We Study Billionaires - The Investor’s Podcast Network - TIP313: Ed Harrison from Real Vision talks about Current Market Conditions (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we're excited to bring our good friend Ed Harrison from Real Vision TV. Ed is an expert in investment banking. He's a former diplomat and technology executive. Ed is an incredible host at Real Vision, and he conduct some of the most exclusive discussions with the world's most influential thinkers in finance. So we're really excited to have them on the show to talk about the current market conditions and various investment ideas in the third quarter of 2020.

Starting point is 00:00:27 So without further delay, here's the 10th,000. talented Ed Harrison. 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 The Investors Podcast. I'm your host, Dick Broderson, and as always, I'm accompanied by my co-host, Preston Pesh. Today's topics are value versus growth stocks, the economy and the coronavirus, and last

Starting point is 00:01:08 but not least we are covering the US dollar and the euro. We are super, super grateful to have Ed Harrison with us here for the very first time. I'm here at one of the top thinkers right now. Ed, welcome to our show. Thank you. I don't know if I can live up to your billing of one of the top thinkers, but I hope that I can provide some insights into sorts of things I'm thinking about. Modest, I like that. And I just want to say for the record, Edwards started this interview out and Swedish. So, I mean, he of all people before the interview, just speaking Swedish, because apparently he knows how to speak Swedish. He is probably the person in the world who should be the least modest at all. So putting a lot of pressure on you there, Ed. Yes. And you know,

Starting point is 00:01:56 the reason I speak Swedish as we're talking before is because Danish was too difficult for me to learn. So I went with Swedish instead. All right, Ed. So I wanted to kick this interview off with a discussion about growth and value. Because whenever people hear growth stocks, at least most people think about fang stocks, and they relate their outperformance to an accelerated digital world. Now, you have a very interesting but different thesis of why growth is performing better than value right now. What is that? The macro view that I would posit is that we're in a very low growth, low inflation environment, which means that nominal GDP growth is lower as a result. It's lower both on the inflation front and it's also lower in terms of the actual GDP growth, the real GDP growth itself.

Starting point is 00:02:52 So if you look at cyclical turns in the past, say, for instance, in the 1970s or 80s, you got this massive jolt up in GDP and then this cycle continued higher both on a real GDP basis and an inflation, basis. So that means nominal GDP growth is low. And when you look at companies throughout the indices, the S&P 500, Russell 2000, whatever it might be, in some senses, you can look at them as a proxy for GDP. That is, is that companies in aggregate are not going to outperform drastically what the nominal growth of the economy is doing. So as a result, you're seeing a lower trajectory of earnings growth. And that means that to the degree that people want to hit their earnings hurdles, that is, they want to hit their hurdles for investing, 7%, 8%, whatever it might be,

Starting point is 00:03:46 they're going to have to go to the companies that are going to have the highest growth. And so to me, that's one of the key factors driving growth over value, at least since the great financial crisis. So you're doing some amazing writing, Ed, and, And you have a very interesting equation. You have momentum equals growth, growth equals long duration, and long duration equals secular stagnation. What does this mean and how do we complete the equation? So I wrote a post very recently fleshing out these ideas. So if you take what I was just talking about and you move it forward to what's happening right now and you look at nominal GDP growth across a wide swath of countries being lower this particular go-round, just as they were in the

Starting point is 00:04:39 last financial crisis, the last recession that we had, what you see is a need for yield. What you see is that we're seeing the yield curve compress in a way that you have a flattening of the yield curve with interest rates penned at zero in the short term and then the rest of the curve flattening towards zero or even in negative rates in Europe. And so what that definitely means is that you're going to need to have some yield pickup somewhere else. So to the degree that you need the yield pickup, the question is, where can you get it? And why is it that it's there? If you look at it, let's talk about it from a discount factor perspective. If you look at the discount factor because of the yields falling, then that means that companies that pay their investors based upon

Starting point is 00:05:32 prospects that are five, ten, twenty years down the line, those are companies whose prospects are more interesting in a low-yield environment because the discount factors mean that those earnings are relatively speaking more valuable than they would be in a five percent yield environment or a 7% yield environment. And so I'm looking at those growth companies, which are the companies that actually pay investors, let's say the Tesla's of the world, or the, what would be a good example of that. I think it's that Nikola is another great example that's similar to Tesla. Those kinds of companies are going to pay much further down the line.

Starting point is 00:06:14 And those payments that they're going to get or the prospects of those payments are worth much more. So you're actually getting a long duration play. It's a bond proxy, if you will, as a result, because you want to go to the longest duration and this is what you get when you get a growth company is you get a long duration play, and that is what's going to win in a low growth environment. So, Ed, what do we do as investors to position ourselves based on this information that you just shared with us? So I think that the real problem is you can look at it from a portfolio perspective. I look at it in terms of the optionality that if you look at 2000 or the run-up in the NASDAQ in the 1990s up to 2000, what you saw was that some of these companies that had the prospects of great profits down the line went to zero. They went bust and they went out of business. So perhaps if you took a portfolio,

