overtaking the other. Thank you for the insightful response. I think it's very interesting that to you, it's not an either or, which it is to a lot of people, but we can have two systems. You see that all the time even in today's system. I mean, you have a lot of non-financial firms that create things that are sort of money-like. I mean, even stocks and bonds that are issued by corporations are very money-like. I mean, they're just financial contracts, just like any monetary contract is. And all of these systems are created by the private sector, and they kind of run parallel to, you know, the U.S. dollar system in essence.

Starting point is 00:06:37 So, Colin, to continue issuing debt, the U.S. has to convince investors that the debt will not only be paid back, but that the buying power of the return currency will be retained. What are the arguments for and against investors continuing to trust U.S. Treasuries? The way that I like to think of treasuries is that treasury bonds or really most government issued what we call debt. They're really money-like instruments. So, for instance, I mean, what's the big difference between a one-month treasury bill that yields zero percent and a cash note? there really is not much of a difference between these two instruments. The Treasury bill, in my view, is almost as close to cash as the actual cash note is. And the spectrum of moneyness along which all of these instruments exist is just a matter of maturity, duration, and basically

Starting point is 00:07:36 what the interest rate is on it. So a 30-year treasury bond is just a really illiquid form of cash basically, where it's just harder for us to, I mean, you can't go to Walmart and buy things with a 30-year treasury bond. So the degree of moneyness in that instrument is relatively low compared to a cash bill. But I think the kicker is that it all comes back to inflation and what is the level of trust? What is the level of demand for these things? And so I oftentimes see people say that there's a low demand for treasury bonds or that the U.S. government debt probably can't be trusted in the future. And to me, if that ever happens, the way you'll see it play out is you'll see it play out as an increase in inflation. So the way that I think of this is that

Starting point is 00:08:25 if the government were to go out and try to finance a whole bunch of spending by just printing cash, they could dump a whole bunch of money on the street. People have to sell real goods and services for that money at some point. So the money, whether or not you fund government spending through dumping bills on a street or issuing bonds is sort of, I think, an institutional or technical, operational sort of part of the whole process that the government doesn't have to do either or. They could dump money on the street. They could sell bonds if they want to.

Starting point is 00:08:59 But in either case, the non-government sector funds that spending by putting a price on the instrument. And if the government were to go out and dump bills on the street, the price that we would see is the rate of inflation in essence. And if so, if you ever saw that the U.S. government looked like it was losing credibility, that demand for the government's financial assets was declining, you'd see a big increase in the rate of inflation as the demand for money versus all other things declined. And so to me, I think people sometimes make this differentiation between debt and cash, which is a, I mean, at a very technical level, it's a useful distinction. But at a government funding level, I don't see it as being the key driver.

Starting point is 00:09:47 I mean, interest rates, the government can set interest rates on 30-year treasury bonds at zero in perpetuity if they want to. The non-government can't make them raise interest rates. The non-government can change the value of that thing, though, versus all other goods and services. And so that would show up as the rate of inflation increasing. And that's really the number to keep an eye on. And we haven't seen signs of that yet. But we're in a pretty interesting experiment right now where, I mean, the U.S. government ran an $865 billion deficit last month.

Starting point is 00:10:21 That's for comparison purposes, year-over-year comparison was, I think it was $9 billion the year before. So we're talking about big, big, big numbers here. The U.S. government's talking about a new stimulus program. So we'll see how inflationary all of this government spending is in the coming years. Let's talk more about inflation, Colin. Because whenever most people talk about inflation, they say that there is low or no inflation in the U.S. because they look at the CPI number.

Starting point is 00:10:53 You also have a small group of people talking about that we might have much higher inflation because they primarily look at the increasing money supply. How do you measure inflation? This kind of goes back to our original discussion. I see this. Some Austrian economists refer to inflation as an increase in the money supply. And I think the reason economists don't like that is because especially economists who understand the idea of a credit-based monetary system, they know that the money supply in the long term,

Starting point is 00:11:27 it will always increase because you have more and more farmers. who are trying to get seed for next season. And these are just, I mean, basic mathematical facts. I mean, with population growth and some basic increases in productivity and things like that, just output growing in general, you're going to have more and more of all of these debt contracts in the long term, no matter what, just because people are interacting more, they're creating more financial agreements. And so to be specific, the money supply is mostly created by private banks.

