Merryn Somerset Webb talks to Charlie Morris, editor of the Fleet Street Letter, about how to invest in the era of Donald Trump.
• If you missed any of Merryn’s past interviews, you can see them all here.
Merryn: Hi. I’m Merryn Somerset Webb, editor-in-chief of Money Week magazine. I’m here to day with Charlie Morris, who is editor of the Fleet Street Letter, and we are going to start by talking about the election. Charlie, we’re speaking not long after the American election and the great victory of Donald Trump, and I suppose the first thing I really want to ask you, is how does this change things financially?
Charlie: Well, some of the trends that we’ve seen that have gone nuts in the last few days since the election actually began in February of this year, January or February of this year, and we saw really early this year the sort of end of the bull market in bonds and since Donald Trump’s come into power, that has moved very, very strongly indeed.
Merryn: OK, well let’s go back a bit. What brought about the end of this great bull market in bonds? You said that it ended, but it’s been going on for more than 30 years, so it didn’t just end. Something happened. What happened?
Charlie: Well, when do yields get to zero? In theory at least, they’re not supposed to go lower and in some countries they did, which is still surprising, but in America, really in 2013, we saw the first major reversal. That followed on… it was going to happen in the UK and then Brexit changed things and delayed the bond bear, but really in the late summer gilt yields decided they’d had enough and they were ready to go up. And it’s happening in Germany to some extent and it’s even happening in Japan despite their best efforts for it not to happen, so we are seeing a land of rising bond yields.
Now, as I said, since Trump won the election, it’s gone absolutely ballistic. That would be seen as tightening in most people’s eyes except that inflation expectations have rallied very firmly as well. So again, at the beginning of this year, we kind of saw the trough for inflation. We had people who had been very worried about deflation over these recent years with the sort of globalisation and the slow down and the fall in velocity of money, all these sorts of factors coming together, and you can throw in demographics as well if you like. But whatever the reasons, the game has changed and inflation expectations and bond yields are now firmly rising.
Merryn: OK, so what is it that has changed inflation expectations? We’ll accept that people expect more inflation, so they demand a higher yield on a bond, so yields go up, bond prices fall, I’ll give you that, but what is it that changes our inflation expectations? Where do we think inflation is coming?
Charlie: I think that what’s important in the election is that Trumpism really it’s all about… you know, the positives for the stockmarket… let’s talk about the stockmarket for the moment. The positives for the stock market are lower corporation tax, that’s straight on to the profits, right…?
Merryn: So, he’s suggested bringing the corporation tax in the US down from the 35% or whatever it is at the moment, to what, around 15%?
Charlie: Something like that.
Merryn: Which would make it very competitive globally, yes?
Charlie: Absolutely, and so that’s good news for the S&P 500. But against that actually what’s happening in the bond market is even bigger news and I think that when you look at the last few days and what’s happened is that companies that make the bricks or provide transport or railways or airlines or they mine stuff, anything like that has gone up.
Merryn: And this is because Trump has promised a huge infrastructure spend. We haven’t just got the great wall between the US and Mexico, not just the wall, we’ve got a whole lot of other infrastructure as well, transport infrastructure, roads, bridges…
Charlie: Yes. So, those stocks have all done extremely well, as has biotechnology, and the reason that’s bounced is because Hillary Clinton was going to put some price caps in place to make drugs cheaper. That’s not happening, so biotechnology has done well along with healthcare.
And I suppose the other area that’s done extremely well are financial stocks, so banks and life insurance companies and so on, also general insurance companies, because in a higher rate environment then these companies actually make more money than they would do in a lower rate environment.
Merryn: And also Trump has talked about reducing regulation on the financial sector, hasn’t he, quite a lot, so they’ve got the double whammy of hopefully getting a high yield but also seeing their regulation change.
Charlie: That’s right. If you want to know what his policies are and you want to cheat, then my recommendation is you go to the Heritage Foundation website and the gang there are basically his policy unit, so I think that what they think is what he thinks.
Merryn: So, what we’ve got coming here is a huge spending binge that he has really no way to finance and that’s inherently inflationary?