Starting point is 00:07:17 portfolio approach, and then you had the Amazon's in there, you had the eBay's in there, as well as the Pets.com in those portfolios, you would make out as well. But I think that what people are doing today is that they are saying to themselves, not only do we want to have the Nikolas and the Teslas in our portfolio that don't have any proven profitability, but because the world that we live in is different now, where the companies that are going to IPO actually have profit more. And actually, the companies that have moats and that are going to give us profits five and 10 years down the line are bigger, like the Facebooks, the Amazon's, the apples of the world, we're going to invest in those. So I think that it's a barbell strategy, if you will,

Starting point is 00:08:03 that is combining the growth companies of today and the growth companies of tomorrow together. So Amazon and Apple on the one side, Tesla and. Nicola on the other side. Our audience are primarily value investors. That's sort of like of the very root of where we're coming from. And we're used to all of these priced book ratios and price to earnings ratio and key metrics that the way that we were brought up just look different now. The ratios are the same.

Starting point is 00:08:35 But the performers for a long time have been different than what we have been taught. What are the outlook for us old school value investors in this environment? I think that it's really a question of picking winners and losers at a particular time in the market. I mean, even though I'm giving you the thesis as to why right now you might be outperforming with growth over value, I think that over the course of a business cycle, there's going to be a reversion to the mean in terms of the outperformance of growth over value because we've seen such a huge run-up in the shares that I was talking about. I'll give you an example of something that I was looking at earlier. So, for instance, one of the divergences that we've seen between growth and value is as a result of

Starting point is 00:09:25 what I would call the buy-at-home strategy versus the COVID-oriented companies. And a lot of the value stocks are in the COVID-oriented companies like travel, like leisure. A perfect example of that is Wyndham. I saw that Wyndham actually gets 96% of its revenue from U.S.-based travelers. So if you're thinking to yourself, here's a sector that's completely beaten down. It's gone down 40% on aggregate. Where would I found value within that sector on a relative basis that would be able to beat out the odds in this particular environment? Wyndham is an example of that kind of thing. So I think that even within the value world in certain categories, there are winners and then there are losers and you want to be able to pick the winners not just in terms of do they

Starting point is 00:10:22 have the wherewithal over time, but in terms of what's their price earnings, are they relatively cheap? And I think that those are the kinds of players that we're talking about. Let's transition and talk more specifically about COVID-19 and the implications for us as investors. Previously this month, White House coronavirus advisor Dr. Fauci said that the chances of scientists creating a highly effective vaccine, and highly effective here would be 98% of more guaranteed protection. The chances of that happening was slim. Rather, scientists are hoping for a coronavirus vaccine that is at least 75% effective, but even 50% or 60% effective would be acceptable too. So if we, on the contrary as investors, believe that we actually will have an effective

Starting point is 00:11:14 vaccine within the next, call it 12 to 18 months, like you hear a lot of people talking about, it's like we need that, call it medical bailout. I think that's a term that I got from you. If that is how we think about it, how can we best position ourselves? I was thinking of exactly that word, the medical bailout. That's what we're looking for. And I think that either you have the bailout or you don't have the bailout. I think that what Dr. Fauci is saying is essentially that we're not going to get a medical bailout, that even to the degree that we get a vaccine, it's going to be incomplete. It's going to take time to roll out.

Starting point is 00:11:49 And so effectively, we're going to lose two years of earnings growth that is in a normal world. We're going to have two years of COVID-associated growth. So when we talk about this bifurcation in the market between the at-home companies, and the COVID-affected companies like the leisure and the hospitality. When you look at it from a discounted cash flow perspective, you're talking in the order of 6 to 12 to 15%. Just thinking about a DCF, how far out you can go. Even if you have 2% discount rate, you're still going to have a hit to year one to year two of those earnings. That could be as much as 15 or 20% that you're losing for certain companies. And so I think then you have to ask yourself, which are the companies are

Starting point is 00:12:37 valued well, given that we're definitely going to be in this bifurcated market. Is the differential that's been in play in the markets greater than the actual differential that you think that discount, this 15%, this 20% discount would call for? And just going back to the Wyndham's as an example, I think that the answer is, is perhaps, yeah, you could pick the differential between a stock, which is really a mature stock like Apple versus a Wyndham in terms of the PE ratio. Is that something that you're willing to pay for over a seven-year period of time? I think the answer is probably no, that you would want to pick up a company like Wyndham, which even though some of its earnings are going to be discounted over the first year, the second year, actually are going to be discounted less. Their earnings are going to fall less than the average company. And over time, you're going to see benefits as a result of that differentiation. So, Ed, I want to flip this on its head. How will the economy look in terms if we don't find an effective vaccine, but rather we have to live with COVID-19 until everyone kind of reaches a herd

Starting point is 00:13:51 immunity years from now. And so how should we position ourselves for something like that? I think then it becomes a little bit more complicated in terms of the differentiation of the markets are already playing out for us. The market is basically saying is that certain sectors of the economy are just going to be crushed because COVID-19 is going to be with us for the long term and there's going to be a wholesale shift and other sectors of the economy are going to do really well. And the question is, is do the prices that are implicit in the price earnings ratios, the discounted cash flows, do they represent value on a relative basis in that scenario that you're painting? I think that the run-up in the more speculative areas of the market don't represent