Starting point is 00:11:58 Private banks create loans, which create deposits. And deposits are money. And the reason why those loans are typically always increasing in the long term is just because of those basic underlying economic drivers, the population growth and growth just generally increasing in the long term as productivity increases. And so to me, it doesn't tell you anything to say that the money supply is going to grow because that's just an operational reality of the way we've structured a debt-based financial system. The amount of debt, the amount of deposits and the amount of loans, always going to grow in the long term. So at a more technical level, that's why I think a lot of economists prefer to refer to inflation as an increase in the price level. So we usually use a basket of goods and inflation measures the rate at which the price of those goods is increasing over certain time periods. And I think one of the things that economists also don't like is when people sort of cherry pick an instrument inside of the good or the inside of the basket. For instance, you could look at like housing inside of the CPI and you could argue that

Starting point is 00:13:09 inflation is higher because of that. And that technically is, it doesn't represent inflation. It doesn't represent the entire basket of goods is the argument. So it would be like looking at the S&P 500 and saying, you know, oh, Apple has done so well over the year. There's asset inflation. But then when look at the whole basket, you're like, oh, well, the whole basket hasn't actually done that much. The whole basket is a better representation of what's happening in the aggregate than sort of cherry picking one or two items out of it. Even if those items are important, it doesn't reflect the whole aggregated basket of prices. And that's the really weird dichotomy or bifurcation of what we've seen in the last, really the

Starting point is 00:13:51 last couple of decades is that you have these sort of extremes where technology and things that are highly deflationary are falling in price a lot. And a lot of these other more valuable services and goods like healthcare and real estate have really surged in price. And it's created, I think, a really difficult way to assess, is this good or bad? But at the aggregate level, the way that most economists calculate something like the CPI, it aggregates out to not a huge change in prices. So whether or not they've constructed the CPI correctly or not, I think that's for somebody else to assess. But when you look at the aggregate prices, inflation has been low. And that seems to be reflected across, again, across a lot of financial markets as well. I always point out

Starting point is 00:14:45 commodities. It's amazing to look at commodity markets that are down 70% from their 2008 highs and think that inflation is high. It's just there's a lot of confirming. evidence that shows that inflation really has been low. It's not just these deflationary tech trends. So, Colin, you've said that the risk of inflation is more likely to come from the Treasury and not from the Fed. I would like to explore that statement a bit more. Could you explain the responsibilities of each of the two institutions and then transition into a discussion of where inflation could most likely come from? This ties into kind of everything we've been talking to with like the Fed and a lot of the money creation that we've seen.

Starting point is 00:15:27 The way that I think of the Fed is the Federal Reserve or any central bank is really, they're just a bank for banks. And this is the thing that I think confuses a lot of people. When the Fed implements programs like quantitative easing, they're really trying to liquefy the banking system to some degree. They're not necessarily pumping money out onto, you know, they're not dumping money on the streets for people to go. pick up. And that's, I think, the vision that a lot of people have. What they're really doing is,

Starting point is 00:15:57 I mean, for instance, quantitative easing at the most basic level is the Federal Reserve is creating new money. And what they're doing is they're creating central bank reserves. Central Bank reserves are the deposits that other banks use. And only banks use reserves. No one else can access the Federal Reserve systems. It's a closed deposit system for the banks. And when the Fed implements something like quantitative easing, they're literally swapping, they're using a reserve. They're creating from thin air. They're purchasing a treasury bond. And the treasury bond leaves the private sector. And so the way I've always thought about it and the way that the reason I've always described QE as being really a non-inflationary event is because what the Fed is doing

Starting point is 00:16:42 is at the private sector level, they're swapping the composition of the private sector's financial assets. They're trading basically an interest-bearing treasury bond, which is a very safe instrument, and they're swapping it out for a non-interest-bearing or lower interest-bearing cash reserve, basically. And so the private sector doesn't have more financial assets because of this. They have the same quantity of financial assets. It's just that their composition has changed. And the kicker is that the Fed, again, the Fed is just a bank for banks. It doesn't operate in the private sector. It's not going out and competing for goods and services at Walmart. And so when they take that treasury bond out of the private sector, that financial asset is as good as retired, at least temporarily.

Starting point is 00:17:32 And so that's a big part of why I think people have sometimes confused the feds programs for this idea of money printing. And the treasury kind of comes into this in an important way, because the Treasury is the entity that they're really creating excess financial assets or net financial assets for the non-government sector. And they do that by running a deficit, basically. So, for instance, that $864 billion that I mentioned earlier, that is net new financial assets for the non-government. And in my view, that's important to understand because the Treasury is the entity.

