ED HARRISON: Hi, Ed Harrison here for Real
Vision. I have the distinct pleasure of talking to
Daniel Lacalle, who is the chief economist and CIO at Tressis. Daniel, welcome back to Real Vision. DANIEL LACALLE: Thank you very much. Thanks for having me, Ed. Always a pleasure. ED HARRISON: Yes, definitely. I'm really excited. I was telling you just before we came on,
we spoke about eight months ago, right before this interview, I was reviewing some of the
things that we were talking about, but a lot changed. Because you and I, we were talking about the
economies as the reopening was happening, and that was eight months ago. What happened in the reopening is that the
US was looking terrible, and Europe was looking better. You were like, hang on, that's not how it's
going to play out over the longer term, even over the medium term. In fact, you were exactly right. What we're now seeing is a rally in shares
in the economy of the United States in particular, going forward. The real question is, should we think about
this? How do we frame this economically, and how
do we invest against it? That's what I want to talk to you about over
the next hour or so that we're going to have this conversation. Frame it for me first what's happened between
when we last spoke, and what's happening now. DANIEL LACALLE: I think that what we have
seen is the difference of how you target stimulus very clearly, very, very clearly, the United
States has focused the vast majority of the stimulus plans on preserving the business
fabric, on helping families and on keeping the economy alive. Whilst in Europe, what you have seen is the
vast majority of the stimulus plans aimed at preserving and increasing current government
spending. Big difference. Big, big, big difference, actually. If we think about it, one of the things that
we have seen as well is that the idea that was implemented in Europe, that putting together
these massive furlough job schemes was going to be the way to both preserve the job market
and recover faster has proven to be wrong. The reality is that we look at unemployment
in the United States today, it is slightly above 6%. In the Eurozone, it's above 8%, plus more
than 10 million people in furloughed jobs. I think that what we have seen is a much worse
recovery of the employment base, I think that what we have seen is a much more detrimental
to the economy response to the second wave of the COVID-19 crisis and the misguided lockdowns. In the United States, you've had a much more
flexible, and at the same time, much more prudent approach to the measures to contain
the virus, and obviously, the vaccine rollout. We can't forget that. The vaccine rollout has been an absolute success
in the United States compared to a very slow bureaucratic and, again, incorrect rollout
in the Eurozone, in the European Union. ED HARRISON: Everything you're saying is interesting,
because when you look at it, just a complete reversal of where we were before, with everyone
touting the Eurozone, and their response to the virus and the US doing terribly, and actually
the UK was doing relatively poorly too. Now, the UK is also --- JASON ZIEMIANSKI: What we're showing you here
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to realvision.com, and see what you think. We look forward to seeing you there. ED HARRISON: and their response to the virus
and the US doing terribly, and actually the UK was doing relatively poorly too. Now, the UK is also rolling out the vaccine
very well. It seems that their economy is getting back
on track well. What do you see going on there? DANIEL LACALLE: I think that what is happening
in the UK is very similar to the United States, and that's what we've discussed in our conversation
last time is that the United States and the UK are much more open, much more flexible
economies than the Eurozone one. Therefore, the idea that the Eurozone was
going to recover faster, with all due respect, was almost impossible. The reality is that it's such a directed economy
and there are so many layers of bureaucracy driving, not just the vaccine rollout, which
is much slower than in the United Kingdom or in the United States but the way in which
the stimulus plans are being implemented fundamentally to direct it to preserve and increase government
spending. Therefore, what happens is that the multiplier
effect of the measures that are taken is actually much lower. Obviously, that takes into account the very
negative decision to implement aggressive lockdowns, then opening then locking down
again, instead of a more flexible and more limited and targeted approach, like we have
seen, for example, in the United States. I think that what we're seeing basically is
that the economies that have a larger level of flexibility, a larger level of private
intrapreneurship as well driving the small and medium enterprise factor, and in which
the government actions have been fundamentally driven to preserve the business fabric, those
are recovering faster. If you actually look at the Eurozone as a
total and then separate by each of the countries, you see that there's a huge difference in
the recovery process as well in the more flexible, more open economies that like, for example,
the Netherlands, or Germany itself. ED HARRISON: Before we get into what the implications
are for asset allocation, I wanted to take a step back, because obviously, asset allocation,
when you're a long term investor, you're thinking about the long term, so think about this framing
it not just from what's happening now, and has happened over the last eight months, but
just a general framework, how we can think about this over a longer period of time. I'm thinking in particular about the conversation
you and I had in July, where we were talking about, from your perspective, a longer term
view where we saw weaker growth coming out of each recession. The way that I guess I would frame it is that
what we're seeing now is a manifestation of what we've seen before, which is that there's
some level of government intervention, less perhaps in the US and the UK, or at least
more targeted towards the private sector. This intervention has morphed from being just
a monetary policy intervention, heavy on monetary policy to monetary and fiscal policy. What you, at the time, were calling it the
everything, bailout. First of all, is that your view today still,