Starting point is 00:14:37 value from that perspective. Tesla and Nikola are perfect examples of that. I think that there is going to be certainly big cap companies are going to do better, but it remains to be seen whether or not, the huge run-up that we've seen in the technology companies is going to compensate you for the differential in outcomes, especially if you're looking at, say, Walmart, large-cap companies that have economies of scale, economies of scope, they're going to figure out how to deal with this. They're already online. They're already allowing you to shop at home. I just saw something of Tesco hiring 16,000 employees. in order to take advantage of the new at-home shopping. Tesco is one of the biggest supermarkets

Starting point is 00:15:28 in the UK. There's a perfect example of a company that should not be trading at a huge discount to other companies, be given the fact that it can adapt and it will have the wherewithal to be able to have the growth going forward. So I think in that case, again, still you will see a relative outperformance, but it would probably be the larger cap company. within the value space over smaller companies within the value space. Without asking you to second guess Dr. Fauci, and then even so, how are you thinking about it in terms of probabilities? A lot of people see this as a binary thing. Like, it's going to happen or it's not going to happen? And I guess you can make the argument for that, but there's a huge

Starting point is 00:16:14 difference of a binary income if it's 991 or if it's 50-50. And without putting you on the spot, be like it's 62 versus 38%. But how do you think about it? How do you gather the information? How do you process your information whenever you are considering these thesis, which are so important in the investment climate they're in right now? I'm thinking of it in terms of standard deviation and the bell curve. And I think that what a lot of people know from financial markets is that financial markets are not shaped by a normal bell curve in terms of the distribution of outcomes, that there are fat tails. And then the question is, is why are there fat tails and where are we within that distribution? I think that the reason that there are fat tails is because

Starting point is 00:17:02 even though there's a certain degree to which outcomes are random in the middle of the curve, the closer you get to either side of the curve to either tail, the more psychology comes into play. And so we're at a period in time where when you talk about what are the probabilities one way or the other, we've moved well over on the curve in terms of people talking about the probabilities of massive bifurcation in the market where certain companies go to zero and other companies just do outlandishly well. That taking on a feeding frenzy that gets you to two, three standard deviation differentials between different parts of the market. And to me, that's the setup for underperformance for those sectors, like the ones we were talking about earlier, the growth sectors over the medium term, that eventually whatever happens,

Starting point is 00:17:59 probability-wise, is going to move you out of the fat tail edge of the curve, probably actually over to the other side immediately. You know, that's how it usually works. It is that you go from one fat tail to the other fat tail from the outperformance to huge underperformance before you revert to the mean in some capacity. So that's what my expectation is, is that irrespective of what the probabilities are of outcomes for COVID and in terms of the medical outcome that we're already into the second and third standard deviation differential move. And I wouldn't call it a bubble per se. I would just call it that we're into the psychology

Starting point is 00:18:41 segment of the market. Let's take a quick break and hear from today 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 saunas 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, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency collapse, using AI to expose human rights abuses,

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Starting point is 00:22:54 That's so interesting that you say that. So then I have to put you on the spot again. I could say and say if that is how you think about it in a portfolio perspective with those extreme outcomes that you just mentioned before, how should we position us? And what are some of the risks if we go X versus Y? What are your thought process around that? I'm definitely much more oriented towards the value side in terms of how I'm thinking about it. And so this is a value podcast. What I started out talking about is how a growth investor might think about it. If you're thinking growth, let's say you're thinking about the portfolio period.

Starting point is 00:23:33 Think about it from the optionality aspect. When I said that, for instance, that all of your earnings comes from years 5, 10, 20 years out on a relative basis, there's a lot of uncertainty there. So there's a high embedded optionality in terms of the equity prices that you're paying for those stocks. And as a result, some of them aren't going to do well, others are going to do well. In this period of time, as compared to, say, 20 years ago when we had the tech bubble, companies are more mature, so the optionality is a little bit less than it was before, but you still have to take a portfolio approach in order to not get caught out being overly allocated to companies that end up not doing well over the longer term. But ultimately, I think that

Starting point is 00:24:20 you're going to underperform even if you take the portfolio approach because we've moved into the second and third standard deviation, a differential, that the price earnings ratios within the at-home segments of the market are so extremely higher than the industrials, than the value stocks, the bank stocks, the financials, the consumer staples, that if you take a large-cap portfolio of stocks within those segments, you're much more likely to do well over the medium term. And I'm talking about that in terms of a half or three-quarters of a business cycle, say five, seven years time frame.

Starting point is 00:25:03 So Ed, Stig and I are both big fans of Real Vision and definitely the work that you do there. One of the things you cover quite well is this contrast between economic expectations or impacts versus political decisions and the fallout from those decisions. When you look at these two variables, it's amazing to see how COVID has produced effectively a binary outcome for businesses based on policy decisions. Talk to us a little bit about your thoughts on some of this stuff. As you were saying that, I was thinking to myself about how it's reflected in terms of markets, in terms of bifurcation, because the bifurcation, that is the potential for companies,

Starting point is 00:25:40 especially small companies, companies that are leveraged to close contact, what I'm calling the COVID companies, their potential to go to zero, i. bankrupt, is greater in places that don't handle it well. So it makes a big difference as to how government policy is. And the way I'm looking at it now, especially if Fauci's right that there's no civil bullet and that we're looking at another 12, another 24 months from now that will still be sort of in the post-COVID period on some level that you want to have a long-term sustainable perspective. So an example would be here in the United States where my son is going to go to high school. It's remote. And the reason that it's remote.