Starting point is 00:18:14 that really prints the money. It's not the Fed sort of accommodates everything the Treasury does and the Fed accommodates what the banking system does. But the Treasury is the entity with the big bazooka here. They're the entity that could potentially create inflation. And I've said this on a number of interviews in the last few months that I think that there's a real risk that the amount of spending that the Treasury is doing, even given the depth and scope of the pandemic, there's a real risk that you could see inflation, not necessarily like the 1970s, but there's a real risk that inflation could look a lot like the 90s or even the early 2000s, where you had like three, four, five percent inflation in various readings, which I think would be shocking

Starting point is 00:19:00 to the Fed. And I think it could have them on their heels in say, I wouldn't be shocked if you saw rates of inflation like that in, say, 20, 22 or something like that. So probably not this year. The economy is way too weak. Everything is way too depressed this year and probably into even the early parts of next year to see something like that. But I think you can get into 2022 and have the Fed on their heels a little bit, trying to backtrack on some of these programs and stuff and trying to control inflation. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating. Sondas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd,

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Starting point is 00:23:50 So giving everything that you just said here in some of your expectations about future inflation, how do stock investors apply that principle? Inflation is such a big driver of all financial. assets. It's reflective of, I mean, it drives the bond market, obviously, and to a larger degree stocks in a sort of almost counterintuitive way in that what inflation does for businesses at a very operational level is it determines the amount of certainty that businesses have going forward. And so what happens in periods like the 1970s or during any high, moderately high inflation like that is you get a lot of business uncertainty in the way consumers are

Starting point is 00:24:37 spending because inflation creates so much, it reflects so much uncertainty about what the future of the financial system is going to look like. And that creates a lot of volatility in the financial markets and in the stock market in particular because the stock market hates uncertainty about the future. And the thing about low inflation that is so good for stocks is that it just creates a huge amount of certainty going forward because entities are able to structure and better predict what their cash flows are going to look like, what consumer spending is likely to look like. And what becomes so problematic with the growth stock versus value stock debate is that growth stocks tend to be firms like, for instance, something like Tesla that has a very

Starting point is 00:25:26 sort of unreliable balance sheet. A lot of the income statement items are sort of sketched. etchy, uncertain. There are typically uncertain balance sheets and income statements to a large degree. That's really what a growth stock is. It's why it deserves its premium is because there's a huge amount of risk and uncertainty about what its future financial prospects are going to be. And inflation can be very disruptive to something like that because it will magnify the amount of uncertainty going forward. And so you've seen this in the last 30 years that growth stocks just, they beat the pants off of value stocks because to a large degree, the amount of certainty that growth stocks have, they're able to earn this huge premium,

Starting point is 00:26:07 these huge revenue and huge earnings multiples because the amount of uncertainty is declining across time in the economy. And if you see an uptick in inflation, you should see a reversion to the mean to some degree because in essence, value. stocks, the old boring style companies, they become much more reliable. They become much more dependent in a higher inflation environment in a relative sense, just because the amount of uncertainty that the growth businesses have to operate within is going to increase so much, which will reduce the amount of demand for their stocks and should ultimately reflect the balance sheets as well. It should result in not necessarily lower earnings, but certainly a lot more unstable earnings,

Starting point is 00:26:54 which should reflect, especially on a risk-adjusted return, much lower returns. So, Colin, I've heard you argue that the stock market is a better hedge of inflation than gold. And I'm sure a lot of Warren Buffett-style value investors would agree with you. I'm just curious if you can elaborate a little bit more on this. I guess it depends on what your definition of better is. But I like to look at it from sort of a risk-adjusted perspective. So, for instance, if you look at the stock market over any fairly long time horizon, the stock market beats inflation by generally a pretty healthy margin. The stock market even tends to perform pretty well in hyperinflation.

Starting point is 00:27:37 You see this in places like the Weimar Republic or more recently in places like Venezuela. But even in a somewhat stable inflationary environment, like we've seen in, for instance, in the USA in the last 50 to 100 years, The stock market is a good inflation hedge in that it typically beats the rate of inflation by, gosh, at least two, three, four, five percent in most cases across any 10 or 15 year rolling period. And the kicker with regard to gold is that it's not necessarily a better nominal inflation hedge, especially during periods where inflation is rising. it's a better risk-adjusted inflation hedge, and that, for instance, over the last 40 years,

Starting point is 00:28:27 gold and stocks have actually done very similarly in terms of their total returns. The difference is that the path that gold has taken to get there has been dramatically different than the stock market. The stock market, even with the big downturns that we've seen in the last 15, 20 years in the stock market, the stock market is just much, much more stable. I think the standard deviation on the stock market in the last 40 years is something like 17 or 18. The standard deviation on gold in the last 40, 45 years is like 30. So even if you're getting the same unit of return, you're taking the higher unit of risk,

