We Study Billionaires - The Investor’s Podcast Network - TIP386: Global Investment Opportunities w/ Lyn Alden

Starting point is 00:00:00 You're listening to TIP. 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 I can already feel that this is going to be a great episode, because today we are joined by the one and only Lynn Alden. Lynn, welcome back on the show. Hey, happy to be back. Always glad to be here.

Starting point is 00:00:43 So, Lynn, I wanted to talk to you in the audience about global investment opportunities, but I want to talk about inflation first, because inflation is just such a tax on everything that we do. So I wanted to have that covered as our foundation before we venture into the different investment opportunities that you see in the market. And you recently wrote a great blog post about Treasury Inflation Protected Securities or Tips. So let's kick this off and perhaps you could explain how tips work and whether it's a good inflation hatch in today's environment.

Starting point is 00:01:15 Yeah, so at the current time, we're seeing a pretty good amount of inflation compared to the historical average over the past couple decades. And, you know, it looks like in certain areas that's rolling over, but it's still quite elevated, especially compared to bond yields. And so investors find themselves that, you know, the risk is that if you hold cash or bonds that are yielding 0%, 1%, 2%, while inflation, well, inflation, you know, well, inflation, is 4%, 5%, 6%, you're getting devalued. You're losing purchasing power.

Starting point is 00:01:42 And so one of the ways that investors can deal with that is to buy treasure inflation protected securities or tips. And so some countries issue those as a small part of their sovereign bond market. So my article focused on US tips. And basically what they say is, we'll adjust the bond coupon that you're getting based on inflation levels, official CPI in the United States. And so that kind of takes away that risk of inflation. But my whole article focused on the fact that tips can be very useful as an inflation defense,

Starting point is 00:02:15 but they're not perfect. And so obviously, if you have that extra inflation protection built into your bond, there's no free lunch. And so that comes with some costs. And so the main cost is that the tips yields are lower than normal treasury bonds. And so in the United States currently, you're getting like a negative 1% yield on your tips. So you're getting, you're basically going to earn inflation minus about 1%. It's ironically, you're guaranteed to underperform inflation by owning inflation

Starting point is 00:02:45 protected securities, which sounds terrible, but it's one of those things where, you know, right now the 10-year treasury yield is under, it's under 1.5%. And the inflation expectations by the market are maybe 2.5% while inflation is currently 5%, because they're expecting that this is not going to stay at this level for a very long time, and that the average inflation over the course of the, say, the 10-year duration of this bond will be lower in the mid-2 range. Now, if that's the case, if the inflation expectations are true, then normal bonds and tips will have about the same return.

Starting point is 00:03:21 They basically are optimized around kind of, you know, that break-even point. However, if inflation ends up being higher than those inflation expectations, like if inflation is 3%, 4%, 5% averaging over the decade, then those tips, despite the fact that they will mildly underperform inflation will still do better than normal treasury yields that are, you know, yielding 1.5% while inflation's, you know, three, four, or five percent. That's the kind of tradeoff that you get by owning tips is that you're not guaranteed to keep up with inflation, but we have more protection if inflation runs notably higher than people expect. The other big risk of tips is that you're reliant on a government statistics for inflation, which include a specific

Starting point is 00:04:00 basket of goods with hedonic adjustments and people can debate endlessly about how active that measurement is. I've done a work on this, and I think it at least mildly understates quote unquote true inflation, but everybody has their own unique inflation basket. So basically, with tips, you risk having your official inflation metric, not keep up with real inflation, and then you also will mildly underperform even that official metric because of the negative yield. It's always hard whenever you ask questions like, so for us investors, which I know I tend to do, because who are us investors, like how old?

Starting point is 00:04:35 are we, what's our consumption, what's our income level, what's our debt, like, there's so many things that go into a discussion about investors in general. So, our tips with the flaws that you listed, would you recommend that to any specific type of investor and perhaps not to others? So I think anyone who has bonds in their portfolio at this time, which is not everyone, right, because younger investors might choose to exclude bonds because of the poor yields and the inflation and to focus on other assets and take the higher volatility that comes with that, right? So obviously, tips might not be ideal for them. But I think anyone who has bonds in a portfolio could benefit from having a percentage of those bonds be tips. And so I think

Starting point is 00:05:17 this is an environment where tips are, I think, useful to have if you own bonds. So giving that tips aren't good assets to protect against inflation, at least for many different investors. What's the best way if you want to? defend ourselves against inflation. And perhaps I can give you this unreasonable constraint that you can't say Bitcoin. And the reason why I'm saying that, because I'm sure there's a lot of people out there who are saying, oh, Len, we have had her on the show a bunch of times, speaking with the president about Bitcoin. Can we talk about that? It's not there's anything wrong with that. We have a bunch of great episodes for that. But we also have a lot of listeners

Starting point is 00:05:54 who do not believe in Bitcoin. They don't want to invest in it. More like traditional, perhaps stock investors who look into different asset classes than crypto. What can they do? Generally, commodities. And so it's hard to get sustained inflation while commodity prices stay low. Generally, a history of inflation is a history of commodity price inflation. And it's, you know, commodities historically are very poor performing asset class. If you look over, say, a century of data, commodities are one of the worst places to hold money over a long term. Because if you're holding the commodity outright, it doesn't compound, it just sits there.