Starting point is 00:26:30 is because the contamination levels, the infection rates are so high that we're so afraid that you could get it in school and then bring it back to your family. So they have to do it virtually. It's about getting the virus levels down to a level where the community transmission is low and then starting again. The biggest mistake that the United States made relative to other countries is that we didn't do that. We did the lockdown, like other countries, like Denmark. We did the lockdown like Norway. But then we left the lockdown before community transmission was clearly low,

Starting point is 00:27:10 and we weren't ready for the testing associated with the levels of community transmission that we had when we came out of the lockdown. So now we had a huge second wave, and then the knock-on effects in terms of what I just said about schools and also shopping are great. So what happens in that environment to companies like small businesses that don't have economies of scale, economies of scope? Either they merge or they potentially go bankrupt. If you're a restaurant and you have 3,000 different restaurants, it's a greater opportunity for you to have restaurants in places

Starting point is 00:27:47 that have low transmission and people are spending money at the restaurant than one individual restaurant, which is completely at the behest of a local economy, that restaurant is much more likely the one, the local restaurant, to go bankrupt. So in a country like the United States, that's what's going to happen is we're going to have a much more concentrated industrial economy after the fact. So let's zoom out a little here and talk about the U.S. and the European economies. And And given everything has happened with COVID-19, what really stands out for you? I would say that the Nordics stand out for me. There are two different parts of the Nordics.

Starting point is 00:28:31 There are what, say, Finland, Denmark and Norway have done versus what Sweden has done. I think both of the countries, both of the models are geared towards what's long-term sustainable. In Sweden, what they decided is that we want to have as close to the, you know, normal life that we had over a longer period of time. And that's come at a cost in terms of the lethality of the virus and also in terms of the community spread. But the community spread in Sweden relative to places like the United States has been going down and has been stable to going down versus the United States. We had a second tick up. Then you have the Danes, the Norwegians,

Starting point is 00:29:16 the Finns, which said, okay, we're going to lock it down. but when we come out of the lockdown, we'll be in a much closer position to do exactly what the Swedes had been doing the whole time. And that has also been effective. So I think that it's in the rear view mirror with regard to what Sweden did. But I think that dichotomy is interesting in terms of thinking about where you are today. And then therefore, how you can talk about Europe versus the United States over time. And I think that the way that I'm looking at it is that really it's about community spread, it's about sustainability, and the U.S. has really done the least effective job on both of those fronts. What we see in the rest of Europe, like, for instance, Spain,

Starting point is 00:30:05 even in places like France and Germany, is sustainability is a big problem. Because right now, there's a increase in the number of cases in Spain, even in France and Germany, and we're now going into the fall where we have the flu. We also have people moving indoors. So it's really not clear whether or not there's a sustainable tamping down in those countries in the way that there has been, or at least there seems to have been, in places like, just to use an example, New Zealand. Let's talk about some of the implications of COVID-19. Let's first start with the US dollar. Do you see the U.S. dollars losing its status as the main global reserve currency in the decades to come? No, I definitely don't.

Starting point is 00:30:56 I think that if you look at DXY, which is the index, the dollar index that people usually quote over, say, a 30, 40-year period, what you'll see is that DXY has been much higher and it's been much lower than it's been recently. You know, the channel that we've been trading in recently is both much below the highs for the dollar and much above the lows for the dollar. So we're not anywhere close to some sort of systemic crisis. And then the question becomes, because the systemic crisis is something that will cause people to overthrow the dollar, what's going to replace the dollar? What's going to replace the dollar is something that's freely convertible, something that has

Starting point is 00:31:40 a lot of collateral in that currency that you could use in order to create money, make loans and things of that nature. Treasury bonds, as an example. You have nothing like that in China. You have nothing like that in Europe because, you know, at a European wide level, there's not enough collateral there. Japan's not going to replace the U.S. in terms of issuing the reserve currency. So really, when you go through all of the different possibilities, the only possibility is the U.S. dollar loses some of its role relative to a group of different currencies and different options, including, say, gold or Bitcoin, but it doesn't lose its status as the principal reserve currency. And so I don't think that there's either a meltdown coming in the dollar as a result of

Starting point is 00:32:31 it's losing its reserve currency or a meltdown that's going to create the loss of the reserve currency. So ultimately, I think we're still range bound with U.S. dollar. And we're sort of of now at an oversold level. So we're hitting levels with 92 on the DXY that are bumping up against resistance for the dollar in terms of its low. It's interesting that you will mention the DXY that's very often being quoted. One of the things that always stood out to me looking at it is the weight of the euro. It's very much a how it's the you doing kind of index. And this is not necessarily saying that there's anything wrong with that because it is the second most important. important currency, but how would you say that the U.S. dollar has fared against the other