Starting point is 00:29:08 or at least you're during a much higher amount of variability in the returns across time by owning gold. And so you could look at it on a nominal basis and argue that they've generated the same basic total return over long periods of time, which is true. But from a risk-adjusting perspective, from a cash flow management perspective, the stock market's actually been a better hedge because it's given you more certainty across that entire period of return horizon. Let's continue talking a bit more about this environment we're in now and COVID and everything that plays out. We've seen subsidies to corporations at unprecedented levels in the past few months. And on one hand, you have people saying that you must bail out close to all corporations since COVID-19 is nobody's fault. And then on the other hand, you have people asking for the market to be less manipulated.

Starting point is 00:30:03 What are your thoughts? I see both sides of the argument. And I think that I'm going to end up agreeing with both sides of the argument before this is all said and done. And my view basically was that when this thing really flared up back in March and April, my view was that it made sense for the government to step in and be highly involved. Because like you said, this thing wasn't anybody's fault. It was almost like we got hit by a natural disaster. And to say that we required some sort of market outcome that was as if this was the result

Starting point is 00:30:37 of bad actors or something, to me was sort of a false comparison. I mean, this wasn't like the financial crisis where I was really vehemently against all the bank bailouts and a lot of the stuff that happened in 2008 because that to me was, it was a lot of that was just bad decision making that resulted in a big boom that you had to have a bust after all that. And so a lot of banks, they deserve to fail. And to me, this is just different. This is more like a meteor hitting, you know, New York City and with all this collateral damage. And I don't think you can just sit around. and say, well, the Bank of New York deserves to fail because this meteor hit them. I think as a community, we had a responsibility at least at first to step in and try to help

Starting point is 00:31:23 where we couldn't. So I thought it made a lot of sense for the government to step in and try to be highly involved, especially given the cost of funding. The low rate of inflation made government spending, I think, a lot more viable. The aggregate amount of pain this was going to cost to other people by spending some extra money at the government level was not going to cause hyperinflation or anything like that. And so at first, I thought that it made sense for the government to be really involved to try to build a bridge to getting us to the summer or a point down the line where you could then begin to peel a lot of this stuff off and the impact of this natural disaster kind of started to at least go away a little bit. And it's crazy now that this thing is still around. And the argument gets a lot more difficult because the more and more we spend on this

Starting point is 00:32:16 thing and the longer and longer we do it, the higher the risk of inflation is. And that will create a different kind of pain down the road for everyone. Because inflation destroys our purchasing power and it creates an aggregate amount of pain that the government could ultimately be the cause of. And so we're we're nearing that point, I think, where the government has to start making potentially some tough decisions about how are they going to navigate the rest of this. Because, I mean, you can have a scenario here. Let's just be crazy, for instance, and say that COVID becomes a seasonal thing, that this thing is always around every year for the rest of our lives and that it just mutates and it kills 100,000 people every year for the rest of our lives. Are we going to spend $4 trillion at the government level every year because of that?

Starting point is 00:33:08 Maybe that's an unrealistic scenario, but it's a scenario that we have to start to seriously consider the longer and longer this thing plays out. And I think we're nearing the point where people are starting to maybe consider that, hey, this thing, maybe we'll never have a vaccine for this or maybe we'll have a seasonal vaccine for this. And it might become less dangerous, but we can't spend four, five, six trillion dollars every year on this thing and expect, that we'll never have any sort of negative repercussions. And so I was in the beginning, I think fully on board with, hey, it's worth the risk given the low risk of inflation up front that we should spend a truckload of money on this and be compassionate and support the

Starting point is 00:33:51 economy as best we can. And as we kind of move further and further along with this thing, I think I'm more transitioning into the other camp where I'm now beginning to say, look, we've done a lot and at some point we have to accept the potential reality that you can't just spend insane amounts of money on this in perpetuity and expect that there's going to be no negative repercussions. So Colin, financial news seems to be more and more reported like it's a sporting event. Like sports, the state of the economy is unfortunately often oversimplified. What is a prevalent narrative of the U.S. economy that you hear right now that's just wrong. God, I mean, there's a million of it. I mean, you turn on financial news and you're totally

Starting point is 00:34:39 right. So much of the problem with financial media, in my opinion, is that, and this is part of why I think podcasts like yours are growing so much and it becomes so popular because we're having an informed, meaningful discussion about things here. We're trying to educate people. We're trying to spread real fact-based information and help people understand the world for what it is. And the problem with a lot of financial media is that they don't give a crap about that. They don't care if you're informed. They just want to drive eyeballs to whatever is the hot thing today. So you turn on financial news these days and like CNBC is probably all Tesla all day today.