and to the degree that it is, what does it mean for the economies over the longer term? DANIEL LACALLE: I think that we've gone from
thinking about the bailout of everything to the bailout of anything. For example, we are seeing news today in Europe
about governments bailing out companies whose problems have absolutely nothing to do with
COVID-19 problems that came from 2018, 2017, 2016. That is an important problem. I think the other important problem is that
there's a widespread view of seeing government as the lender of first resort, as the solution
of first resort instead of the solution of last resort, which is very negative in terms
of implications for the level of growth that we get once the pandemic is over, but also
for productivity growth, which is absolutely critical for the estimates of real wages. I think that that has not changed, actually. If anything, in my opinion, the recovery that
we are likely to see once the base effect of the reopening is behind us is likely to
be much weaker, precisely because of that situation that we just mentioned before, is
that there's a constant decision of bailing out or helping the sectors of low productivity. Once the recovery is in full swing, what we
are likely to see is a massive increase in taxation on the sectors of high productivity. If you subsidize low productivity, and you
tax high productivity, and at the same time, government presents itself as the lender of
first resort with a generalized view that that is actually a good thing, then the weakness
of the recovery is significantly poor, is much, much, much weaker. That is one big concern and to come back to
the point of productivity growth, which is, in my opinion, a key factor, because if productivity
growth is not just subdued, but actually zero, as we have seen in some economies in the previous
recoveries, then real wages don't grow. If real wages don't grow, then the problems
of discontent, the problems of concerns about the situation of an average household in terms
of the real disposable income increase. I think that when we are thinking about a
recovery in which one of the predicaments that we hear constantly is that we are going
to see a massive boom of consumption once the economy fully reopens, if we don't see
real wages going along with it, and if we don't see productivity growth
improving, then this risk, not risk-- the evidence of simplification is not just lower
growth, it is a much worse situation for the poor and the middle class part of the economy. ED HARRISON: Yeah, and that's a great framing,
and it leaves me thinking about a lot of different things. Because ultimately, from a policy perspective,
you have to get this right. Let me give you an example that earlier today,
I had a tweet out, David Rosenberg who I speak to off and I was reading one of his latest
missives, and he pointed out that the Reserve Bank of Australia's Governor Philip Lowe,
he was actually talking about exactly what you were saying. He said that for inflation to be sustainably
within the 2% to 3% target that they have, wage growth, wages growth as he calls it,
needs to be materially higher than it is currently. He said, the evidence strongly suggests that
this isn't going to occur very quickly. He doesn't see it happening until 2024. His conclusion, therefore, is that we, the
central bank, we're going to keep interest rates really low as a result of that. Wage growth not going up, we are going to
solve the problem by having incredibly low interest rates. To me, that's a question. Is that really the solution? If so, how? If not, why not? DANIEL LACALLE: Well, obviously, as a central
banker, what he is saying is they have two tools, increasing money supply, and lowering
or increasing interest rates. Those are, in essence, the pillars of the
tools that they have. The problem is that you don't address real
wage growth with monetary policy. You address real wage growth by implementing
policies from a fiscal perspective that incentivize high productivity. That is something that governments in general,
it's not a question of this party or another, that governments in general tend not to do,
because by definition, a government that wants to keep things as similar as possible to where
they are today, will inevitably direct the vast majority of the support schemes that
fiscal policy gives them to maintain the status quo of the sectors that exist nowadays, and
subsidize in many cases the low productivity sectors, but because the fiscal response is
so huge and the deficit spending is so large in the periods of crisis, what happens when
the economy recovers is that the fiscal policy turns too detrimental to productivity by continuing
the subsidy on low productivity, but massively increasing the taxation on high productivity. It's a double negative. The point that many economists are making
today is "don't make the mistake". That's my point as well, is don't make the
mistake of to try to get a few 10s of billions of dollars of extra revenues in a 3 trillion
[?], don't go and massively increased taxation, because that is going to generate a much bigger
problem of productivity growth, and with it, real wages. You don't solve that through legislation by
saying, look, we're going to increase wages by law because it doesn't happen. More importantly, I come back always to the
point you're hearing me all the time say the word real, because I'm interested in real
wages, not in nominal wages. Because if you increase inflation through
monetary policy like we've seen today in which the disinflationary components remain. Absolutely, they do, but there has been a
problem for many years of non-replicable goods and services that are rising much faster than
real wages, and then headline CPI, education, health care, insurance, you name it, fresh
food, all of those factors. We need to be aware of the fact that the level
of inflation for the worse off in the economy is much
higher than that for you and me, or the people that are watching us today, which we all belong
to the upper middle class. The point that I'm trying to make is that
lowering interest rates and going further into negative real and nominal interest rates
is not what is going to drive real wages higher. What is going to drive real wages higher is
if the fiscal policy is targeted more towards the creation of new businesses, and to the