Starting point is 00:33:15 fewer currencies in general? Are you specifically looking at the euro here? Is that the benchmark? Is it a basket? Should that basket be different one way or the other? Yeah, DXY, I think what you're pointing out is it's kind of a flawed way to look at the dollar, especially given that other countries, there are a wide plethora of countries that have different characteristics than say the euro, which is a large percentage of the basket. The fiat currency countries that have relatively stable currencies versus the U.S. dollar, those are the countries that I'm thinking about when I think about DXY, whereas the emerging markets are completely different story altogether. I mean, for me, the biggest problem with the emerging markets and the dollar

Starting point is 00:34:03 is the extremes in terms of debtors and also in terms of assets. That is, is a bigest problem. is that emerging markets are using dollar assets and dollar liabilities as an anchor in terms of creating credit. And that creates problems when the dollar goes up or down in drastic amounts versus their currency. If the dollar goes way up in value versus emerging market currencies, suddenly if you're a dollar debtor, you're in big trouble because now your liabilities potentially have gone up at a huge percentage compared to your assets. On the other side is the fact that if the dollar goes down a decent amount, then the same thing is true with regard to those who hold U.S. dollar assets, that suddenly now their assets

Starting point is 00:34:56 are worth anywhere near as much. And so they have the same problem in terms of their balance sheet. So there's a lot more volatility there in terms of emerging markets. And so there's also the potential for trouble in emerging markets as a result of the bands being much wider than they are for the more stable fiat currencies. So, Ed, if the central banks keep printing like this, do we ever get to a position of hyperinflation or what happens? My view in terms of hyperinflation is that hyperinflation is that hyperinflation is a resource phenomenon. That is, is that you are a country that needs real resources. Let's say,

Starting point is 00:35:40 you need steel, you need food stocks, you need all sorts of raw materials, whatever it might be. And in order to get those raw materials, those food stocks, you need it not necessarily in your own money, you need other people's money because you can't get those stocks on your own. Let's say it's oil that you need as an example. So what happens is, is then you start printing up money in order to get those materials. Or as an example, even within your own currency, your industrial base is depleted as a result of war, which is an example that you had with Germany during its hyperinflation. Then you start printing up the money and the money is chasing a finite amount of assets, but it's increasing exponentially in its amount. And that leads to the hyperinflation.

Starting point is 00:36:30 So the real constraint there is real resources as compared to when you have massive overcapacity, as we do now, in the United States and in other places, where you could really just ramp up the amount of things that you can do with the money. There's no hyperinflation that's going to result from that. So I guess people out there listening and they read in financial news that now it's just been printed a trillion dollars. and then another trillion dollars. And it's like the Fed balance sheet is just exploding right now.

Starting point is 00:37:06 So if the first thought that we already covered was, well, then it must mean that we will have inflation. You laid out the arguments why that's not the case. The follow question to that would be, well, where is that money going? Like, where can we now see those trillions of trillions of dollars? That is the question. Then what happens as a result of that? If you think of the credit outstanding United States economy, and then you think of treasuries

Starting point is 00:37:33 and the Fed's balance sheet as being a small percentage of that, what you really get is a sense that the private sector banks are the ones that are most important in terms of creating velocity of money, in terms of creating more credit. So what the Fed is basically doing is, in essence, filling a hole at the highest, of value areas of the economy. So they're buying up treasury bonds. They're buying up mortgage-backed securities. They're buying up investment-grade bonds. And they're giving the people who sold the bonds to them money. And then the question to happen is, what happens with that money? Well, if there are no credit worthy customers to loan that money to, if you're a bank,

Starting point is 00:38:22 you're not going to loan the money to them. If you already have tons of your capital tied up in dodgy credit as it is to oil companies, as an example, probably you will be constrained, credit constrained. And if you're a customer of those banks, of those financial institutions, and you have in some way, shape, or form problems with your own balance sheet, you're less likely to take on more debt unless you won the risk of bankruptcy. So really, at the end of the day, what we see is that the money is going to make it to the holders of very liquid assets. And then from there, the question becomes, where does the money go beyond those liquid assets? It gets displaced potentially into less liquid assets, but also still liquid like stocks and bonds, you know,

Starting point is 00:39:21 financial assets. It doesn't necessarily make its way into lending into the broader economy. So one of the reasons I think that you see QE money printing leading to asset prices going up is because this is where you can take the money. You're displaced out of certain assets, and then you move into the next available assets in quality down the line. So how about the euro? Talk to us a little bit about that, Ed, as far as how you see it being positioned today in the global economy and how that plays out moving forward. Yeah, I see the euro as a currency for Europe, and that is for the euro area and for

Starting point is 00:40:06 those who deal with the euro area principally. So if you think about countries like Poland, or you think about Romania, Bulgaria, Hungary, some of those countries, you can take out mortgages in euros, even though the Polish lot or the Hungarian for rent are your currency. Those are countries that would be within the euro area market. But when it comes to the global market, when you think about things like commodity prices, oil, etc., the euro plays no role. Why? Because there are no euro assets that you want to hold other than specific country assets like German bunds, or maybe it would be Finland and their government assets, which aren't that great anyway. Or you could hold, say, Italian bonds, which actually are not highly rated. So that's not an asset necessarily that you want to use as collateral for loans. So when I think of the euro, I think of it really as, as a domestic currency, if you will, the euro area and the area around the euro. Only when the euro area creates assets that people can use as collateral, then I think we'll see the euro take