Starting point is 00:06:28 And if you're holding commodity companies, it generally tends to be lower quality. businesses. Now, there are some commodity companies that have done very well, especially in energy because they've been protected by a cartel for decades. But generally, it's not good to have a company who doesn't control the price of their own product. So they generally are not the highest quality, wide-moat businesses that might be appreciated. The caveat there is that during an inflationary decade, commodities generally trouts everything else. It's not even close. And so in the 70s, it's pretty much all you would want to own. In the 2000s, you know, commodities in emerging markets, which had a lot of commodity exposure, we're the way to go. They challenged everything else.

Starting point is 00:07:06 And so generally, when you have these inflationary decades, you want to have some commodity exposure. And that ideally you want to mix it up a little bit so you're not two folks, the one commodity. You want to pick the one commodity that maybe doesn't do very well. Oil and gas are the biggest commodities. I mean, that market is bigger than all other commodities combined. So a lot of it comes down to what that's going to do over a given three to five year period. But overall, I think, you know, one of the best ways to have protection against inflation is to have commodities and commodity companies. And if someone wants to reduce the risk, they can use commodity trend following, which is basically saying, you know, you're kind of

Starting point is 00:07:39 acknowledging that it's not a great asset class to hold long term and that you generally want to restrict your exposure to them when they're in an upturn, because the upturns can be pretty violently good, right? Just like explosive gains, but then the downside can be brutal in the opposite direction. So I think some sort of either commodity exposure or commodity related investments, It could be commodity trend following, could be commodities, could be commodity equities. They're generally the better way. There's also real estate, if you can get it at appropriate prices, right, which is harder these days than it was maybe a couple years ago.

Starting point is 00:08:09 But obviously certain zip codes, certain regions of the world of your country, wherever you might live, can be protection against inflation. And partly it's because with real estate, you can leverage it more than most other asset classes without it being silly, right? You can leverage it with a mortgage because it's. It's a stable asset. And so what you're essentially doing is you're shorting currency. You're shorting the currency you borrow that in.

Starting point is 00:08:35 So if you have a reasonably priced house, then you have a 30-year fixed rate mortgage on it at a rate that's at or below the inflation rate, you're shorting a depreciating asset, and you're going along an appreciating asset. And so that's historically been a better way, at least better than stocks historically. And then when it comes to stocks, you generally want to focus on ones that can control their costs very well. And so, you know, people sometimes assume stocks will perform better than bonds than inflation. And that's a mixed track record. So obviously, if you have something like hyperinflation, you'd rather own stocks than bonds because bonds will become worthless.

Starting point is 00:09:09 Stocks will still be worth something when the dust settles because you still own productive assets. But if you have double-digit inflation like the United States had in the 70s, stocks can perform about as poorly as bonds can in that environment. It really depends on some other factors like, you know, what's happening to their own costs, what's happening to their valuations, what's happening to treasury yields. But generally, if you do equities, other than commodity equities, you generally want to find companies that their revenue is variable, that they have decent pricing power, but then also that their costs are rather fixed or controlled. Maybe they have large depreciation write-offs, for example. Those sort of assets, which ironically tend to be some lower

Starting point is 00:09:47 quality assets in good times, can actually do pretty well in those inflationary times. Interesting. So, Lynn, identifying the most attractive asset class, that is just something that constantly changes because circumstances change. For example, gold was relatively cheap in the late 1990s, and the price was less than $300 an ounce. I know it probably sounds crazy, some people out there, but the real rates were high, so opportunity costs for being in gold, but just corresponding seen as high.

Starting point is 00:10:15 And on top of that, gold was coming off this 20-year bear market, like no one wanted to own it, right? But then the price of gold just exploded in the years after that. And today we have a new situation, not just with gold, but just in general. So if you have to be ranking different asset classes on how attractive they are, how would that look like? So overall, I think a diverse mix of asset classes is far better than any one asset class, especially in this really uncertain environment where partially whether or not we're going to get inflation or not is based on government decisions, right? because it's going to come down to their fiscal decisions. And so you have this somewhat binary outcome

Starting point is 00:10:55 where you're dependent on variables that are currently unknowable. You kind of know more as you go along. And so the first thing I would do is diversify, but then I would tilt that towards asset classes that I find to be more attractive. And so overall, I generally think that high quality commodity producers, you know, I think looking back at the end of this decade, I think this will probably be a commodities decade similar to the 2000s or the 1970s or the 1940s. And so I like midstream energy transporters. I like some of the higher quality energy producers, you know, ones that, you know, have low cost, production, strong balance sheets, long reserves. I like copper, you know, certain metals, for example, especially related to electrification, I think is an attractive

Starting point is 00:11:36 area. They got a little bit overheated earlier this year. They became quite consensus. So whenever they're maybe not on fire is a good time to maybe go into those. I think many emerging markets are reasonably attractive for a long term of the current time. That doesn't mean they're going to do well next year or the year after. But I'd be somewhat surprised if emerging markets have another lost decade like they have the past decade. So they had this big period of consolidation. A lot of that was valuations going down and stronger dollar, which tends to go in cycles. A lot of capital is kind of really very much shoved into the United States at the current time. And so overall, I find that valuations and overall fundamentals and emerging markets are actually pretty

Starting point is 00:12:15 attractive, especially if you go country by country. And so that's generally my approach here. I also, I still like U.S. equities. I'm just, I'm more selected with them because many of them are at very above average valuations, but I still go through U.S. equities and find that in general, growth your stocks are more likely to be overvalued, even compared to their history than value stocks. So obviously, growth stocks to be more expensive than value stocks, we're always happy to pay up for a better company. But if you look at, say, how much growth you get for your money, they're a worse deal than they were, say, three years ago, whereas value stocks are about the same deal that they were three years ago. And so that, you know, that's varied over time.

