Alec Cutler: it feels like the 1970s – what should you buy?

Merryn talks to Alec Cutler of the Orbis Global Balanced Fund about the inflation of the 1970s compared with that of today, and what investors can do to counter it.

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Merryn Somerset Webb: Hello, and welcome to the MoneyWeek Magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine. This podcast is being recorded on February 11th, 2020. With me today is Alec Cutler, who is director and manager of the Orbis Global Balanced Fund. Alec, thank you so much for joining us today.

Alex Cutler: No, thank you.

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Merryn: Can we start perhaps by you just telling us a little bit about your fund so we know what it is that you do?

Alec: OK. So just for context, Orbis, I’m not sure everyone knows who Orbis is, but we were founded in 1989, and we run 26 billion in sterling over eight strategies by 400 people in ten offices around the world. And I’m fortunate enough to lead the multi-asset team and our flagship fund in the multi-asset team is a £3bn Global Balanced Fund.

And the Global Balanced Fund, as the name implies, can invest in equities, in bonds, but it can also use hedging on the equity side and invest in commodities. So a lot of flexibility to deal with all the environments that the markets can throw at us.

Merryn: And how has that worked out over the last couple of years?

Alec: It started out great and we rotated. We were actually a fairly growthy fund for the beginning, for the first few years. It’s a ten-year-old fund now. And I rotated towards value and then deeper value and deeper value as it underperformed. So up until last year, we struggled, 2018-2019 and half of 20. And since the bottom of the Covid sell-off, which just happened to be the day the recession started and ended, we’ve done quite well. So we bounced back quite strongly.

Merryn: Excellent. So my guess is that you’re moving into an environment that is really going to suit you at the moment. Now, we’re talking just as the latest CPI numbers have come out for the US. Quite shocking, and it’s beginning to look like… no, it definitely looks like anyone who at any point over the last year said that inflation is transient was completely wrong. In fact, it’s beginning to feel a little bit 1970s out here.

Alec: Yes, I couldn’t agree more. And I think it’s sending all the active managers scrambling to find notes from the 1970s and to call their mentors and find out if they know anything about the 1970s. I’m fortunate enough to have lived through it. I’m old enough.

I did try and… Well, I thought about trying to track down my mentors but they’ve all been deceased. So it would’ve been wonderful to be able to talk to Allan Gray and Anthony Hitschler, two people I respect greatly. But unfortunately both passed away. So when do you realise you’re the old person in the firm? That was it.

Merryn: Yes. Well, it’s interesting, isn’t it? There are so few people around, certainly working, who have experience of managing money or, in fact, doing anything in a heavily inflationary environment.

Alec: Yes. I was a teenager. I went to college in 1984. So it was pretty much my adolescence. And I remember it. I do remember it being a painful period. I do remember my father being out of work. I do remember him bringing home a coal stove that I then had to stoke every morning at 5:30, and four months later, had to try and clean the black soot off the entire inside of the house.

It was not a good time. Stocks went down. Bonds went down. And everything else went up in price. And the investors of today, as you point out, maybe one in 1,000 experienced that environment, and the vast majority of investors have only ever known a 20-year bull market punctuated by three-month sell-offs.

Merryn: Yes. And there’s a feeling that most people expect some kind of reversion to what they consider to be the norm. I’m hearing a lot of people thinking that this is only going to take a little while and then inflation will fall back down again and interest rates will stay low and the next decade will end up being a little bit like the last decade.

It reminds me of when I first when to Japan to work there in the early 1990s. And the bull market had fairly decisively ended. But nonetheless, most of the brokers still believed that that huge bull/bubble market was the norm and they expected it to return. They all said to me, you’re here at just the right time. It’s about to take off again. It never did, of course. But it’s interesting how long that idea that normal is what just happened. It carries on.

Alec: Yes. And it’s my favourite area of study in behavioural finance, is the anchoring theory, where people anchor at a certain point in time and they tend to anchor at a point in time that’s either very fun or happy or a good memory, like a stock price peak, or very, very painful, like the bottom of a bear market when they got out. So that is certainly what’s going on now.

And I talk a lot about the five stages of grieving right now because that’s the process that pulls you away off that anchoring. You anchor on that wonderful feeling of markets that are going up 10-12% a year, and hey, I own the big mega cap growth tech names and they’re wonderful.

And you get a minor correction and another correction and you’re in a state of denial because we’re always, this is how you get a rebound and buy the dip. And then you blow through the dip and you start to become angry. And you’re starting to see investors lash out at their professional money managers who’ve been telling them to deny everything.

And I suspect, if you flip over to the Federal Reserve and the central bankers, they were the lead cheerleaders. There was no inflation. Then it was transitory. Then it was, we’ll be back to 2% by the end of 2022. That was Powell in December. And now he's, we’ll be back to 2.4% at the end of 2022. And I suspect after this latest inflation reading, he might be talking about 2.6% by the end of 2022. So it’s a sort of cross this line and I’ll kill you type denial.

The anger will come. If this is the real deal, the anger will come towards the Fed. And that will manifest itself in a complete lack of confidence. And as you know, inflation is a confidence game, so once you have a loss of confidence that anyone has control over inflation, then inflation just starts compounding and feeding on itself as people go into inflation behaviour. Buy today what’s going to be more expensive tomorrow. Ask for a raise, which is why the Bank of England governor is telling people not to ask for a raise, as tone deaf as that sounds.

Merryn: Yes, I don’t think anyone is listening.

Alec: Yes.

Merryn: And certainly, I’ve told my readers not to listen. Why should they put up with losing real income every year? It might be better for the economy as a whole, but on an individual basis, why should you be the one who takes a hit?