incentive to increase the percentage of sectors of high productivity, because that is what
is going to drive real wages higher, and the percentage of the population that is in the
workforce higher as well. One of the concerns right now is this concept
of the jobless recovery, isn't it, is the fact that as we mentioned before, we are still
seeing an elevated level of significant improvement in the United States but a very concerning
level of unemployment and underemployment in the European Union, in which you have the
epitome of massive fiscal policies allegedly targeted towards helping the worse off. The best social policy at the end of the day
is creating jobs and creating jobs can only come by not pulling the brakes on the high
productivity sector, in my opinion. ED HARRISON: In all of that, the one thing
that stands out for me is when you focus on the real, you're talking not only about real
wages, but real wages as compared to the price level, i.e. there's nominal wage growth, this
is how much more money I'm getting. Then, of course, there's the inflation associated
with it. Interestingly, up until this point, inflation
has been tame, and it's been going down over a secular period of time. Globalization, a lot of different things are
responsible for that, but in the regime that we have now, which you described as the everything
bailout regime now becoming the anything bailout, where the government is the lender of first
resort, is that the way that inflation moves forward? Is low inflation something that we're going
to continue to see? DANIEL LACALLE: Well, we will continue to
see low headline CPI, consumer price index, low or subdued headline consumer price index,
but we must not forget that before COVID-19, there were already problems all over the world
of protests in France, Germany, and Spain and Chile, in many Latin American economies
and some other emerging economies about the rising cost of living. How do we reconcile a very low headline CPI
with increasing protests against the rising cost of living? Again, it comes back to the basket and it
comes back to the weight of each of the products in those baskets. If rent, fresh food, education, health care,
insurance go up faster than real wages, yet technology leisure and hospitality come down,
headline inflation is obviously going to continue to look subdued and it will actually see a
very big move back to a weak level in the second part of this year after the base effect
is gone. However, the sticky part of inflation remains
higher than what central banks or governments are thinking about, and that creates the discontent. We saw it, for example, in the inflation figures
of the Eurozone. We saw the Eurozone headline CPI being very
weak, significantly below the 2% target of the ECB. Absolutely, it was. However, you saw at the same time that fresh
food was up 4%, that public services were up 3% to 4%, that things like that are rising
faster. That is the problem, in my opinion, is that
we need to be a little bit more granular about inflation, particularly from a policy perspective,
because it's hurting the people that it's supposed to defend the most. Because on one side, policy continues to be
driven towards increasing inflation at any cost, inflation for those non- replicable
and essential goods and services actually is there for the things that we actually want,
and we actually buy, and the things that we actually buy on a daily basis. If fresh food is up 4% and technology is down
7%, the impact of inflation is very high. However, what do I eat every day, and what
do I not buy every day? I don't buy everyday a phone or a camera. I think that this is something that central
banks need to pay a lot of attention to in the next years as this bailout of anything
continues, which it will, because you're likely to see a rising difference and a rising wedge
between the people that have access to assets, the people that have access to debt, the people
that have access, on their daily basket, more of a similarity to the basket that the government
uses, and the middle and lower classes. I think that that's an important factor, particularly
as you very well said before, because it's much more difficult for the middle class to
rise up the property ladder, or the wealth ladder, when you have repression on wealth
and at the same time, you have a rising price of housing, of all those essential core goods
and services, which negatively affect-- what it's basically doing is shrinking the middle
class in both sides. On one side, because their inflation is higher
than what the government or the central bank perceives, and second, because they basically
invest the little that they actually saved in deposits that are being consumed by monetary
policy. ED HARRISON: Yeah, that's not a good outcome. Let me ask you also on inflation, since we're
talking about that, about other factors that have been large in terms of thinking about
inflation. I'm thinking particularly about China, I'm
thinking about demographics, technology. Then finally, just general overcapacity at
the end of this particular business cycle because of the pandemic and the fact that
the new normal is going to be very different than the old normal. DANIEL LACALLE: A very good point. Those three factors, China as a massive exporting
machine of cheaper goods and services, technology and demographics are disinflationary. Absolutely, they are. I think that when policymakers look at the
way in which they think of inflation and the way that they think of target inflation, they
should take into account those things. You cannot think of a 2% as a moderate inflation
when the challenges that I mentioned before about
the basket that we are using or that is used officially for CPI reflects such massive disparities
between different types of consumers. You also cannot think of that any policy in
terms of increasing money supply or lowering interest rate is justified simply because
inflation is not at 2% when in reality, considering that we live in open economies in which technology
is creating positive disinflation, because disinflation is not negative. Technology disinflation, which is productive
and competitive disinflation is actually very good. The ageing of the population and the demographic
component are not disinflationary factors that should be addressed via monetary or fiscal