Charlie: That is inflationary. And at the same time, you know, he wants to make America great again which, of course, means more growth. Now we’re not talking about real growth, which for that you need lots of productivity, we’re talk about growth growth, the old-fashioned style where it’s just nominal, so inflation will do.
Now in 2009 people were very surprised when the economy was terrible on both sides of the Atlantic and yet the stockmarkets soared, and you could say that it was Wall Street that had a very good deal when Main Street didn’t have a very good deal. Now what’s happening is that whole idea has gone into reverse, good times for Main Street, bad times for Wall Street.
So, I do think, you know, a standard balanced portfolio with lots of bonds and lots of equities, depending on your risk tolerance, is going to come under real pressure over the next few years as adjustment takes place.
Merryn: OK, you’re talking about a standard portfolio. That means one that has 40% bonds and 60% equities…
Merryn: That people have been holding and considering to be diversified for the last 20, 30 years.
Charlie: Yes, diversified in a falling bond yield environment which has put both sides of that equation up.
Merryn: Yes, so now that that’s turned, we don’t want the bond bit at all anymore, is that what you’re saying? We don’t want the bond bit at all, we only want the equity bit?
Charlie: Yes. Now because bonds, of course, if you look at something like the British gilts… so we’ll get to corporate bonds and so on in a minute, but the British gilts, ten year gilts, have a negative real return of minus 1.7% per year, so actually the bond yield is not high enough to overcome the impact of what the market expects inflation to be in the future.
So, you are locking in a guaranteed negative 18% capital return over the next ten years if you buy a ten-year gilt.
Merryn: And why on earth would you want to do that?
Charlie: You wouldn’t want to do that.
Merryn: But somebody is!
Charlie: Well, in America it would be better. You’d get zero. So, in America you get a zero-real yield, which is much better than minus 1.7, but of course 15 years ago you got 4 and you could sit in an armchair and risk free have 4% real return. So, it’s very difficult in the world to find real return.
And one of the problems with the stocks… you know, stocks like the idea of growth, lower taxes, lots of growth, a lot of spending, and companies will enjoy that, but history tell us that inflation kills the P/E ratio, so the valuation of a stockmarket comes under pressure as inflation rises.
Merryn: As inflation rises to what kind of level because we’re always told that markets love inflation up to 3 or 4% and beyond that they’re not so keen. Is that right?
Charlie: Well, Russell Napier who’s your great friend, I’m going to quote him and he will tell you 4% and after 4% the bull market is over! Was that a good impersonation, I don’t know? But I have a lot of respect for Russell Napier, it’s a very good book and, yes, 4% doesn’t sound very happy.
Now, we don’t exactly know whether that’s an expectation or whether it’s going to be existing inflation. It will take some time for real inflation to actually pick up to where the bond market thinks it’s going to be in a few years’ time but it will come. There’s no doubt about that. So, we’re looking at de-rating in Western stock markets, particularly the ones with the hotspots, so the consumer staples, the defensive stocks that have done so well.
Merryn: But does this make complete sense? I mean, you look at all these defensive stocks, the consumer staples that you’ve been holding for so long, and you go to any presentation and someone will tell you about how you shouldn’t be holding bonds, just as you’ve just told me, because yields are going to fall, etc, etc. But they never then go on to say, and everything that you’re holding is a bond proxy, ie all those consumer staples, will also fall because if they’re bond proxies, if the bond market collapses, so does everything that you’re using as a bond replacement. Right?
Merryn: I think that’s the natural extension of the idea that the bond bull market is over.
Charlie: Let’s take a company like Coca Cola which is in Charlie Munger’s eyes the best company in the world because their product is sugared water which is basically as close to 100% margin as you can get, plus a lot of marketing. So, it’s a phenomenal business and it makes an awful lot of money.
Now, over the long term they’ve got pricing power and they pay a dividend and all those things, so would you rather own a British gilt yielding minus 1.7 or Coca Cola over a ten-year period? The answer must be Coca Cola unless the P/E ratio moves through the roof which it currently isn’t. And some of those stocks are a bit punchy, quite punchy, given they’re not growing very quickly, but they are a better bet than a Treasury inflation protected security or an inflationary gilt. The lesser of two evils.