Starting point is 00:35:23 It's all anyone's talking about because it just happens to be a random. company that's increasing in value a lot. And, you know, it's somewhat controversial because the CEO says some stupid things every once in a while. And just a nonsense talking point, though. I mean, the impact of Tesla on the aggregate economy is not really important in the long run, whereas the conversations that we're having about like these things today, these things touch everybody and they impact people and their decision making in the future across the entire economy. And it's a totally different approach to discussing financial news than something like an eyeball-driven media machine that has to meet a certain amount of profit or revenue every year that has shareholders and lots of different conflicts of interest. And so the financial media is in a lot of ways fake news because I'd argue that 95% of the stuff that's reported on a daily basis is not even news.

Starting point is 00:36:22 It's not important stuff. It's just filling space and getting eyeballs. And in a lot of cases, it's scaremongering. I mean, that would be my big complaint about the majority of financial news. I think you're absolutely right. It's interesting sitting here in Europe and reading the financial news in Europe. And it seems like here the narrative is, you know, the U.S. market moves because of Europe. And then I read the U.S. financial news. And they're all about, yeah, the European for Nature monks move because of what's happening here in the US. So I guess there was just one sample of how simplified things can often be and that reason is an availability bias. So let's look internationally. Growing the money supply and subsidizing everyone or close to everyone is not a

Starting point is 00:37:11 US phenomenon. As we've seen in the rest of the world, they haven't been shy of doing that either. Knowing that, which currencies do you think could break out significantly from the current trading range with the U.S. dollar? Gosh, the dollar has been so strong. I actually, I think there's a reasonable argument to make that the majority of currencies could be strong in a relative sense in the next decade. I mean, going back to our whole discussion about inflation, if you start to see the U.S. government's impact on the rate of inflation, you should see this filter in the market.

Starting point is 00:37:46 the Forex markets and you should start to see if there's even an uptick of inflation to three to four percent, it should whack the dollar pretty good. A realistic scenario where the European economy remains in this sort of very low inflationary environment, they look a lot like Japan to me in terms of just their demographics and the way that the EMU is structured is so it's much harder. to implement big fiscal policies in the EMU because of their political structure. And so if you were to see an uptick in inflation in the next, say, two, three, four years, I think you could see the dollar get hit pretty hard.

Starting point is 00:38:32 And I know you've had some guests like Luke Roman and people like that who have talked about this. And we disagree on some of the technicalities about, for instance, rising interest rates on bonds and things like that. But I think we see the risks similar. Similarly, in that the, I just view it through the rate of inflation, whereas he might see it through rising interest rates or something like that. And I don't think you'll actually see it in rising interest rates necessarily, at least

Starting point is 00:38:56 at the Fed level. I think there's a decent chance actually that the Fed could keep rates at 0% and be way behind the curve even as inflation rises. But you'll see it in the rate of inflation if the risk increases. And if that happens, you're going to see a lot of these big long-term trends. They're going to reverse. It's the same sort of thinking along the lines of the value. value investor trade is that the value stocks become a better relative investment in a rising

Starting point is 00:39:23 inflationary environment. And the dollar should become a worse relative option versus virtually most currencies as inflation rises in a relative sense. So Colin, where do you see value in international stocks? I'm of the view that a lot of Europe is not necessarily dead money, but very low growth money for a long time. I think that the political structure of the EMU makes it very difficult for them to fix a lot of the problems that we've seen in the last decade. From the Euro crisis, in my opinion, it was never really resolved. I don't want to get too deep in the weeds about

Starting point is 00:40:04 this, but the EMU just is a deficient monetary union because it does not have a centralized Treasury in a way to fund the various entities, an aggregate level, really. And so that's very problematic from economic perspective because you're always going to have depressed levels of aggregate demand in certain places like Italy or Greece because they're going to have trouble funding a lot of their spending to a large degree. And so they have necessarily sort of austere government programs going on across time. And so I can see a scenario where Europe is dead money. And it's hard for me to look at the United States and be super bullish just because we've been

Starting point is 00:40:47 on such a huge tear. And the tear is so central to a handful of tech companies. And I think there's a big opportunity for a lot of Asian, Southeast Asian economies to really take a lot of global market share in the next couple of decades. And you know, you kind of have started to see this trend play out with the growth of China and India and places like that. And I just don't believe that that trend is even remotely close to finish. And I think those economies are becoming more and more capitalist.