Starting point is 00:41:26 on more importance. So these corona bonds slash euro bonds that they're trying to start to put out, they'll be an interesting test to see whether the euro can create assets that have some sort of applicability that are AAA that people might want to use as collateral for loans, and then people will look at them almost like money in the same way that they look at treasuries almost like money. You know, what is it that a reserve currency needs to have? Things like it has to be freely convertible. That's definitely the case. It has to be a large market that's behind it. That's definitely the case with the euro. And then you start to go down the line and where you run into trouble, for the most part, is where, where you run into trouble, for the most part,

Starting point is 00:42:07 is where you come across the assets for collateral, where you come across the stability of the euro as a block. You know, when you think about Brexit as an example, that you could have a country from within the euro zone actually leave the EU and therefore leave the euro as well. Those are the things that create a certain level of instability that make you question whether or not the euro is moving in the direction of becoming a much more of a reserve currency asset. So I think that it definitely depends upon where the euro is as a, as a, the euro zone. Where is it from a political perspective? Is it politically holding together? And Italy is definitely top on the list when you think about that because the greatest thing would be going forward, let's imagine you say to yourself,

Starting point is 00:43:04 Okay, so you have these triple B or double B plus Italian bonds that have been issued. But now we have these new Italian, German, French, Finnish Dutch super bonds that are at the European level that are AAA, that I'm willing to buy and invest in. Actually, I can use them as collateral for loans. That's a totally different story because now I know that Italy is staying within the Eurozone. and that the Germans have said that they're willing to mutualize their debt with Italy, at least in part, we have this debt mutualization. And, okay, now I'm willing to say, yes, the euro is a project that is going to continue over the longer term. I mean, to me, that's where the rubber hits the road, because debt mutualization is a thorny political issue. And until you get the debt mutualization,

Starting point is 00:43:59 honestly, I don't think the euro becomes a greater reserve currency. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. Vanta automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure

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Starting point is 00:47:32 But I always, I can't help but think, well, try being in Europe and talk about a flawed currency and talk about so many limitations you're setting for yourself whenever it comes to the currency. So it's just very interesting the way that you, in many ways, if I may say as an outsider, are looking at Europe and the currency system, but also how you are looking at the US dollar and everything that's going on. Let me say, by the way, Steve, because you're in Denmark, I mean, you're in a unique position. Just think about this.

Starting point is 00:48:03 I mean, Denmark is essentially using the euro on some level. I mean, it's like your relationship to the euro is like the Dutch guilders relationship to the Deutsche Mark before the euro existed. I mean, they're essentially the same in terms of how it works, but you have not given up your monetary sovereignty. Why? That's the question. why would Denmark not give up monetary sovereignty to be into the euro? And that's the critical

Starting point is 00:48:29 question that is a problem with the euro as a reserve currency asset. If you have a country like Denmark, which is a part of NATO, which is a part of the euro system, which is a part of the EU in your monetary policy is basically shadowing the policy of the ECB and you're not using the euro, that tells you right there that there's something wrong with the euro. So let me just be provocative as Deegan say that until Denmark gets on the euro, you know that the euro is not going to be a bigger part of the reserve currency status. I love that you say that and try to single me out because I was just about to say before the British, or again the part of the EU, not necessarily giving up the pound, but still, I think it's such a good point. And, you know, the system we have,

Starting point is 00:49:23 there's just so many exceptions because we are countries. Of course, you have a ton of exceptions in the U.S. because you all have states, but there are so many things that are still regulated on a federal level. It's just such a different system here. Like you talked about in the other countries. You know, we have the Danish currency. It's packed to the euro within a ban of 2.25 percent, but it's a part of the euro. So that's effectively what it is, but it's not. And then you have Sweden, they're a part of the EU, but they have a floating currency, and then you have Norway, and they're not a part of the EU, but still follow a lot of the trade agreements. They have a floating currency too. So it's just, like, you bring up such a good point.

Starting point is 00:50:03 Like, if you look at the numbers, you know, 500 million people size, bigger than the U.S. economy, and you're like, oh, there should be something going on. There should be something right going on. But then whenever you sort of like dig deep into what's really good. going on, it's just such a flawed system on so many levels. I can only agree with you. I think ultimately what it boils down to is that you need a political and monetary union to reflect one another. It's difficult to have a political union that is very different, which you do have from the monetary union. And until the two are a sort of coincident with one another, then you're going to have problems.

Starting point is 00:50:48 So, Ed, based on your comments for the dollar and the euro, how should investors think about that with their positioning? I think real interest rates, the progression of real interest rates over time, that's going to definitely be a interesting factor. The U.S. curve, I think, has generally been steeper than the European curve. And so potentially you could actually make more money in U.S. dollar assets at the long end of the curve. because the European Central Bank has shown that it's willing to go negative. And the U.S. Central Bank has recently, in the last two years, shown that it's willing to start jacking up interest rates, even in the middle of a period where places like the ECB and the Rijks Bank and so forth are having negative interest rates. So I think that this whole dollar demise period is overblown in terms of the longer term. I think that the U.S. dollars should hold up relatively well within the ban that it's been trading within over the longer term and that we're near the bottom of that band.