Starting point is 00:12:53 But overall, I generally like value stocks. And then if I have, if I go into growth stocks, which I still do, I just have a higher hurdle rate. I'm more selective with those and saying, you know, what are my absolute highest conviction growth stocks because I'm concerned about maybe the broader valuations in that, in that factor. 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 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.

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Starting point is 00:17:20 Back to the show. Let's specifically talk about equities. I know from reading your blog, this is just an amazing, absolutely amazing. I encourage everyone to go read it. We'll make sure to link to that in the show notes. But what you put on the blog is that you pay attention to CAP and also the market cap to GDP. That's commonly referred to as the Buffett indicator. That's probably how many of listeners know it. Could you please talk about the methodology of both factors, why you look at it, and perhaps also what the empirical evidence suggest for those two factors?

Starting point is 00:17:51 So in addition to looking at individual company valuations, I do like to pay attention to broad valuation measures for different markets. And so the most popular one is probably Schiller's Cape ratio. So that's a sickly adjusted price or earnings ratio. And the theory there is that instead of just looking at price earnings, earnings can be quite ephemeral, right? So they can go away in recessions and then the stock looks expensive. And then, you know, earnings can be very high during the peak of the cycle and the stock looks cheap.

Starting point is 00:18:17 And so Robert Schiller's approach there says, okay, let's look at a point. full business cycle of average earnings, either for that company or for the stock market as a whole. So the common version takes the last 10 years of earnings, averages them together, inflation adjusts them, and you're comparing current price to that more structural earnings average, which normally includes a recession or two in the mix, not always, but usually. And so you get this smoothed out approach. And historically, that has been a very good indicator for long-term returns, not short-term returns. Cape ratio tells you virtually nothing about what stocks are going to do

Starting point is 00:18:55 over a six to 12-month period. But generally, if you look for 10 years, higher Cape ratio periods provide much lower returns than low Cape ratio periods. And it's challenging because, you know, you have tax changes, you have changes in how corporations operate in terms of say share, buy-baks, for example. And so generally, for a number of reasons, the United States has had higher valuations over the past 25 years than most other periods in history. And yet they still provide decent returns. There is a good study by Mb Faber a couple years ago, and he's updated it once or twice, where he says, okay, so we noticed that the United States had good returns even when you had high cap ratios. However, if you had a approach over the 25 years where you

Starting point is 00:19:41 invested in whatever markets had the cheapest cape ratio, you did way better. And not every year. Sometimes you would invest the cheapest markets and they just got cheaper. And then you invest them again, they got even cheaper. But over the course of his, say, 25-year data set last I checked, if you had a habit of buying, say, the 25% cheapest markets around the world and then updated that every year, you crush the S&P 500, even though there could be a three-year stretch or five-year stretch where you don't. And so generally, valuation matters over the long run, even though it does not matter over the short run.

Starting point is 00:20:13 But then you want to say, okay, what if a certain valuation metric has some sort of data artifact in it that is throwing it off or making it unrepresented? How much faith should I have in one metric? So we can actually say, well, that's one useful metric, but we can go look at a bunch of others. We can look at the average price of sales ratio of the market. We can look at the average dividend yield of the market. We can look at sector adjusted valuations to compare one market to another. A popular one is the market cap to GDP ratio is popularized by Warren Buffett. if you add the market capitalizations of all companies in that market together, what a percentage of the GDP is that? And you actually can't, unlike the CAPE ratio, you can't really compare that

Starting point is 00:20:53 between countries because some markets are just inherently far more financialized than others, but you can compare it to its history pretty well. And so generally speaking, that follows cap ratio pretty closely. And generally during periods of unusually high market cap to GDP, you generally are unlikely to get good 10-year-forward average returns, whereas when it's unusually cheap, you're much more likely to get very good for 10-year returns. And again, it's not guaranteed, and it doesn't tell you much about the short-term. But when you're combining multiple of these evaluation indicators together, it gives you an idea of forward return potential long-term, which by extension, if you do that to multiple markets, can give you an idea of where you should

Starting point is 00:21:37 invest or what areas you might want to overweight or underweight without being certain what's going to happen, but with having greater probabilities of putting the odds in your favor. One might come to the conclusion that investing globally from a fundamental standpoint is just as, you know, just by the cheapest market. What I really like about your research is that you go dig deeper than that. Because aside from value, which is a great, great starting point for your analysis, but you're also looking at growth, debt, stability, and the currency. So could you please talk to us, why are you using those as you can? key metric to include a type of value.

Starting point is 00:22:16 So the funny thing is that according to data, value might be enough, right? So like using MbFabors data, for example, you could ignore everything else and just buy what's cheap. The problem is you have to put faith that that's going to keep working, which it might or might not. We don't know. And you have to give it a long time to know. And so you won't be sure until 10, 15 years later when you had an opportunity, a big

Starting point is 00:22:36 opportunity cost if you were wrong. And so what I like to do is, I like to say, okay, value is a very, very important component, but there's other things. And so one is, we want to adjust things for growth and sector exposure. For example, if you have one country, they have a whole bunch of fast-growing tech stocks, and you have another company that's got a bunch of kind of lousy businesses and they're cheaper, and you say, well, you know, I'm only going to buy that cheap company. It's like, well, it might be worth paying up. How much more expensive is that other country market compared to this one? Because it is worth paying up if you can get better companies. If you can pay

Starting point is 00:23:08 30% more, but get companies that are twice as good or growing twice as fast, that's worth it. It's good to compare things on a sector-by-sector basis and to look at various macro factors with those countries. And so, for example, I like to look at, in addition to valuation, I like to look at growth. So, for example, you generally expect higher valuations out of faster growing countries, right? So higher population growth or growth sector exposure. And so you should, for example, expect higher growth out of India than Russia.