But they’re both impacted by the same thing and the good thing about the stock market is when there’s a change of regime, things happen quite quickly. So, we’ll see the P/E ratios on these kinds of stocks and utilities and [unclear] and all those sorts of areas, they’ll be de-rated quite quickly. And so once they are de-rated, they’re a screaming buy because, of course, they are better than inflationary gilts.
Merryn: Now, in the Fleet Street Letter you’ve got two portfolios, right? Tell us a little about those and what’s in them?
Charlie: Well, we talked about a 60/40 portfolio earlier and I guess one of the things that I’ve been very sour on in recent years is the content of the 60/40 portfolio because if you look at both parts of the equation, it’s not exactly throwing value at you. But I wanted to construct something that had the same idea, ie bonds, low risk equities, high risk-ish, but in a different way. So, I’d have two portfolios, whisky and soda. Soda’s attempting to do the job of bonds without any bonds and whisky is attempting to do the job of stocks but, you know, we have a very sound process trying to identify the themes.
And so, in a nutshell, I suppose what we’re doing is trying to run away from the market and identify the bits that make sense to own. It’s not a high turnover trading strategy by any means but it’s just trying to make sure that we have some good thinking, some good assets, and assets that will cover off different scenarios. So, yes, I believe that inflation is going to be higher but there will be months when it contracts, there’ll be months when the opposite view is required, so you must diversify, and so you want to find different things that are going to go well but respond in the same way.
So, for example, in inflation, yes you can own a mining company and that’s great but there are times when that’s wrong. You could also own a supermarket because a supermarket if you fill your trolley full of goods, you go and pay your huge supermarket bill, and when you do so the supermarket hasn’t actually bought the food yet that you’ve just bought.
So, they are wonderful inflation hedges historically. That’s why there’s all this cash and that’s why they launch banks because they’ve got all this… they’re sitting on your cash at the expense of the supplier. So, there are different ways to fight inflation, not just buying commodity stocks.
Merryn: OK. So, the election in America hasn’t really changed your views at all. It’s simply solidified that?
Charlie: Yes. I think it’s brought forward the timetable, so my thesis all year has been I don’t like bonds and bond deals are going to rise, banks are the place to be because they’re cheap and they also respond positively to a bad environment for bonds. It’s not that the economy’s going to crash and I think there are a lot of people who are confused. They see problems in the stock market and they think that the economy’s going to crash. No! We’re in a populist environment. The economy will be fantastic.
Merryn: But in the short term surely… we’re not talking about long term growth here, in that you can build an awful lot of roads but once they’re built, they’re built.
Charlie: We’re not talking about real growth here. We’re talking about nominal growth.
Merryn: No, this can’t last for that long, so we’re talking about what, sort of a four or five-year period?
Charlie: That’s fine. That will do for me. It’s good enough for the recommendations we’re making.
Merryn: Nothing Trump can do can change the dynamics of the US economy. He can’t change the demographics, well not single-handedly anyway, and he can’t deal with the debt problem, he can’t make the US more productive. So, all these long-term problems that we’ve talked about before that the US has will still be there in four years, and eight years?
Charlie: Well, let me challenge the productivity question because, yes, low productivity has been a very negative investment theme but actually one of the things that low interest rates have done is protect companies that shouldn’t have been protected. So, actually if you look at the churn rate of businesses, ie the number of businesses being created and the number that have gone bankrupt, it’s actually pretty low compared to history and that really is a reflection of low productivity. So, it’s kind of strange that you’re saying the economy is not strong enough because not enough companies have gone bankrupt.
Merryn: So, you’re saying that very low rates have allowed crappy companies to continue and this has brought done productivity across the board?
Merryn: It’s the oversupply argument basically. So, we raise interest rates, have a nice it of creative destruction, and all is well?
Merryn: Unless you happen to work for one of the businesses that goes under in that scenario?