policies, simply for a very simple reason. Because they have absolutely nothing to do
with those, not that they have to do with the fact that we age and we consume in a different
perspective and in a different way. China's competitiveness as an exporter, not
only China but other emerging markets, India, etc., those are positive disinflationary effects. We are able to acquire more goods and services
and better quality ones with a higher control of prices. Policymakers need to take those into account,
not as negative disinflationary effects. They look at inflation, policymakers, and
they say, oh, prices are coming down, that is bad. Well, hold on a second. Is it a competitive, is it an export-led,
or a demographic-led disinflation, because that is actually good, or is it a postponement
of investment and consumption decisions because of the fear of lowering prices? Because those are two completely different
things that have completely different policies that need to be used to address them. I think that basically, what I find is that
central banks and governments are using the tools of 19th century economy for a 21st century
economy, is that they are thinking of inflation and deflation as one only thing. I don't see any problem in the fact that this
camera that I'm looking at is 75% cheaper than it was a year ago. There is nothing negative about that, but
what we cannot say is that this camera is 75% cheaper, I don't know if it is, but imagine
that it is, is 75% cheaper, and the fresh food that my children eat every day is up
7%. I'm not addressing the second, but I'm worried
about the first. We need to be more granular about inflation
because if we address with the same policies of the 20th century a 21st century economy,
what we are doing is actually not through evil, but what they're doing without is generating
a second consequence that is even more negative. That is policy driven inequality, which is
what I mentioned before, is that the poor and the middle class are unable to climb up,
and at the same time, the government is thinking that there's no inflation. Of course there is. Talk to anybody in the world. There is inflation on the goods and services
that they buy on a daily basis. The fact that hotels are down is irrelevant,
because I go to a hotel, if I go on holidays or on business a certain period of time, once
or twice a month depends on my schedule, but it's not the same as what I do on a daily
basis. I think that that's what we need to do. Because if not, the risk of discontent that
we have seen in so many countries here in the Eurozone-- I'll come back to the protests
that we had in France day after day after day after day against the rising cost of living. Those are important factors in my opinion. ED HARRISON: Yeah, and if you think of it
as inflation in the things that you need, and deflation in the things that you want,
obviously, if you have better means to deal with inflation, then overall, you're in a
better position. The people who are getting the inflation and
who have less to deal with that inflation in the things that they need, they're going
to be a worse off situation. That leads to political unrest as you were
saying. There's another thing that you were saying
that I thought was interesting when you're bifurcating between the good inflation and
the bad inflation. One of the things about the bad inflation
that you were talking about, is, I got a sense of debt deflation, i.e. we're over our skis
in terms of the amount of debt that we have, that the economy's not really doing incredibly
well. Immediately, it made me think about our interview
last time and your thought about once we have this-- people are talking about it as this
pent up demand. Once that's over, what kind of economy are
we going to go back to, what kind of dynamics in terms of that bad inflation are we going
to avoid or actually have? DANIEL LACALLE: In my personal opinion, and
sorry to be a little bit pessimistic here, we're going back and massively to the concept
of secular stagnation, and I'll come back to the point. I think we're going to see this recovery of
consumption, we're going to see the recovery of the economy once the vaccine rollout is
completed and all of this, but the IMF, the OECD, the ECB, all of the international bodies
are telling governments, continue to spend, because they fear the outcome of the previous
crisis. They fear that if they don't continue spending
aggressively and increasing the deficits in the recovery, then we're going to have the
2011 type of European crisis, which has nothing to do, by the way, with austerity, has everything
to do with bad government spending. The point that I'm trying to make is that
we need to go back to 2019 to understand where we're going, because we're going there accelerating. In 2019, and 2018, already, the signals of
stagnation, that driven stagnation were very evident. Remember, in the fourth quarter of 2019, Germany
was close to recession, Italy was growing at 0%, France was growing at 0%, and the US
economy was starting to slow down as well. I think that what we need to understand is
that once we get out of the 2020-2021 response to the COVID-19 crisis, and the mistake of
putting all of the structural challenges of the economy under the COVID- 19 umbrella is
that we're going at 300 miles per hour to that same place that we were heading into
in 2018, which is much lower growth, much lower productivity growth, much higher debt. This is the constant problem of policy versus
what it tries to achieve. We know by now after decades of different
recoveries, that out of each recovery, the multiplier effect of government spending on
the economy is lower, and in some cases, negative. The more we spend on fiscal policy, on increasing
the imbalances created by current government spending, the weaker the outcome is going
to be. Unfortunately, I think that we tend to forget--
we tend to talk a lot about the recovery and the new normal, which is fine, because we're
looking forward without remembering that in 2019 and 2018, the signals of weakening growth
were already there. The point of debt deflation that you're mentioning,
here's the problem I have, with the ways it's addressed. Debt is rising, government debt is much higher,
and they're trying to generate inflation in order to reduce
the debt in real terms via increase in prices. Okay, we'll understand that. What is the problem? The problem is that when your response is
