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I’ve got something special for you this morning – an extended version of my recent interview with Dylan Grice, who’ll be speaking at the MoneyWeek Wealth Summit in a couple of weeks (it’s on Friday 22 November – get your ticket here if you haven’t already).
Dylan made his name in the wake of the 2008 financial crisis, working alongside Albert Edwards at French bank Societe Generale. His regular Popular Delusions commentary was widely acclaimed as among the most consistently interesting and thought-provoking pieces of City research available.
In 2013 he moved to Switzerland, where he spent several years working with Calibrium, a family office. But he’s now set to return to the UK to launch Calderwood Capital, a new hedge fund and research service.
This includes the return of Popular Delusions, the first issue of which is already available and which is as contrarian as ever – Dylan takes a look at the appeal of Venezuelan debt, considers why MMT (or something like it) is heading our way fast, and delivers one of the most brutal book reviews I’ve ever had the pleasure of reading.
You can find out more about Popular Delusions here. But in the meantime, enjoy the interview.
The bull market in “duration”
Given Dylan Grice’s focus on “macro”, my first question to him had to be about the financial crisis, and the fact that, a decade on, it feels as though we are still waiting for some sort of ending to draw a line under it all.
“I’m not sure there is ever a cathartic event that fixes everything – certainly not one that people recognise at the time,” he says. “The nature of the world is that you go from one unsustainable situation to another – when you get right down to it, that’s the second law of thermodynamics!”
The end of World War II was arguably a cathartic event, he notes. But no one recognised that at the time, partly because most people – including the brightest and best thinkers of the day – believed that a third world war was both inevitable and imminent, and that this one would be fought with nuclear weapons rather than conventional ones.
“Richard Feynman [the acclaimed thinker and physicist], after he helped build the bomb, spent five or six years in this very dark place. Equity markets were phenomenally cheap in the 50s, presumably because there was a massive risk premium – everyone thought the world was going to end any day.”
Another example, Grice notes, “would be back at the start of the bond bull market in the early 1980s. At the time, people thought the government had no control over inflation… But we now know that the move towards independent central banking in the late 70s and early 80s was the signal for a multi-generational bull market in bonds. The second oil shock was arguably a cathartic event – but how many people recognised that at the time?”
That said, while catharsis is nigh-on impossible to recognise while we’re living through it, the fact that trillions of dollars worth of government bonds currently trade on negative yields “doesn’t make a whole lot of sense – and the desire for inflation and stimulus appears to be a risk point for the undoing of this bull market in duration”.
By “duration”, Grice means any assets that are particularly sensitive to moves in interest rates – so not only long-term bonds, but also illiquid assets (such as private equity) and stocks whose focus is all on growth rather than profits (I often describe these as “jam tomorrow” stocks).
Is it fair to talk about a bubble in these assets?
“I hesitate to call it a duration ‘bubble’. In theory, the risk-free rate – government bond yields – should equal nominal GDP growth. And that’s what we’ve seen. So on one level it looks entirely rational. But the question then is: why is nominal GDP so low? Because inflation is low. What’s keeping inflation low? Frankly, we don’t know. And that’s what makes me nervous about trying to stimulate inflation. Because we just don’t know.”
Why we’re almost certain to see some sort of MMT
Yet that won’t stop policymakers from trying. But while central banks haven’t exactly run out of options – they can keep trying to “flood the market with liquidity”, for example – the problem is that “it’s not obvious that it’s having any effect beyond making rich people even richer”. So the government is likely to get involved.
“Modern monetary theory (MMT) is getting a lot of headlines. It seems to mean different things to different people, but while there are all sorts of potential configurations, each one of those sounds incredibly inflationary to me.” However it comes about, “the next period of my career I expect to be defined by people coming to terms with inflation”.
In the first edition of the relaunched Popular Delusions, Grice defines MMT and its offshoots as “any policy idea which is based on the argument that ‘government can afford it since it’s non-inflationary’”. He also points out that, while he’s not a fan, “bad ideas can still become policy.”
And given that policymakers all believe in the power of ‘top-down’ interventions to “make the world a more prosperous and harmonious place”, it’s only a matter of time before they decide to give MMT a go, regardless of political tribe.