Starting point is 00:41:23 And as they do that, it's hard for me to imagine that they won't become really the center of the global economy over time and that the USA's market share, especially as a share of market cap of total equities, doesn't decline over time. not necessarily go away or, you know, the U.S. market doesn't have to perform terribly over time, but in a relative sense, I think that Southeast Asia is really, they're positioned so well to benefit from so many long-term trends in the coming decades that to me, it makes it just a must hold for the long term as part of an equity portfolio. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:45:21 fundrise.com slash income. This is a paid advertisement. All right. Back to the show. if that plays out, how do you put on a position with that knowledge? Gosh, you could do it in a lot of ways. I mean, again, so much of this is tied to inflation in the way the dollar performs. I mean, a lot of people look at international equities in the last 10 years or so and say that, you know, oh, they haven't performed very well. I shouldn't own these things.

Starting point is 00:45:49 And a lot of that is just that the dollar has been so strong that in domestic terms, the U.S. market just looks like such a good relevant. relative play in large part because you've had so many favorable tailwinds. And again, inflation is a big one regarding all of this. And if you were to see that reverse, this is all kind of tied into that same sort of trade that I've been alluding to that is the inflation trade where if the dollar goes down and you see inflation uptick even a little bit, it doesn't have to go up a lot. It just has to even jump to three, four percent. You're going to have a big reverse. in the relative value of domestic versus international equities.

Starting point is 00:46:32 That's the other big kicker is that owning international equities to some degree is it's an inflation hedge. And so it helps you better diversify a portfolio not just because it better reflects the global stock market, but because it better protects you from inflation to some degree. So international equities aren't just a way to diversify your stock market risk. they're a way in a large degree to diversify your currency risk. So I don't know if I actually answer your question there. I mean, I can't recommend specific instruments just because I'm a portfolio manager.

Starting point is 00:47:08 But things that give you access to, I think especially emerging markets, they're very attractive on a long-term, even valuation-based basis. And I'm a big fan of index funds. I don't get into stock picking a lot. So, I mean, virtually any of the big low-cost index funds they give you access to this. I think, you know, you've got to be careful because these things are, they are risky, but that's where a lot of the premium, the long-term premium will come from the fact that these things are riskier.

Starting point is 00:47:39 And you've got to be willing to hold them for the long-term and go through potentially five, 10-year periods where they don't perform very well, like they have in the last five to 10 years. The tendency, though, will be that at least in my view, that holding a chunk of these will diversify a global stock market portfolio in a meaningfully important way in the coming 10, 20, 30 years. Let's just jump back to one of the things you said about inflation there before. You mentioned inflation could go up to, call it 3, 4, 5%.

Starting point is 00:48:12 In that case, how would the Fed look at this and how would the Treasury for that matter, look at that? Would that be a clearly they're targeting high inflation in that today, but is that a nice way to start wiping up some of that debt, like we've seen historically, that inflation has been used like that, or will it be combated right away with a higher interest rate and then everything that follows from a high interest rate in terms of other asset prices going down? I view the Fed and most central banks is they're somewhat impotent when it comes to trying to control inflation, just because the mechanism through which they do it is so imprecise.

Starting point is 00:48:51 It's so indirect. And so, you know, kind of going back to the beginning of the conversation, the Fed is just a bank for banks. And so when the Fed tries to, for instance, control the rate of inflation, they typically will raise interest rates, which basically raises the interest rates that banks are going to ultimately be trying to pass on to other customers. And the weird thing is that what this oftentimes does is it actually hurts the banking system itself to a large degree, which makes it a little more difficult for banks.

Starting point is 00:49:21 to lend. And you see this in periods like 2000, the early 2000s where the Fed's trying to raise interest rates to try to mitigate some of the inflation that they're seeing in the economy. And they're really trying to get a hold on the housing market. And they just can't seem to do it. They can't seem to stop people from wanting to buy homes. And that's the thing with so many of these policies that I think you can't stop people from doing crazy things like bidding up the NASDAQ in in 1999, or you can't stop, you know, raising interest rates isn't going to stop people necessarily from buying homes in 2006. And, you know, you see the same thing time and time again, that these government policies tend to be very reactive in the way that they actually impact things.