Charlie: Right. But what that’s saying, as you just say, is that creative destruction goes in cycles and we’re at a low of the creative destruction cycle. That should increase under this environment which, you know, that does help the productivity part of the equation.
Also on the Government debt the nominal number of bonds in issue will increase and will always increase, but in real terms compared to GDP it will start to fall because that’s the plan, inflate it away.
Merryn: That’s the plan in the US and also, of course, the plan in the UK. That’s our plan here, is to do what we did post-war, to get inflation up to, what, 4 or 5% or so and try and inflate away the real value of our debt like that?
Charlie: Yes. I also believe that what’s interesting for us now, we’ve got this Brexit movement that’s going to take place and Trump respects that movement, so I do think that puts us into a better position, the front of the queue rather than the back of the queue.
Merryn: Or the non-existent queue. So, we’re really in the same place in the queue.
Charlie: Yes, we’re in the same place, having no queue! Yes, I do take that point. But you’ve got to wonder if this populist movement then spreads into Europe and that’s, I think, a big question looking forward. And looking at the bond market in Europe, it hasn’t yet reacted. It’s said, populism is not here yet. So, when you get populism, we know what happens, the bond market just dies.
Merryn: Do we have to keep calling it populism? Can we call it something else? Populism is such an unattractive word. It’s like Brexit, a very unattractive word. Can we call it anti-state-ism or something like that, because that’s really what it is?
Charlie: Small Government-ism, libertarianism…
Merryn: Is it libertarianism?
Merryn: A little bit? I think in the US maybe it is a reaction. I think all the way through it’s the reaction against the state in one way or another, so I’ll go with anti-state-ism.
Charlie: Well, I was speaking with someone just very recently who is a lawyer, a very clever lawyer, came from the Shires, brought up in a working-class family, has done very well in the city, and honestly thought that the people had got it wrong and weren’t clever enough to make their own decision. And I said, you’re wrong, you’ve come from a working-class background, you’ve got to the top, well done you, but you think everyone else is too stupid. I disagree. I think the people know what they’re doing.
Merryn: [Overtalking] working class than you did, Charlie.
Merryn: But, you know, this is a very worrying development.
Charlie: It is. And there’s an arrogance about it and it’s extraordinary. People want to be heard and that’s what democracy is all about and I don’t think they’ve made the wrong decision.
Merryn: But the main investment takeaway from this is it will bring inflation and we need some investment ways to deal with that, and that basically means staying out of the bond market, and getting into what sort of equities particularly? You talk about American equities coming down in price quite a lot and then there being a fabulous buying opportunity, but what about elsewhere? What about in the UK where our equity market here is not particularly expensive, is it by historical standards?
Charlie: No. There’s a 4% yield and if you look at dividend futures, they justify, that’s going to… their status is going to stay. It’s not a flaky fall back. A lot of people say it is a real fall. There’s probably not much growth behind it, and so what? It’s a better deal than the bond market. There are parts of the stock market that are fantastic. We’ve already mentioned the financial sector, there’s life assurance, and we’ve also got the commodity sector and suchlike.
I think you could also be brave. I know it’s the most stupid recommendation that I’ll ever give in my life and I’ve always been taught never recommend an airline, but you could actually say an airline in this environment, and oil’s not too high…
Merryn: Why an airline?
Charlie: Because the economy’s not going to die and their prices if it is. So, that’s an opportunity. I’m not suggesting we fill a portfolio with airlines and there’s none the Fleet Street Letter at this moment…
Merryn: Are they always saying never ever, ever buy an airline? Then that’s lesson number one for…
Charlie: Yes, never buy an airline.
Merryn: Just for the record, Charlie’s recommending airlines!
Charlie: Yes. Yes, I might be. I might be. Then there’s also other countries, so we can go elsewhere for diversification and obviously going back to February again, we’re in an upcycle for commodities and for certain emerging markets, and so you can pick the good ones. Again, taking it back to the politics, a country that’s got bad politics and a bad relationship with America but now a good relationship with America probably is Russia and also they’re a commodity producer. So, you think, well, that’s a cheap market that could be re-rated.