to increase deficits by massively pumping up current government spending, you don't
reduce debt in real terms, either. That is my problem. My problem is that the inflationary policy
does not achieve the level of inflation that would reduce the debt that has been accumulated,
yet the fiscal policy and the deficit spending, which is fundamentally driven towards current
government spending generates even more debt even when there is inflation. That is why we're seeing such a problem, for
example, right now, in some emerging economies, is that despite the fact that inflation is
rising, none of the indebted sectors get out of the debt burden, because the constant increase
in current spending outweighs the improvement of the debt via inflation, or the improvement
of fiscal revenues. ED HARRISON: Yeah, that's not a good picture. I think it's a great segue into thinking about
asset allocation. Because the question that comes to mind is
if that is the eventual outcome, and I'm investing for the medium to long term, then I want to
know what I need to do in order to deal with that situation. Let's talk about where we are right now from
an asset perspective. When you were talking about the everything
bailout, I'm thinking of in terms of the everything asset price inflation. All sectors going up, whether they're good
or bad, whether they're low growth or high growth sectors, everything's going up. How long can this go on, and what do I do
in order to protect myself if it can't go on for that much longer? DANIEL LACALLE: I always say that we have
to think about this as if you were surfing. You need to understand that you're riding
a wave, and you can be either at the bottom of the wave, because then you make no money,
and you can be at the top of the way because you're going to crash. My point is the following, is that when you
have such a level of correlation, just insane, absolutely insane-- and by the way, policymakers
should pay more attention to the risk of such level of correlation between assets. When you have that level of correlation, we
need to understand three things in my opinion. First, economic cycles are shorter and more
abrupt each time. Many times we talk about a diversified portfolio,
and we're not diversified at all, because everything is so correlated. In reality, when you look at many of our portfolios
and we think I'm very diversified, and reality that you only have one bit, and that is what
most people have in their portfolios, which is weaker dollar. That's your pillar of the portfolio, you're
long emerging markets, you're long equities, you're long emerging economies and Eurozone
bonds, and you are exposed to the so-called value sectors. Thank you very much, you are short, the dollar. Then you have to be very aware of how dangerous
that is now. The point that I'm trying to make is that
from the asset allocation perspective, if you're looking at the mid to long term, you
need to understand that this process of secular stagnation that I mentioned erodes the value
of the so-called value sectors, they become less and less valuable, because those sectors,
those companies that are valued from a position of the rent that they get from just being
there reduce their value and their margins and their profits. Point that I think that therefore, that you
need to take is that when you have an environment like we had between October and the end of
the year, in which the so-called value sectors start to recover, you reduce exposure to them,
like you were surfing. When you see that sovereign, almost insolvent
bonds go significantly higher in price, you reduce
exposure to them, and you stand basically in with a portfolio in which you have exposure
to technology, exposure to the stocks that are benefited from the ageing of the population
that we mentioned before, the technology revolution, and the increase of competitiveness globally
from more exports, from China, etc., etc., the sectors that benefit from those secular
trends, sustainability technology, and demographics and you avoid the ones that are optically
cheap, or the ones that are too expensive compared with their solvency ratios. ED HARRISON: In terms of the reflation trade
that's been going on now, it seems a lot of the reflation trade has been a rotation out
of the sectors that had benefited during the previous bout of secular stagnation, exactly
the companies that you were talking about, but toward the value stocks, and in particular,
obviously, energy and financial services. I want you to talk to me about that, but also
the simultaneous move into what I would call the bubblicious stocks. It's almost like a barbell between, okay,
here are these stocks that are benefiting from the new way forward, we're going to go
into this supercharged version, but much more risky version of those and we're also going
to move into these undervalued value plays, and that's what I'm going to do during this
whole reflation period. How good of a scheme is that? How long can you make that trade before you
get run over by the change because of secular stagnation? DANIEL LACALLE: Very good point. I think that you have a window of opportunity,
more or less, in my opinion until May of this year. The reason why is because all of those reflationary
pressures and the base effect from 2020 still help you, and most of the analysis that you're
going to receive from investment banks, from brokers is going to continue to be focused
not on the earnings today or in the margins today, but on expectations that are completely
impossible. I think that you have basically, I don't know,
but I think that you have more or less the first half of 2021 to continue to bet on the
mirage of the recovery of the value stocks. Once that happens, you start to get the base
effect goes negative. Remember this. People are seeing, oh, in between March and
May, the base effect in inflation, in growth, in so many things, in sales for many of these
sectors, it's going to be phenomenal. It's going to look awesome. I think I was going to look in September relative
to September last year, and I think that that is an important factor, is that you have to
be tactical about the reflation trade without forgetting the disinflationary pressures that
I mentioned before and without forgetting that there's a very wide difference and a