Starting point is 00:23:38 and therefore it can support sustainably for long periods of time, higher equity valuations than Russia. You can also look at debt levels because they affect forward growth as well. They also affect the possibility of currency devaluation or other undesirable things that can throw off your investment. That's why you can rank countries based on both public and private debt levels. Then you can look at things like stability. So, you know, there's different ways to measure that. You can look at there's human rights indices, there's terrorism indices, there's corruption indices, there's, you know, how many coup attempts have happened in the past

Starting point is 00:24:13 10, 20 years, for example. And so generally, if you're investing in emerging markets, you're accepting a higher level of these various risks, these lower levels of stability in exchange for higher growth and usually lower valuations. And then the last one would be more specific currency metrics. Like, does the country have a current account surplus or a current account deficit? Do they have, especially for emerging markets, do they have very high foreign exchange reserves relative to their GDP or are they low? Because if they're low and they're running a current account deficit, they're at risk of becoming an Argentina or a Turkey, where they have their currency loses tons of value and they have little way to defend it. And so I look at various currency

Starting point is 00:24:52 metrics. And so what I do is I try to rank countries around the world or at least have a map of kind of what's going on so I can spot anomalies. areas that might be very risky or that might be very opportunistic so that I go in and then qualitatively look around and see what I think. And so I like to maintain that big quantitative metric to find where is a good combination of both quality and price? Whenever you specifically look at the US dollar, I can't help but think how do you weigh the euro? Because I've seen a lot of different baskets that's compared to. And the euro always takes up a lot in that basket for obvious reasons, but always makes me wonder, so is the dollar

Starting point is 00:25:31 strong? Is the Euro weak? Is that actually what we're seeing right now or vice versa? How do you weigh that relationship with the euro whenever you're evaluating the dollar? Well, so the dollar index is the go-to one, which, yeah, the euro is over 50% of that. But you do have the other 40-some percent of it is a basket of other major currencies. So that's still pretty useful metric. But then you want to double-check that by going in and comparing the dollar to specific currencies, especially major ones. So, you know, how is the dollar compared to the yen? How does the dollar compare to the Redmond B? How does it compare to, say, a basket of emerging market currencies? And so that can tell you, is one currency weak or is the other currency strong? And so historically,

Starting point is 00:26:14 the dollar, because we are the global reserve currency and we have kind of a more unusual currency situation than other countries, we tend to go through these big cycles of dollar strength and dollar weakness because we're kind of the funding currency for the rest of the world. world. And so that has implications. And so over the past five, six years, we've been in what I would consider a strong dollar period where the dollar is elevated compared to the majority of other currencies, not necessarily every single currency, but the vast majority of them. The dollar has been elevated compared to, say, if you measure it 10 years ago. Now, over the very long run, the dollar's actually gone down, say over almost 50 years of being free floating. The dollar has gone down

Starting point is 00:26:56 against a basket of major currency comparisons. But it's been these kind of big three waves. You know, it had a big period of weakness in the 70s, and it had a huge spike in the 80s, and that rolled over with the Plaza Accord. Then another spike in the late 90s, early 2000s, that rolled over. And then ever since around 2015, we've been in another big spike. And so it hasn't gone as high as the previous ones, but we've remained somewhat elevated, where the dollar is pretty strong.

Starting point is 00:27:24 And that has implications. So that's historically strong dollar environments are very problematic for emerging markets that often have a lot of dollar denominated debt. So that kind of acts as sort of like a quantitative pithing for them. Generally, you have every time the dollar goes to one of those big strengthening cycles, usually some emerging markets get absolutely crushed. I mean, in the 80s, it was Latin America. In the late 90s, it was Asia. And this recent cycle, it's been a little bit more varied. You have Turkey, you have Argentina and just overall. You just kind of have a stagnation worldwide. But, you have these high dollar-based debts that have gone up in value. And so a big thing to watch going forward is, is this strength of dollar, like, is this cycle of dollar strength ending? Because if so, you probably want to be in things like emerging markets and commodities, or are we kind of, you know, going higher or staying at this plateau for a number of years, which can, you know, prolong this cycle and make it so that maybe emerging markets continue

Starting point is 00:28:20 being a lost, lost money for, you know, for at least a few more years. Lynn, I would like to transition into talking about this wonderful report here. And I'm holding this up to the camera, which clearly works a lot better if you're on YouTube than if you're listening to this as a podcast. But you give all the markets a score, which I found to be really useful and interesting, because you're right. Like, if you follow the Mep Faber approach, which is very interesting. You know, whenever you study, like it works for all countries aside from Denmark and Sweden. And those countries are very specific for different reasons. But there's also a question about accessing.

Starting point is 00:28:56 I know that you're spoiled in the States. I live in Denmark. And we don't have the same access. So just because we can see a study like, oh, the Filipino market is just great or Colombia or whatever it is, that's great. You can't access that ETF. And so our selection is different generally in Europe. It's just regularly different than Europe.