Starting point is 00:50:07 And so, you know, going forward, if we started to see some uptick in inflation, I think the Fed would do what it, what it's been doing in the last few episodes where they'll raise interest rates, they'll be behind the curve. They'll probably, you know, reduce. I think the balance sheet has become the main course of action for the way that they're trying to control things now. And like I was saying, you know, controlling the balance sheet is, it's just basically exchanging financial assets across the composition of the private sector, which is probably, I mean, in my view, it's an even more imprecise and meaningless sort of way to impact the rate of inflation than interest rates changes even are. So the Fed, I think, is just very, there are tools for fighting inflation

Starting point is 00:50:54 going forward are very blunt. And I think that if you saw an uptick in inflation, I think that you'd have to see, in order for the government to try to get real control of it, you'd have to start seeing a change at the treasuries level, the amount of spending that they're doing, the amount of new debt they're issuing. And I don't know how politically feasible all that is. You know, a lot of the narratives, at least in the USA, seem to be trending in the direction of bigger and bigger government programs, things like the Green New Deal and UBI, universal basic income, things like that. And so, I don't know, it's hard for me to imagine the scenario where we don't see more progressive policy implemented across the next 10, 20 years. So, Colin, here's the million dollar question. And how can investors outperform today's market, but also have protection from these violent downward moves that we've seen?

Starting point is 00:51:55 Being really patient is going to be the ultimate diversifier in the coming 10, 20 years. And I think that what that means is I think you've got to be patient with a lot of different instruments. The world looks so uncertain. I mean, arguably the most uncertain that I've seen it in my career. year. I mean, when I started out in this business, God, it was easy to generate. You could generate. I remember you could put money in the bank and you could have earned 4% a year in it. I mean, generating a 4% return was the cakewalk 20 years ago, whereas now the whole bond market looks incredibly difficult to generate a real return from. The stock market arguably, especially with

Starting point is 00:52:39 the big surge in the last few months from a valuation perspective, looks not necessarily really bleak, but certainly I would argue low return going forward. And so when you look at a diversified portfolio, your options just, it's very difficult, I think, to build a portfolio that's going to generate a stable and steady return going forward. And I think you have to be opportunistic going forward. You have to be patient. You're going to have to let some of these markets.

Starting point is 00:53:04 They're going to ebb and flow. The stock market is going to see big downturns again at some point. I wouldn't be surprised at the bond market does too. And so I think you've got to be patient. you've got to be really well diversified. There's a strong argument that alternative types of assets are more attractive now than they've been in a really, really long time. And so things like commodities and gold and holding some cash and holding,

Starting point is 00:53:31 if you own real assets, things like those, I wouldn't be surprised if things like real estate or even commodities, which has been demolished in the last 10 years, I wouldn't be shocked if things like those are the best performing assets in the next 10 years. And so it's going to be just so important to be diversified. And one thing that I'm such a big advocate of is people in a low return environment, they need to be so much more mindful of their taxes and their fees. Because the taxes and fees are the things that you can control.

Starting point is 00:54:05 You can control your mentality and you can control taxes and fees. And those are the things. There's the only things that going forward are going to generate. certain additions to your total returns. And a lot of people can't control those. They won't control them. And in an environment where, let's say we only earn four or five percent, if you're paying high fees and you're paying a lot in taxes and you're being

Starting point is 00:54:32 undisciplined and you're hyperactive in your portfolio and you're creating all these taxes and fees because of that, you're cutting your return potentially by one, two percent, which is in the grand scheme of things, that's cutting your total return potentially in half. It's going to have a huge multiplier impact across a 30 or 40 year time horizon. Colin, this has been absolutely amazing. I'll definitely give you an opportunity to give a handoff where the audience can learn more about you, Promenic capitalism, and Orkin Group. My firm is Orcam Group and I write a lot of material on Pratka, which is Pragal, which is

Starting point is 00:55:13 Pragmatic Capitalism, the URL is P-R-A-G-C-A-P-C-A-P-com. And if you want to learn a lot about, I write a lot about the nuts and bolts of the financial system, go to the education section. There's a huge page at Orcam Group, which is, that's my financial firm. But there's a huge page there where I've listed kind of all of my favorite videos and outside resources and a lot of the material that I've written about how the monetary system works and how I sort of think about things and you can find most of it there. So you can also, you know, I love to interact with people and help where I can. I don't know everything, but I like

Starting point is 00:55:50 to think I know at least a little bit. And so I'm so happy to try to help people and get back a little bit to educating people about things because it's a tough, tough thing to understand. And money is a big confusing topic. And I don't think anyone really fully understands it. But we can all kind of help each other out by trying to have good thoughtful conversations like this one. I can just say that, Colin, that your resource cap.com is a fantastic resource because you're basically doing what you're also doing here on the show. You're making something like money that is so complex and so abstract. You really simplify them, but you don't simplify them too much. Colin, again, thank you so much for taking time out of your business schedule to be speaking