widening difference between the headline inflation and the one that we look at for our investments
and for policy, and the one that consumers perceive because the latter affects the sales
and the margins of the so-called value sectors. ED HARRISON: Now, in terms of those value
sectors, when you look at value in general, let's look at Europe as an example. You're looking at old line industrials, you're
looking at cyclical stocks, you're looking at financial services. Then if you move to the United States, you're
also looking at the energy sector in particular. Of those sectors, which ones are the worst
off in the post-May period, and which ones are potentially a better play for the post-May
period? DANIEL LACALLE: Industrials are better, oil
and financials are worse. The reason why is because the energy sector
in particular should never be included in the concept of value, a sector that generated
an 11% return on capital employed at $11 a barrel when I was working in it, and generated
a 10% return on invested capital at $130 a barrel a few years ago should never be included
as a value sector because it's optically cheap in terms of PE or in terms of the multiples
until you make the valuation relative to how which returns they make relative to cost of
capital on a normalized environment. That is one that is very, very challenging,
and that you can play tactically. I think that most people actually do. I think that investors in general have become
aware of the fallacy of the long term investment in the energy sector. Financials, particularly in Europe, the problem
of the financial sector is not just inflation, it's policy, and it's negative real and nominal
rate policy and regulation, in the case of Europe, in particular. Those two things erode their net income margin
and make their core capital very small even when they increase it. They need to constantly increase their core
capital in order to address the non-performing loan issue, which was already 900 billion
before COVID-19. You also have to understand that things that
you for example, talk about and have written in your Twitter account, etc. and all these
things that we're talking about, the digital dollar, the digital euro, those are bad for
banks. That's destruction of the bank business. Let's be fairly honest, the policy of central
banks and government is not going towards improving the profitability of banks, it's
going towards reducing it and zombifying them. Therefore, the market gives you very good
opportunities to buy and sell out of them, but not consider them value plays because
you cannot consider that a stock is a value stock because the multiples at which it is
trading right now look optically cheap, when the return that it generates relative to its
cost of capital is very low or negative, so I think that those elements, we need to take
into account. I would take away from the value concept those,
but I would think about the industrial sector as an important one where there can be significantly
interesting opportunities. The situation that is going on with sustainability
that I mentioned before is a good one for the utility sector in the long term, secular
stagnation as well. There are pockets of value in the value segment. ED HARRISON: When you talk about energy, I
want to home in on this a little bit. There are the integrated energy companies,
there are up and downstream. I know since you were in this field, you know
all about that, and then there's midstream. I know that Warren Buffett, he likes to midstream
because that has consistent cash flows. Are there pockets within that, both up and
downstream and midstream, that are better than other sectors, and especially when you
look at the integrated oil giants which comprise the full panoply of assets? DANIEL LACALLE: Well, I agree with Mr. Buffett
there, that midstream is an attractive part because it's great, basically almost like
a bond, isn't it? I agree with that. Now, the problem of the integrated sector
goes back many years ago, and we need to think more around the beginning of the 2000s. The integrated energy sector used to be exploration
and production is a cyclical business in which you invest in the low part of the cycle, and
you reap the cash in the high part of the cycle, and you churn the asset base by buying
and selling assets. It was basically an asset management business. The refining business was countercyclical. When exploration and production didn't work,
you got the cash flows from refining and marketing. That generated an almost stable environment,
and you added the gas and power, you basically had something that was used to be ages ago,
and almost by-product of oil production, natural gas, you're actually generating profits out
of gas and electricity. All of that generated an integrated view that
would allow you to generate positive returns in the different parts of the cycle. When did it all go wrong? When oil companies started to talk about the
oil price. I remember when Exxon used to say I don't
care what oil price there is, what we need to do is to be profitable at whatever the
oil price is. Then they started to be pro-cyclical instead
of anti-cyclical, so they started to invest aggressively in exploration and production
when oil prices were rising. They started to invest aggressively in refining
when overcapacity and refining was already there, and refining margins were going up. Instead of having investments that have been
made at the bottom of the cycle, and that reap high returns at the peak of the cycle,
they started to have investments that were made at the peak of the cycle that needed
a higher peak of the cycle. The entire concept of what an integrated oil
company had to be disappeared, because they're doing the opposite of what they do. Now for example, think about it, when are
they investing in renewables? Now. They're investing in renewables now. Are you crazy? Now, what they should be investing is in exploration,
but no. When did this change? It changed when the industry-- and I'm sorry
to-- went from being run by engineers to being run by lawyers. It's been a disaster, and the value destruction
of the integrated oil and gas sector is so phenomenal that it's very difficult to justify
in any way. The problem that I see is to consider that
that is value because, yes, part of their assets generate value, but there's an interesting