Starting point is 00:29:17 It's not just in Denmark, but all of the European Union. We have different types of access, and if we can find ETF, we can typically only find one. And sometimes those terms can be outrageous. But whenever you look across the globe, which countries perform at the top and which at the bottom in terms of attractiveness? Yeah, so the ratings change every year, and they're based on those previous metrics I discussed. So some of them have very high ratings in certain areas, very low ratings in other areas, and they average out to, say, you know, in some cases, like a medium high rating. And so at the current time, and again, this is not based on what's going to happen in six to 12 months because it incorporates things like valuation that don't

Starting point is 00:29:59 tell you almost anything about short-term performance. It's more about what areas are likely to do well over the next, say, five to 10 years versus what areas are at risk of kind of meltdowns are doing very poorly. And so overall, the current time, Southeast Asia scores pretty well among multiple metrics. So that would include, you can look at a developed market like Singapore, you can also look at merging markets like Malaysia, for example, India, Indonesia. So overall, that market was very, very strong, obviously decades ago. It had another bout of strength in the 2000s decade, but many of those markets have been in kind of a lost decade. But they have generally very high currency fundamentals, generally current account of surpluses, generally high reserves relative

Starting point is 00:30:44 to their GDP and just overall decent demographics and growth trends. Another side of the coin, I'm also pretty bullish on Russia long term. They've done very poorly over the past decade, which was a commodity bear market decade, and obviously Russia is a very commodity-oriented market. So if you expect decent body performance in the 2020s, then in Russia, generally, you get very high-quality commodity companies that generally have less debt than their Western counterparts and for lower valuations. and often longer reserve life.

Starting point is 00:31:17 Now, the cost for that is you put up with some higher degree of political tail risk. You don't have the same rule of laws you have in the United States or most of Europe, but many of those companies are very, very well managed. Many of them are managed like their Western peers. I often like to point out that luke oil, for example, the Russian energy company has outperform most of its Western super major peers over the past 20 years. And it's in large part because they didn't do bad acquisitions or things like that. It was just really well managed.

Starting point is 00:31:49 And so low debt levels and good production and just, you know, not making any major mistakes and being a large insider ownership, for example. And so overall, I kind of like that barbell approach where, you know, a lot of Southeast Asia is energy importer and as good growth demographics. And then Russia, you have bad growth demographics and cheap. But it's also, it benefits from a higher commodity price. So I kind of like that barbell approach. South America doesn't currently score as well as some of those regions, but I do think that

Starting point is 00:32:18 if you were to get a weaker dollar period, probably would also see a pretty powerful, I think, resumption of growth in those markets. And they would have a decent shot of moving out of this kind of lost decade that they've experienced. Whenever we look at the list, what I really like is that you gave them this score. You have this moderate opportunity that's more than 20, a better investment. know, Junete like 23 and above, like Singapore, you had top rank as 26. And then you have in the United States 15 points together with France. So everything else equal the worst countries to be in. So how do you think about position sizing according to this, to the

Starting point is 00:32:57 overall country score? Should you, for instance, still be invested in the states? How much should you invest in Singapore? And if I could just add a third one to that, because you did mention that you did a specific, a few individual picks in the States, but does that just mean like if you're ranked that you shouldn't be indexing at all? This report's kind of meant so that very different types of investors can use it. So some people might want to express that view through ETS. Some people might want to say, oh, this market looks interesting. Let me go see if I can find individual stocks there that might be attractive.

Starting point is 00:33:30 And so that's the first caveat that it's going to be used in different ways by different people. I think another thing obviously to keep track of is where you are, what are your expenses based it, right? So, you know, even if, let's say an American finds that the U.S. market is overvalued, you know, they might not want to put 100% of their assets in other countries because, you know, now they're taking on currency risk, which could be favorable currency risk. I mean, the foreign currencies could appreciate compared to their home currency. But the point is, they're taking on potentially more volatility because now their assets are denominated in a currency that's different than what their expenses are denominated in.

Starting point is 00:34:06 And so generally, I think it makes sense for majority of investors to have a home country bias to a certain extent. Obviously, it depends on the size of their market. If they live in a very small country, it's hard to overweight that too much without having too much concentration risk. But overall, I think generally you start with a home bias, but then you can tilt in certain directions based on where value is. If you generally approach to say a value-oriented or a contrary-oriented mindset, when a market is done very poorly for a decade and when it's cheaper than normal, and you're seeing some science, If you understand why that happened and you're seeing signs of reversal, it's worth potentially overweighting that market. So I probably compare to most Americans, I have more non-American equity exposure than I think

Starting point is 00:34:49 the average would. Generally, what we've seen over the past decade is the United States outperform pretty much every other market. And so we see an usually high capital concentration in the United States current time. It's a very crowded trade. If you look at the MSCI ACWI index, which is one of the broad. out of the United States market is just under 60% of global market capitalization, which is pretty remarkable. Every other country combined is 40%, or 41%. Partially, that's warranted because

Starting point is 00:35:19 it's been, you know, the United States benefited from these huge fang companies, for example. But it has, you know, there's not a lot of more places to get capital to then keep shoving into the United States. It's very, everyone's on one side of the boat. It might be still a couple stragglers on the other side of the boat, but it's not like we still have tons of people we get on that side of the boat. And so the big risk, I think, is that if everyone's piled into that trade, and then we go through one of these big dollar-bear cycles and the United States market just performs poorly, that everyone's kind of caught off on the wrong side. I mean, there was a brief moment of time in the late 80s where Japan's market capitalization exceeded state's market