Starting point is 00:51:56 So when I think about the euro and I think about the U.S. dollar, I think the euro at like 118, I don't really see it going up significantly more. from here over the medium term. When we talk about the currencies, obviously growth rates come into play as well. I would say that the U.S. growth rate, most people are still of the opinion that U.S. growth, nominal growth, as well as real growth, will be superior to European growth. And interestingly enough, if you look at the snapback from the COVID rally, even though the United States has done demonstrably worse in terms of its effectiveness at halting the disease, its economy has done better than the European economy in terms of its growth rates, both on the way down and also on the way up. So I think that it may well be the case that over the medium term that the United States

Starting point is 00:52:55 continues to outperform in terms of growth. Maybe it's just because it's a more dynamic economy. I'm not going to get into that. I think that's a very almost political issue, but it should be helpful for the currency as well. Fantastic. All right, Ed, I think everyone of our listeners have been listening to you and for you to outline your investment thesis and you to talk about the economy and just for you to talk about currencies, I guess I can only say, wow, so many great nuggets to take out from this interview at where can people learn more about you and real vision tv two different places i wear

Starting point is 00:53:36 two hats i've been for the last what is it now 12 years i've been writing at what was a blog which is now a newsletter called credit write down so they can come and see my own unfiltered view if you will at credit write downs dot com where you know i think maybe every 10th every fifth piece that i put out is free, but the rest are behind the paywall. Then I'm on Real Vision. I do interviews with financial investors, financial analysts, hedge fund guys. And I also do the Real Vision Daily briefing, which you were talking about, which is our video podcast that goes out on a weekday basis. And I'm on that, say, two to three times a week. So they can see me there. And that's also at Real Vision.com. Fantastic. And this has been a lot of this has

Starting point is 00:54:26 been such a pleasure and I can already say now, while I have you on record, we really hope that you want to come back on the show. It's been an absolute pleasure. Thank you so much for coming on the show. Well, thank you for having me because I was going to say exactly the same thing. I hope that it was good enough because I'd love to come back. You ask the best questions. Bro, Eddie. Smooth and modest man. What can I say at? All right, guys. So this part in time in the show We'll play a question from the audience. And this week, we picked a question from Jim.

Starting point is 00:55:01 Hey, Preston and Stig. It's Jim calling from Calgary and Canada. I just read your last current market conditions, which ended up with when the facts change, I changed my mind. What do you do, sir? That famous quote from Keynes. I've been thinking about the bond market and the fact that so many investors have a large allocation

Starting point is 00:55:25 to bonds in their portfolio. And as interest rates go down and as central banks manipulate markets, to me, bonds are becoming less and less attractive. And knowing that the bond market is so much bigger than the stock market, is it possible that bond investors just start looking for something else? And so you get a rush of money out of bonds into other assets and maybe that's stocks. And if that's the case, we could start to see, you know, Things like the Schiller PE or PE ratios in general going way beyond historic levels and

Starting point is 00:56:01 a new normal becomes really high PE ratios. Anyway, just thought I would ask your opinion. I love the show. So Jim, I think this is such a wonderful question and it's something that investors are really considering right now. Bonds have been attractive for a long time since 1981. Because you see interest rate drop and because of that returns have really been great. for long-term bondholders. Today, as you point out, interest rates are really low. You might

Starting point is 00:56:31 even be wondering, why are so many investors still holding bonds? Now, you do have many insurance companies and pension funds that have to do that because that's simply how they're regulated. That is due to a principle called duration and they simply have to ensure that they have enough funds where they can expect to meet a certain amount of claims. Another reason is that many investors like to have low volatility in the portfolio and fixed income instruments such as bonds are just a much better way of ensuring that than something like stocks. Now, my response so far has really been in so-called nominal numbers, not in real numbers. In other words, you need to account for inflation.

Starting point is 00:57:12 So when people talk about double-digit returns on bonds in the 1970s, well, inflation was double-dits too, so just because you might hold a, say, 50% return bond. If inflation was the same, yes, the bond would be better on the holding cash, but your purchasing power didn't change. You will be making 50% more and everything would be 15% more expensive. So what I'm worried about right now, and I think that's also what you're hinting at, is that what happens if we account for inflation? Because unless we enter a prolonged period of deflation, bonds would likely not be as

Starting point is 00:57:48 attractive in real returns compared to many other asset classes. So when you ask whether we would see a new normal with a high Schiller PE, you can say that we're already there to some extent. The CLPE is very high right now, and a part of that reason is because the Fed is printing so much money and keeping a 0% interest rate, and that just drives up the price of stocks. As a class, it should not only be seen in the light of nominal numbers, but rather investors look at what's the opportunity. And if you get 0% on your bonds, suddenly a low to mid-single-digit return in equities might seem

Starting point is 00:58:24 appealing. Now, whether or not it's a new normal, it really depends on how you define a new normal because as we enter the next interest rate cycle, and just to be completely upfront, I have no clue that would happen. If you have higher interest rates, then suddenly bonds and stocks change in value. because stocks becomes less attractive because you can now get a higher return in bonds. And bonds also changes value. If you're locked in long-term bonds at the current price level, your bonds will drop in value