Starting point is 00:56:32 with Preston and me here today on the Amherst's podcast. We're really excited already to bring you back again in the latter part of 2020. Awesome. Well, thank you guys. All right, guys. So this part and time in the show, we'll play question from the audience, and this question comes from Nick. Hi, President Stig. It's Nick from the UK here, a huge fan of the show. My question is about interest rate, inflation and house prices. I heard one of you say on the show recently that you expected house prices to potentially go down

Starting point is 00:57:03 in the next 12 months due to increased interest rates caused by inflation. I thought inflation was inversely correlated to interest rates. So I'm not entirely sure how that works. I'll be really interested if you could unpack it for us. Nick, that's a great question and a very timely question. So when we talk about real estate prices, generally lower interest rate makes prices of real estate go up, while higher interest rates make real estate prices go down. The reason is simply that as a homeowner, you have a finite amount of money and if your installment go up because of a high interest rate, your house price must go down. And the latter is true even if you personally fix your installment because the influx of new

Starting point is 00:57:51 buyers with new terms will then lower the overall demand. The interest rate is used to control inflation in society, though as Colin Rhodes mentioned here in the episode is not a perfect tool to do so, but it is due to the same principle of supply and demand. If you want to lower inflation, we can high interest rate because it decreases the money supply in society, which leads to falling prices, and vice versa. So when you ask me whether I think real estate prices will go down in the next 12 months, I think, yes, we'll see a modest drop. I'm not as familiar with the UK as I am with the US. I would imagine it would be a similar thing in the UK, but it won't be so much because the interest rate. Actually, if we look at the interest rate right now, which is very hard to predict,

Starting point is 00:58:38 but I don't see that behind the next, say, 12 months because of the weak economy, both in the Ukraine and the US. But I see lower prices because of COVID-19. You have a lot of people who are struggling to make payments on the homes, and some of them are either going to foreclosure or going on sale. And this process just takes a long time to play out because most people typically want to make sure that they're not losing their home. And even if their home is eventually put on sale, they typically have a higher reservation price that they will slowly lower, which also contribute to why it takes such a long time for this scenario. And then the other thing that you also have to include into this is that when we're talking about the prices of assets like this,

Starting point is 00:59:23 they're always complex whenever you consider how many factors influence this demand and supply. Therefore, the response, whenever we talk about the impact of inflation, fiscal stimuli, interest rate, is really an everything else equal perspective. There are many different factors. So just one could be that this is an election year in the U.S. And because there's so much political capital invested into fiscal stimulus because of COVID-19, that's just another element you have to account for. So, Nick, just to kind of add on to what Stig said, I think it's important to realize that real estate is very local.

Starting point is 01:00:04 You can go into different cities, different regions, and real estate prices can act in very different ways. It depends on how much land remains for the amount of buildings that are being constructed. It depends on how much industries flowing into and out of a specific region. there is just a ton of factors that go into this. I would argue that if you have a population that's pretty steady, you have an amount of land that's fairly steady as far as the supply and demand of it, and you have this geopolitical factor around that community that's somewhat stable as far as the economics around that area are stable. I think you can use the generalization that when interest rates go down,

Starting point is 01:00:51 the prices will go up and vice versa. As you can see, there's a lot of factors and a lot of variables that go into this. So I think the most dangerous thing that a person can do is sometimes to simplify it too much and to say, oh, well, because of this one thing, because of X happening, Y is going to be the outcome. I think that you really got to reserve against that. So Stig's comment about the COVID-19 impacts and a lot of people being out of their jobs in particular industries being impacted heavily by.

Starting point is 01:01:21 COVID-19. Those are going to impact the real estate market. So I think it's a really great question. It's something that depends a lot on the region that you're specifically talking about and all the factors that are at play at that point in time. So Nick, for asking such a great question, we're going to give you a free subscription to our TIP finance tool on our site. All you got to do, if anyone's looking to learn more about TIP finance, just go to Google and type in TIP finance, or if you go to our Investors podcast website. You can see it there in the navigation bar. Just click on finance. And we're excited to be able to give this to you. So if anybody else out there wants to ask a question and get it played on the show, go to Asktheinvestors.com. And if you get your question

Starting point is 01:02:03 played on the show, you'll get a free subscription to our TIP finance tool. All right, guys, Preston, I really hope you enjoyed this episode of the Ammasters podcast. We will see each other again next week. Thank you for listening to TIP. To access our show notes, courses or forums, Go to the investorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or rebroadcasting.

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