Starting point is 00:35:55 capitalization. I mean, you all know that that went very poorly for everyone involved over the next few decades. And I'm not saying the United States is in that position. Their cap ratios were even higher back then. Japanese, they had like the highest Cape ratios on record from what I've seen. So it's not to that extent, but it is a very crowded position. And so I do think this is a, I am worth, at least for very patient investors, buying quality assets outside the United States and having some degree of geographic and currency diversification, because on a sector-by-sector basis, you can generally get higher quality companies for lower prices. Like you can get a, say, Then, Apple's-Apples comparison, you get a similar bank for a cheaper price. You can get a

Starting point is 00:36:35 similar healthcare company for a cheaper price. You can get a similar tech stock for a cheaper price. And so when you go down that list, generally, I think that there is a lot of opportunity outside of the United States. But in the U.S., again, we see a larger valuation gap than normal between growth and value. So I think commodities stocks in the United States are attractive. I think midstream assets are attractive. I think the healthcare sector is reasonably attractive. I still think a number of value-oriented exposures in the U.S. are also attractive. It's just that we're very tilted towards growth at the moment. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:40:29 Lynn, we have a huge set of investors here following the podcast who like to look at individual stock picks, foreign stock picks, and typically not always in developed markets. I was curious to hear how we should think about currency exposure. Say that our home currency is the US dollar and the euro, for instance. You mentioned legal oil. I remember looking into that many years ago and like the fundamental, it was just so amazing. It was so cheap. So I bought a bunch and the company performed well, but the ruble just plummeted at the same time. So it was a very painful experience. And then as well as today, I do think it's tricky to figure out what's the strength of the currency. Could you talk to us about how do you evaluate that specific currency and where

Starting point is 00:41:16 that might go, short, mid or long term? Yeah, so there's currencies can move for all sorts of reasons. A lot of it's sentiment-based, right? So around sanctions or perceptions of the country. Now, what's interesting about Russia, they've had some of the biggest disconnects between currency fundamentals and currency performance. So if you look at countries like Argentina and Turkey, they've had very, very poor currency performance, but this was predictable. And in fact, I waited Argentina's currency very poorly in multiple reports in a row leading up to the ongoing weakness that they've experienced. And so, you know, when they exhibit things like low,

Starting point is 00:41:52 reserves, foreign exchange reserves relative to either their GDP or their money supply. That's a big warning sign for emerging markets because they're very reliant on that. You also want to look for current account deficits or trade deficits. That implies that either their economy is not producing well or that their currency is overvalued. And it's basically making their exports less competitive and making their imports too strong. And so generally when you have a structural situation like that, it eventually reverses and can be pretty violent when it reverses. Usually a recession or some sort of catalyst happens, capital moves out of the country, and suddenly that reverts. It's like you took the escalator up and the elevator down in a way. And so generally for currency fundamentals,

Starting point is 00:42:37 I want to find countries with current account surpluses, reasonable fiscal debt situations that have high reserves relative to GDP. Another factor for emerging markets is you specifically want to look at dollar-denominated debt relative to the size of their GDP or relative to the size of their foreign exchange reserves. Because these emerging markets that have these truly spectacular currency failures, it's usually because they owe liabilities in a currency that they can't print, usually dollars. So they borrow from the foreign sector in dollars. And so they're actually at risk of nominal default and hyperinflation because they have no ability to relieve themselves those liabilities in the way that it developed market can.

Starting point is 00:43:19 And so if you look at Turkey, they had huge dollar-based debts in their corporate sector. Their government sector has not been very leveraged, but it's specifically in their corporate sector. With Argentina, it's been the reverse where they've gone through this so many times. There's actually not a lot of leverage in their private markets, but their government takes on dollar-based debts, and that's been a source of problems multiple times. And that happened with Southeast Asia back in the Asian financial crisis, the late 90s, that happened in South America in the 80s, where these emerging markets,

Starting point is 00:43:49 they get too much dollar-based debts run into problems. And so if you look at Russia, they have one of the highest foreign exchange reserves relative to GDP among markets. They have, most years, they have a current account surplus. They actually run a very tight fiscal situation. Often they have surpluses. Like most countries, they had a deficit in 2020, but they had less so than most others.

Starting point is 00:44:11 They were pretty conservative with how they managed that. They also have pretty low dollar-denominated debt relative to the size of their economy and relative to their foreign exchange reserves. So they've actually managed themselves very well financially. I think that the head of their central bank is one of the smarter ones out there. And I think she's done a very good job. But they obviously have other issues. So one is, you know, Putin is not very popular on the world stage for a good reason.

Starting point is 00:44:35 They have human rights issues. They have corruption issues. They have sanction issues. And then they're also heavily exposed to commodity prices. So, you know, when oil went crush last year, obviously the ruble lost a lot of its value, at least temporarily. And going forward, I'm pretty optimistic on the ruble. If you look at most of the fundamental aspects around it, especially if you get an ongoing commodity bull market, that should be pretty good for the currency over time.

Starting point is 00:45:00 Another thing you can look at, for example, is the Big Mac Index, which says, you know, if you do a purchasing power parity comparison, that's another way of kind of measuring if currencies are overvalued or undervalued. And by most metrics, the rubles undervalue, especially when you, again, look at all those other metrics. And so if you were to consider currencies to be like value stocks, right now that the ruble would be like an example of a company with like a great balance sheet, super low valuation, but just no one wants to own it at the current time.