factor here. Why are they selling the assets that are most
valuable at the weakest part of the cycle and buying into the most aggressive valuation
part of the cycle, the renewable sector now? You see, they're doing the opposite of what
they should do. That, if you look at it now or 10 years ago
or 10 years after, is simply value destruction. It's the same way that when banks in Europe
decided to expand out of the European Union to places where inflation was very high, because
what they were doing was buy at peak valuations alleged returns that they were only going
to see diminish. Obviously, that value destruction is very
important. My point is when you look at these sectors,
look at the stocks that have the least-- for diversification, you already have your portfolio,
you don't need a company to diversify for you. Look for actually companies that are focused
on something. You want to bet on higher oil prices, buy
exploration stocks. If you want to bet on increasing capital expenditure
in the oil or in the energy sector, buy service stocks. If you want to bet on refining margins, buy
refining stocks, but integrated, I'm sorry, the ship sailed many years ago. ED HARRISON: Very good insight into that sector,
and I wish we could go on about that, because I have a lot more questions, maybe that's
for the next time. I have some other questions for you. Obviously, the big overhang of the dollar
is there. We're going to get to that in a second, but
Japan, we haven't talked about Japan at all. I'm thinking about Japan, because a lot of
the macro issues that we're talking about, they saw them first. The narrative I hear now is that Japan is
to a degree on the other side of the problem. They still have the debt overhang, 247% of
GDP government debt, but how are you looking at Japan as a medium to long term play from
an equities perspective? DANIEL LACALLE: From an equities perspective,
you have a significant change in the corporate governance and in the structure of the Japanese
companies. Remember, the Japanese companies used to be
part of that value trap that we were mentioning a couple of minutes ago. Why? Because they were huge conglomerates that
basically used the returns of the good businesses to finance very bad businesses. There was a constant value destruction. A lot of that has changed, and I think that
that is an important factor to acknowledge out of the Nikkei stocks. A lot of things have changed as well in terms
of addressing total shareholder return. I think that however, Nikkei stocks, you need
to look at them precisely because they're behind that process that you just mentioned,
you need to look at them from a more cyclical standpoint, is that they are more cyclical
than they used to be. They used to be boring, and almost stable
returns, and you just basically bought and sold them according to what the BOJ, the Bank
of Japan would do, wouldn't you, but I think that right now, you have to acknowledge at
least that when they're in an uptrend, they have between three to four quarters of earnings
and margins growth, and then weakness, because what they cannot change is the demographic
factor of Japan. Japan is not only ageing, it's also diminishing
population, and their businesses abroad, again, are very dependent on the cycle. I think that as such, they're a good play
on that, but I don't think you would buy them for the long term in my opinion. I still continue to believe that you have
to look more at US companies for long term investment and if the Japanese companies look
at them from a cyclical perspective. I don't think that Japan is going to come
out of this crisis growing faster than the United States, or addressing its problem of
productivity and growth, again, because of the demographic, and because of the overcapacity
components that were mentioned, but I do think that there's a structural change in many of
the Japanese companies that allow you to invest more comfortably than in the
past in which you were basically subject to companies that had a strategy that was almost
dictated by government. ED HARRISON: When you talk about Japan versus
the United States, that is a great segue into the whole dollar conversation, because when
we were talking about asset allocation earlier, you were saying basically, these correlations
are all there. You're really betting on a low dollar. When you are going into emerging markets,
when you're going into Europe, etc., what you're basically saying is the dollar is weak. When you think about the United States outperforming,
to me, that's not a scenario in which the dollar is weak. We seem to have hit a bottom around 89.90
on the dollar index and the dollar is now in the process of moving up. How do you see that happening over the medium
to long term, and what does that mean in terms of your own thinking about asset allocation? DANIEL LACALLE: I think that one of the interesting
things that we're living right now is something that very few people would have imagined,
in my opinion, me included, is that we see a radical bounce in commodity prices and the
countries that export those commodities are seeing their currency devalue relative to
the dollar. You've seen the Brazil real, Mexican peso,
etc., etc., etc., so many of those currencies. What does that tell us? It tells us that the dollar is not strengthening
or bouncing from the 89.90 level to the 92 dollar index that it is right now based on
the fact that the Federal Reserve is undertaking a more hawkish policy, it is strengthening
because the policies of the rest of the central banks are much more aggressive than that of
the United States. As such, what it tells us is that we're living
basically as a fiat debasement environment, because the dollar is strengthening because
everybody else is weakening, not because the Federal Reserve is undertaking policies to
strengthen the purchasing power of the dollar, actually, probably the opposite, isn't it? I think that that is something that I find
very interesting. I think that it will play out into the second
part of the year, because it also played out if you remember, in QE1 and QE2. If you remember, when the Obama administration
came, and there was a huge, concerted consensus call of weak dollar, weak dollar, weak dollar
no matter what. What we saw was that once that expectation
was followed by much more aggressive policies from the rest of the central banks, but without