Starting point is 00:58:58 as the interest rate go up. But it will, on the other hand, become more interesting to buy new bonds that are now paying a higher interest rate. So going back to what you said before, what do you do as a retail investor? Well, if you're looking to compound your purchasing power, you do have a leg up compared to, for instance, pension funds, insurance companies like I mentioned before, because you do not need to hold long-term bonds. And if you like to have less volatility in your portfolio, you can buy short-term bonds,

Starting point is 00:59:30 which won't drop in value if you see an increasing interest rate. And if you do think the interest rate stays long for a long period of time, you might consider looking into stocks instead. and if you're worried about inflation, you might also include a gold component. So, Jim, I know I covered a lot of ground here, and it is a tricky question that you ask because it's very important to say, based on what's happening today, bonds are not attractive, but you do need to factor in what's going to happen in the future. And that determines the value of the bonds and the decision that you make today. And you might have heard the quote that it's very

Starting point is 01:00:07 difficult to predict, especially about the future. If I can even add to that, it's even harder to predict what's going to happen with the interest rate. So, Jim, from my vantage point, the question you're really asking is, how can I continue to measure something whenever a ruler doesn't exist anymore? Because for all these years, that's how we've looked at the fixed income market, particularly the 10-year treasury, because that was always your ruler as to how you were measuring your returns above that risk-free rate. So if the risk-free rate is zero, how in the world can I measure anything? And the expectation that I have moving forward that on a global scale, I think central bankers

Starting point is 01:00:48 are absolutely going to try to implement this MMT where they're going to try to take rates negative. Now, the question really for me becomes, are they able to do that and for how long are they able to do that if they if they are able to do it at all. And for that, and I think that's what Stigs getting at is like, how in the world can you possibly answer that question? Because it's never been done before. This is implementing negative interest rates across people like, hey, give me some money and I'll guarantee you that I give you back less. That's never been done before. Now, does that mean it can't be done? Probably not. Who knows at this point? I do know one thing.

Starting point is 01:01:32 if they go down that path, they've got to get rid of the hard currency that you have in your wallet because what people are going to be incentivized to do is to go take out as much of that at the bank as possible, put it in a safety deposit box because you'll get a higher return than if you do it digitally with your checking account. We're not there yet, but all trends indicate that that's where they're trying to move things. The reason they're trying to move it there, the root as to why they're trying to move it there is because they can't allow interest rates to go up because of the fiscal spending that's happening, not just in the U.S., but all over the world. So how do you deal with this as an investor? What it really comes down to is you need sound money. You need something that can't be debased. I think what you're seeing in the stock market right now is

Starting point is 01:02:18 just that. There are people that are bidding the value of certain companies, companies that can protect their enduring competitive advantage, even in a depressed scenario. Those companies are just bidding at levels that don't even make sense, historically speaking, based on the earnings that the companies have created. Everyone in the markets' minds are exploding right now. Well, how is this possible? Why is this happening? Well, I think it's happening because people are treating that stock, that equity, as if it's sound money. I think an important consideration to have is you need to own something that doesn't have counterparty risk. When you think about debt that has a counterparty risk. When you think about equity, it does not, unless you're playing

Starting point is 01:03:03 in the derivatives market, right? But if you own the stock that does not have the counterparty risk. So now if the company decides that the base or to create more shares of stock, it's kind of like what you're seeing with Tesla. That's a whole different story that has, I guess you could argue that that has a counterparty risk because decision makers are debasing the stock. But you need to find something that has sound footing that is profitable, that is going to perform well in a depression, deflationary environment. And you're seeing a lot of that in the tech stocks and that's why they're running. Does that mean they're going to continue to run? I have no idea. I would suggest using some type of momentum strategy on those types of companies in order to protect your downside risk.

Starting point is 01:03:48 I don't really know how else a person can navigate this crazy central banking-induced volatility environment that we're dealing with other than treating it from that perspective because we've pretty much taken the ruler, snapped it across our leg and thrown it in the trash can, which is your risk-free rate. So that's the best I can do for you. I would tell you to try to get smart on momentum strategies and then focus on those companies that are going to continue to perform in a depression-like scenario that have earnings so that they don't debase their stock or dilute their stock.

Starting point is 01:04:27 Those are the ones that I'd be looking at. All right, Jim, so for asking such a great question, we're going to give you a free subscription to our TIP finance tool, and this is on our site at the Investors podcast website. Anyone that wants to find this, they can go to Google and just search TIP finance. And the good news for you, Jim, is we have a momentum tool on our website that will assist you on those types of companies to understand where the momentum stops and also when it has a positive momentum trend, it's all there on the site and we're excited to be able to give that to you for free. Anybody else want to get a question played on the show? Go to asktheinvestors.com

Starting point is 01:05:02 and if you get your question played on the show, you get a free subscription to TIP finance. That was all the press that I had for this week's interview here on The Investors podcast. We see each other again next week. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network.

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We Study Billionaires - The Investor’s Podcast Network - TIP313: Ed Harrison from Real Vision talks about Current Market Conditions (Business Podcast)

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