“If I was on the right, I could finance enormous tax cuts. If I was on the left, I could fund New Deals, more doctors and nurses, more teachers… a shorter work week, etc etc. And that is one of the reasons why I think it’s going to happen.”
Returning to the interview, how has this affected the investment strategy of the fund he’s planning to launch with his co-founder in the very near future? “It would be easy to bet on a bear market in bonds – you just go short. But what if you’re wrong for another five years? It’s not a clever way to run a portfolio.”
Instead, “the fund we are launching is explicitly designed to remain robust if there is a bear market in duration assets – it doesn’t particularly benefit from it, but it doesn’t suffer either”.
The future of the financial system
One of the topics we’ll be covering at the MoneyWeek Wealth Summit is the Future of Money. Given the state of the financial system, and the prospect that central banks will be joined by politicians in their flailing efforts to drive inflation higher, what does that suggest about our monetary system? Is a Bretton Woods 3.0 – in effect, a monetary rest – ever going to take place?
Grice isn’t persuaded. “I can’t see it. Right now the US dollar is the anchor of the monetary system and the Americans are perfectly happy with that arrangement. One of the senators [Maxine Waters] who was questioning [Facebook founder] Mark Zuckerberg in Congress about [Facebook’s proposed cryptocurrency] Libra last month said: ‘It should be clear why we have serious concerns about your plans to establish a global digital currency that would challenge the US dollar’.”
The reality, as Grice notes, is that the “exorbitant privilege” afforded by the dollar’s global reserve currency status gives America the ability to influence policy across the world, primarily through the threat or action of imposing sanctions and thus shutting a country or economy out of the dollar-based system. “The death of Swiss banking secrecy was driven by the Americans. And look at Iran, or Turkey.”
So America has no reason to propose a shift in the monetary order, and nor do most of its allies. “The people who aren’t happy with the dollar’s dominance are the Russians and the Chinese – and that’s because they’re jealous. But are people really going to start using the Chinese renminbi instead? For me, one of the things that is stable today is the primacy of the dollar.”
The opportunity created by the passive boom – and the death of value investing
Moving on to investment, does he think it’s a tough time to be an active manager given the rise in passive investing?
“I think the explosion in passive is great for active managers. A lot of these active managers who are going out of business weren’t actually active at all – they were pretending to be so that they could charge more fees. You look at a lot of them and they’ve got 80 stocks and their biggest position size is 3% or something – that’s not an actively-run fund, that’s an index. Those guys are going out of business and that’s a good thing.
“But the more investors you have who are blind to any fundamental other than market cap, the less efficient that market is going to be, and the more opportunities will exist for the increasingly small minority of genuinely active managers.”
Is the surge in passive investing one reason why “value” has struggled as a strategy?
Grice takes issue with the term: “as Charlie Munger [Warren Buffett’s business partner] once said – ‘what kind of investing is it that’s not looking for value?’” But if we agree to define value as “stocks with low price/earnings (p/e) ratios”, then as far as Grice is concerned “value is dead”.
Why? “Any active manager who makes superior risk-adjusted returns has to know something that the rest of the market doesn’t. You have to work really hard for your alpha.”
When Buffett and his fellow Benjamin Graham ‘value’ acolytes were making their money buying ‘cheap’ stocks, the data was hard to come by – nobody had computers, so you needed to hunt down physical copies of company results and “it helped if you had a photographic memory too… But these days, who’s not a value investor? I can go to a free website and sort the S&P 500 by p/e. Why should there be any alpha derived by someone who can do that?”
We can’t discuss investment without talking about Brexit, so I ask Grice if he sees any opportunities in British assets.
“Sterling is definitely cheap, although most of your readers will already be quite long sterling. I have to say that it’s not obvious to me that the FTSE is massively cheap; government bonds are government bonds; and it’s not obvious to me that house prices are particularly cheap either. What is obvious to me is that the currency is cheap.”
Dylan Grice is appearing at the MoneyWeek Wealth Summit on 22 November in London. To book your ticket, go to moneyweekwealthsummit.co.uk. To find out more about the Popular Delusions newsletter, click here.