what the Fed always does, which is to pay attention to the secondary demand of dollars,
the Federal Reserve is the only central bank in the world that looks at the global demand
for US dollars when thinking about monetary policy, everybody else just prints. Therefore, the fact that we saw that massive
increase in the bet against the dollar, at the same time, as we saw an increase in debt
denominated in US dollars from emerging markets, you have the Hoover effect. You have a Hoover effect in which the dollar
is not going to strengthen massively, but it's going to remain in that range in which it was for years between
90 to 95, 97, maybe gets to 100 DXY, not bad going from 90 to 100. In any case, we tend to forget what percentage
it's at, but it's that range where it moves that is basically telling you that the rest
of central banks in the world are conducting the same aggressive monetary policy of the
Federal Reserve even faster. Remember that the Central Bank of Europe has
today an $8.6 trillion balance sheet, 62% of the GDP of the Eurozone versus the Fed's
35%, 36%. I think that the point is, the dollar can
only strengthen as long as everybody else does the same more aggressively, but without
paying attention to the global demand for their domestic currency. ED HARRISON: The last thing from an investing
perspective as a result of what you're saying goes to alternatives to fiat. That is gold, silver, Bitcoin in particular. Last time we spoke, we talked about Bitcoin
being an asset that's moving potentially towards more of a currency alternative. I think that the way that you described it
is that when we think about fiat, an alternatives to fiat, we've seen this play out in the past,
we never know which alternatives come good at the end, so you're betting on horses that
you don't know whether or not they're going to win the game. Also, then there's gold and silver. Talk to me about where you see them now, especially
with gold and silver not doing well but Bitcoin doing relatively well in the recent trading
days. DANIEL LACALLE: The first thing about gold
and silver is, if you look at the supply demand scenario relative to the price in the traded
markets, they're clearly looking significantly more attractive. I think that the point in gold and silver
is that right now, they underperform and rightly so because of very optimistic expectations
of recovery, and very optimistic expectations of mild but rising inflation and continued
almost concerted and synchronized growth. Remember the concept of synchronized growth. Once that fades, that's when they start to
come back. Usually, what the market gives you is opportunities
like this to add to some gold and silver which help you as a protector of the portfolio when
the market starts to realize that the situation is not as rosy as we expect for the global
economy. Also, because the more that central banks
increase their balance sheet, they're going to buy more gold. That's unquestionable, they will buy more
gold. They might not be doing it today, but they
are doing it on a yearly basis. I think that right now, they might continue
to be underperforming for those reasons, optimistic approach or the global wave of reflation,
etc., but good opportunity to buy something so that once the tide comes back, they start
to protect. Cryptocurrencies are extremely procyclical. Cryptocurrencies, we're all talking about
them right now a lot. Why? Because they're going up. The reason why they're going up is because
everything else is going up. We need to understand that they're extremely
volatile, and that's fine. I think that what we have learned is that
their staying power, particularly Bitcoin, Bitcoin's staying power as an alternative
to fiat has been significantly more strong than what many critics expected. I think that in order to be money, they have
to be three things, they have to be a unit of measure, a reserve of value, and a widely
accepted means of payment. Well, two of those, they already are starting
to fulfill, but we can't forget the risk of regulation, intervention, legal and regulatory
threats, which we have read all over the place. Central banks don't like competition in creation
of money. We need to be aware of their volatility. When you have something that has very limited
supply, think about it as a small cap stock. When you have something that has very limited
supply and you have one, two very large buyers leading the price up, the price can come down
very quickly. The point that I'm trying to get to is that
Bitcoin by now is almost, I would say, 60% of the way to being a valid currency, and
if we talked about not only last year, but a few years ago, it was very, very far away. I think that that is probably unstoppable. Again, I come back to the point that you mentioned
in the question is, hold on because there's lots of cryptocurrencies, and we need to understand
that the majority of them will simply disappear, that some of them will thrive, but many will
disappear. Volatile, and we need to be aware of the risk
of the disappearance of many of them but the reality that we cannot even question is that
they are gradually becoming money, particularly for the citizens in countries in which you
and I were talking from the perspective of two currencies, the Euro and the US dollar,
which are relatively stable and relatively safe. Think of the citizens in Argentina and Brazil,
in Iran, in Sudan, in so many countries, or Nigeria, where they see that the reality of
their domestic currency is only one way, which is down. Therefore, cryptocurrencies look a lot less
volatile and a lot less risky than the way that we might perceive them in the United
States or in the UK. ED HARRISON: Very good point. I'm glad to end that on that note, Daniel. As always, it's been a pleasure. We've talked about different things. We didn't get a whole lot to the political
situation, the Eurozone, that's still something I want to talk to you about. Also a little bit more about oil and commodity. Maybe in the next time that we have a conversation. DANIEL LACALLE: Always a pleasure. It's been a great chat. Always great to follow you, Ed, and to chat
with you has been very, very good. Thank you very much. NICK CORREA: Thank you for watching this interview. This is just a taste of what we do at Real
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