Starting point is 00:45:29 Len, one of the things that you mentioned in your report is that some of the problems of the U.S. don't matter until they matter. I love that phrase in itself, but like the structural deficit that seems to gradually starting to matter. Could you please elaborate more on that? So because the U.S. is the World Reserve currency, we have an unusual situation where ever since the 70s specifically, due to specific deals we made with OPEC, most energy worldwide is only price in dollars. So if France buys oil from Saudi Arabia, they pay in dollars. What that means is that any country in the world that needs to import oil needs dollars. And so that has made it so that essentially the U.S. props up the value of the dollar. So it makes our exports less competitive. and it gives us more importing power. And so for the United States, the downside for us is that we started running these

Starting point is 00:46:21 massive structural trade deficits that they just never close. It just pretty much keeps getting bigger over time. And that supplies the rest of the world with dollars. And those countries and take those dollars and it filters up to the central banks and the, you know, the sovereign wealth funds. And then they reinvest those dollars. And a lot of that goes back into U.S. markets. And so they buy our bonds, they buy our stocks, they buy our real estate.

Starting point is 00:46:44 which sounds good. You know, it sounds, you know, you want the rest of the world investing in your country, but the downside is that it means that our net international investment position keeps deteriorating. Basically, the foreign sector owns a larger and larger percent of our productive assets. It's like we're becoming kind of a nation of renters as the foreign sector increasingly owns our most valuable things, our land, our companies, their creditors to our government. And so this cycle's been in place for, you know, you can call it about 45 years now. And there's been counter rallies where other markets do better. So the 80s, you had Japan do very well.

Starting point is 00:47:17 In the 2000s, you had emerging markets do very well. But this has been a very strong period of performance for U.S. assets somewhat at the cost of, say, the U.S. industrial base and the U.S. blue-collar workers. So we've kind of running this big engine of trade deficits to get recycled back into our capital markets, which are very good for those of us that own assets. But we're starting to see signs of that reversing. So for the longest time, oil was only priced in dollars. Now we see Russia pricing it in euros, which is important because they're one of the biggest exporter of oil. They also have, you know,

Starting point is 00:47:48 enough military protection that there's nothing we can do about that from the United States perspective. China is, you know, they're doing trade with Russia and Europe, doing trade with Russia increasingly in euros, rather than dollars. And so that's more currency diversification. And we're starting to see, For example, Saudi Arabia is still pricing their oil and dollars. But as we see maybe tensions between Saudi Arabia and the United States, as we see that now China is the biggest customer of Saudi Arabia, that situation could potentially change over time. And so overall, this system has probably run its course.

Starting point is 00:48:21 The rest of the world is finding it restrictive. And Americans, especially those didn't benefit from the huge appreciation in capital markets are also finding it rather restrictive. And so I think, you know, variety of kind of just mathematical reasons and geopolitical reasons, that is probably going to change over the next decade or so. But it's one of those things that it's got a very strong network effect and takes a lot of time to change. And so we're used to this big trend of, say, bond yields going down, United States running these

Starting point is 00:48:49 big trade deficits, the rest of the world shoving that capital back into us equity markets. But I think that, you know, as you go forward, that could start to look pretty different. And that, you know, if that does start to look different, if that starts to turn, generally foreign markets could have a big catch-up period, similar to what I would describe in the 2000s decade, where going into the dot-com bubble, U.S. outperformed everything else, you had a strong dollar. But then when that reversed, U.S. equity markets did poorly for a while. And once the dust settled, you had a huge boom in emerging markets and commodities. What do you think that the Chinese game plan here is in terms of currencies?

Starting point is 00:49:24 Like, whenever you see this increase in trade that's been settled in euros, is that where it's going, is it more like an intermediary step into, you know, the whole China's increasing power, one belt, one road, being the most important trading partner for more and more countries now than the states and have been for some time, not necessarily just in volume, but the number of countries? That sounded like a leading question. But like, is that the Chinese plan? Like, if you have to put a horizon on like 10 years, decades, centuries, is the whole Euro play right now just an intermediary step? I think so. China's long-term goal is that it wants to be self-sufficient and powerful. And in this current framework, you know, it's still reliant on the dollar in many

Starting point is 00:50:10 ways. And because as we discussed before, at least until very recently, you know, most energy pricing, most commodity pricing globally was dollars. And the United States likes that because we can sanction any country that doesn't play ball. We can cut them off from the dollar-based system. And that makes it very hard for them to secure the things that they need to get. And for China, they are a huge export nation in terms of manufactured goods. And they're also good with technology in recent years. They're big Achilles heels that they're a huge energy importer and commodities importer broadly. And so in order to make sure they get enough energy, get enough food, they have to ensure that they can have commodity exposure. And so partially the Belt and Road initiative is to,

Starting point is 00:50:52 you know, make sure they have access to infrastructure and reserves. in those different countries that they can get those commodities that they need. Two, they want to be able to diversify the ways that they acquire them. So they don't want to be exclusively reliant on the dollar like they used to be in order to get those. The first step is that it just includes diversification. So dollars and euros, if in the worst case scenario, their dollar access gets shut off, they still have the euro route that they can go through.