Merryn: That’s a very cheap market. That’s still on cyclically adjusted P/E of five times or something like that, a P for this year of eight. So, if you think that the US is on, what, 20 and 25 in comparison, that’s cheap, really cheap.
Charlie: And you can buy their biggest .com, vk.com, which trades on the London market under the ticker mail and it dominates the Russian language on social media, and you can buy it for 3 billion market cap, whereas Facebook is 300 billion for the English language. So, you’d think…
Merryn: But more people speak English than Russian.
Charlie: Sure. But it’s still a… to dominate a language is a nice one to have. So, there’s opportunities like that. You can go to a country like Chile which is very well governed and it’s got a very high GDP per capita and, of course, is a commodity producer as well. Then you’d probably want to stick with something like India because it’s fine but then probably avoid China because I think what you’ve got now is a falling currency in China. It’s down about 10% since August 2014 and it’s going to continue to fall.
Merryn: But that’s good news for China, isn’t it? I mean, China have been wanting to get its currency down for ages and we’re all mercantile now, right?
Charlie: Sure. But actually what’s happening is its foreign reserves are falling, from 4 trillion to 3.1 trillion and still falling. That’s never a good sign for a macro investor. We know what having no foreign reserves looks like because Egypt just this week saw its currency fall by 48% and it’s not fun when you get into that position. So, I think it does make sense to go with places that have a future and offer some kind of real yield.
And then there’s Canada, right next door to America. Is Canada Mexico or not, we’re about to find out. So, is it a friend of America, and if it is a friend of America, that’s another source of diversification. So, I think a bit of geographic spread and then a range of sectors which can respond positively in this environment, and you can also own the stuff you don’t want to own provided you don’t pay full price for it.
So, we can all own the consumer staples, we can own property and all those things, provided we can buy it at a deep discount. So, we’re going to watch the investment trust sector for opportunities there when things are heavily mispriced and looking forward and saying, actually, it’s bad but it’s not that bad.
Merryn: OK, so all of this is in the Fleet Street Letter, so subscribe to that and you get this wisdom every week, every two weeks…
Charlie: Far too often! I write every week and, yes, basically there’s a weekly email that goes through the portfolios looking at what we can do and updating the readers. I answer questions from readers, they all write to me and I encourage feedback because I want to know what they’re thinking…
Merryn: You answer every question?
Charlie: I’ve responded to every single email I’ve ever had.
Merryn: I will reply to the emails you sent me always, but it might take a few years but I will get there. Charlie does it more quickly.
Charlie: Sometimes it’s a quick reply, sometimes I stack them up for three weeks and then just go through them all in a morning…
Merryn: But everybody gets an answer?
Charlie: Everybody gets an answer. That might not be true when there’s 100,000 readers but that’s not yet, so I don’t have to worry about that problem.
Merryn: OK, and anyone who gets the Fleet Street Letter is going to be told when it’s time to buy American stocks, told when the best investment trusts are at great discounts…
Charlie: Yes, you get the recommendation, you get the percentages of your portfolio and off you go.
Merryn: And they’re going to end up rich, right?
Charlie: Well, that’s not what I’m saying. I’m just trying to protect and offer a diversified portfolio which is different from making money. If you want to make lots of money, then I suggest you set up a business or work really hard or buy a lottery ticket or one of those things …
Merryn: Buy a lottery ticket? I’m always told that doesn’t work?
Charlie: Of course it doesn’t work, but it works for some, doesn’t it!
Merryn: Charlie, thank you very much, very much indeed. What I’m gathering from you is that the Fleet Street Letter is certainly one of your portfolios is more about protecting capital than making people rich, and the other portfolio, whisky, is slightly more aggressive, right?
Charlie: Yes. So, I suppose the second one, whisky, is really is about trying to beat the stock market and right now we’re 45% cash, having sold ahead of the Trump election, which was the right thing to do, and we’re looking for ideas right here, right now.
Merryn: OK, and subscribers will hear those ideas. Charlie, thank you very much indeed.