Starting point is 00:51:20 And so Russia will still sell them oil and euros, even if both of them were cut off in the dollar-based system. So there's that. Longer term, I mean, obviously China is interested in launching its central bank digital currency. And so that can potentially reduce the friction of using its currency with some of his trading partners. And so there's no indication that China wants to have the same sort of global reach as the United States has had, both militarily and with its currency. But it certainly wants regional sovereignty. It wants to have control over its own region and it wants to not have any sort of foreign power be able to cut itself off in the financial system. And so we've actually

Starting point is 00:51:57 been in a weird case where, you know, for most of this 45-year history of the petrodower system, the United States has been the largest commodity importer and it was in our currency. Now we have this weird situation where China is the largest commodity importer in many cases. They're using the second biggest commodity importer's currency to do it. They have a pretty strong incentive to diversify the currencies and then ideally in the long run for them to use their own currency as much as possible, not that other countries will necessarily use their currency, but that China will be able to use it with some of their trading partners, at least. A lot of Europeans and Americans, whenever they think developing markets, they're thinking

Starting point is 00:52:34 India and China, there's so many interesting narratives, not just the size of the population, especially India has an attractive demographic outlook, a lot more than China has. If you had to compare India and China, which of the two countries are most attractive for invest us and why? I think it depends on the time frame. In longer term, I think India has more opportunity. With the bloodbath we've seen in Chinese equities this year, combined with rather strong Indian equity growth, I think China is a more interesting contrarian play, right? So, you know, this, I could have had a very different answer if I was asked maybe a year ago, whereas now I'd actually maybe lean a little bit more towards China than I normally would have.

Starting point is 00:53:15 But basically, the difference is that India has stronger demographics. And so their population is expected to overtake China's quite soon. And because India didn't do the one child policy that China did. And so they have a younger population on average and a faster growing population. So they have that going for them. Two, a large part of China's growth of the past decade has been from leverage. And so they're about as leveraged as the United States is now. And it's in slightly different areas. And so, for example, China has less leverage on the sovereign level than most developed countries. And they have kind of moderate leverage on the household level, but their corporate sector has had a very large debt bubble, particularly in the real estate area. And we're seeing some of the negative implications that play out now with, say, Evergrand, risking of defaulting. And so we're going to see how far that goes, that they seem to be finally addressing some of that and letting that play out. And it remains to be seen how much contagion that will have. But essentially, if you were to compare China and India over the past decade, Both grew very quickly, but China used leverage, partially to grow at that speed, whereas India

Starting point is 00:54:21 did that rather unleveraged. They did not build up large amounts of leverage on any of their public or private platforms to have that growth. There's more organic growth. The other difference is that China has a higher per capita GDP at this point. Decades ago, they were closer. So in some ways, China's model has been more successful in the sense that they've been able to, that top-down organizational structure has been able to, for better or worse, accelerate

Starting point is 00:54:46 certain things. And the leverage has increased average standard of living in China compared to India. But the question, of course, it opens up is how sustainable that is, right? So with India, you have a democracy. Obviously, there's still human rights issues there, but it is a democracy. And you have better demographics. And so that's generally how I would sum up those two differences between those two countries. Also, China has been very export-driven, whereas India is, is much less export-driven. It's more somewhat separate from the rest of the world. Obviously, it's very strong in software,

Starting point is 00:55:19 so it exports software services, and it imports and exports various things, but overall, it's less tied in with the global economy than China is. Lin, thank you for sharing your framework for global opportunities. Could you talk to us about how investors could build his or her own personalized global portfolio? What should we consider?

Starting point is 00:55:41 How do we do it in practice? I start out with a big diverse mix, right? So I have companies from my country, which is the United States. I have foreign companies. And because, you know, over the very long term, equities are big compound or wealth. Generally, equities or real estate are the ways we compound wealth over decades. And then you just, you can look around for certain counterbalances, right? So there might be environments where you want bonds in your portfolio. And then you can choose, you know, what types the bonds are most attractive, do you want them as a big deflation to hedge or do you want to have them as dry powder to rebalance into more equities? And then if you're in a decade where there's

Starting point is 00:56:18 a reasonable chance of inflation and being a commodities decade, one of the most powerful things is to have some sort of commodity exposure. Could be commodities themselves, could be commodities equities, could be commodity trend following, where you ensure that you're most exposed in the upside and limiting your downside because it's a more boom-bust, lower quality area than other types of equities. And so overall, I think it's about having that, starting from that diverse starting point and then tilting into areas where you think there's more value. So it could be certain countries, it could be certain factors. It could be, say, commodities versus tech, for example, if you think it's being more inflationary, more kind of emerging market-based,

Starting point is 00:56:56 and then wherever someone has kind of expertise, right, or that they follow markets closely. So I incorporate, say, Bitcoin into a portfolio where obviously not everybody would. And a position size is what manages the risk there. And so when you add together equities, some bonds, some real estate, commodities and some digital assets, generally I think that's a very attractive way to kind of preserve and grow wealth over the long term, even though, of course, you're going to encounter periods of volatility. Fantastic. Well, Lynn, I want to be respectful of your time.

Starting point is 00:57:27 I know you're super busy. And before we started recording, you're also saying that you're going overseas. A bunch of stuff are happening right now. So I'll let you go. But before I do, I would like to give you the opportunity to give a handoff to any of your resources to our audience. I appreciate that. I'm at Lindaldon.com for people that want to follow my work. I have free newsletters, free articles.

Starting point is 00:57:49 I also have a low-cost research service. And I'm active on Twitter at Lynn Alden Contact. Fantastic, Lynn. And I can only endorse. I've done that throughout this episode. but I absolutely love reading anything that Lynn is putting out there. So make sure to go to Lin Alton.com. It's always worth a read or go to a Twitter profile.

Starting point is 00:58:08 Lynn, thank you so much for yet again making time for the Investors' podcast. I hope we can do this again soon. Happy too. Thanks so much for having me. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional.

Starting point is 00:58:38 This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP386: Global Investment Opportunities w/ Lyn Alden

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