Alec: Exactly. But what it tells you, more alarmingly than a tone deaf ivory tower attitude, is that if you listen to the central bankers, in order for them to maintain confidence, they say along the lines of, we’ve got this, don’t worry, this isn’t the 70s, we have a much better toolkit now. Powell is into toolkits. And if this, if trying to get people to not ask for a raise, is the toolkit, is the new toolkit, we’re in big trouble.

Merryn: We’re in big trouble. OK, now I’m getting the sense here, Alec, that you think we are in big trouble. How do you see the next few years panning out in terms of inflation?

Alec: I primarily studied the 70s period as an instructive tool to talk to the investors within Orbis not to use the last ten years as your model for the next ten years. So it’s really just to drag people off that “past is prologue” heuristic and to look at and think about periods in the past that might also share some characteristics with the environment we’re heading into. The 70s was a terrible, awful period. The 2000 TMT bubble crash, that was an awful environment for everyone but value investors, by the way.

Merryn: Oh, it wasn’t an awful environment for everyone, was it? Because it was a slightly different time in that, for starters, not everybody was an investor at the time. Many more people are investors now, particularly in the UK, now we have an auto-enrolment system. And it was only really a small part of the market. It wasn’t the same all-round crisis that affected lots of people. It was a bit different, wasn’t it?

Alec: I think I’m affected by my personal experience, where a neighbour’s father came over and knocked on the door. And he was an anaesthesiologist from New York. And he came to the door and he had some papers and he was crying.

Merryn: Aw.

Alec: And I said, what’s going on? And he said, can I talk to you about my portfolio? And he showed me his portfolio and it was all the go-go stocks from the late 90s that had cracked 30%, 40%, 50%, 70%. And he said, I invested in the 70s. I vowed never to invest again. And all my doctor friends were making so much money in the late 90s that I had to get in. And I gave, I’m not going to tell the name of the brokerage firm, my savings and it’s now down 70%.

So I think at least in the US, people really got into it at the end. And as you know, the market causes the most pain to the most people. And there was a lot of pain to go around, in the US at least.

Merryn: OK. Sorry. I shouldn’t have made that interruption.

Alec: That’s OK.

Merryn: We’re back to the 70s and what a bad time that was.

Alec: Yes, it was pretty awful. And studying it brought the analogies to today home very clearly. And I can best do that by talking about the Microsoft, Google, Amazon name of the day. Do you know what that was?

Merryn: Tell me.

Alec: Lowly IBM. So IBM went public in 1973, and it was… And I remember my father talking about IBM and what a great company it was in the 70s. It came public at 40 times earnings in 1973. It was growing earnings at 60% a year.

Merryn: Wow.

Alec: And so came out at a massive premium. Sounds very familiar to some of the things we’ve seen recently. In fact, it came out at a discount to Amazon. But if you combine Microsoft, Amazon and Google’s multiples, it would be about the same as IBM in 1973. For the next two years, it grew earnings at 60%. Can’t get much better than that.

Merryn: No.

Alec: The stock price corrected by 50%, went down 50%, despite the fact that it was doing tremendously well. And if you think about it… And by the way, it didn’t eclipse its IPO price until ten years later.

Merryn: Wow.

Alec: In 1984. So the people that are saying today, well, all I need to do is own great growth companies with fantastic franchises that have very clear visibility of growth, I won’t be hurt, no matter the valuation, so that’s what I’ll hold and just roll through it. You roll through it, you might be rolling through and waiting for ten years to get back to where you are today.

Merryn: That’s interesting, and I still hear this all the time. It doesn’t matter what the price is. As long as you’ve got a quality company, as long as it’s continuing to grow earnings, etc., you’ll be fine. But that is absolutely not what history tells us. History tells us, if you pay too much, however good the company, you’re going to get hurt.

Alec: No, and of the top five names in 2000, the largest names in the US were Cisco, Intel, Microsoft, General Electric and Walmart. Of those names, the only one that’s in the top five today is Microsoft. And in the medium term, between those two points in time, we were buying Microsoft at ten times earnings. We sold it far too early, and it’s a fantastic company. But to say that that can’t happen again is kind of idiotic because it has happened twice. And this is just the type of environment that makes that happen.

Merryn: OK. So what do you think is going to drive the inflation that might bring us back to this 1970s scenario? We know that energy prices have been rising. We know that there’s a supply chain crunch, etc. But all those things are possibly reversible. I keep being told that there are signs the supply chain is easing up already and it may be that energy prices stop here, in which case, they need to keep rising for inflation to keep rising, right? So what do you think is going to make inflation come in at these 7% numbers for more than a couple of months more?

Alec: Yes. Inflation is an amazing beast in that it doesn’t matter what sparks it, it’s what comes next. It is does it compound? How is the PMM behaviour reacting to it? So in the 70s, the misnomer is that inflation was caused by the oil embargo in 1973/74, and then again in the Iranian Revolution in 1979. In studying it, inflation was ramping hard before the oil embargo, and prices of raw materials, in particular, but also wage inflation.

And so then you say, well, what caused that? And the cause of that… And again, this is a strong parallel to today. The root cause of that was the US going off the Gold Standard. The Bretton Woods Agreement put tight guardrails on money supply. It really restricted what the central banks could do. And when Nixon pulled us off the Gold Standard in 1971, it allowed the Federal Reserve to crank up money supply. Cranking up money supply beyond those guardrails started inflation.

And that’s something interesting today. We had a similar thing with quantitative easing and ZIRP [zero-interest-rate policy] and NIRP [negative-interest-rate policy] and all those crazy acronyms where, after the global financial crisis, people said, well, we have a lower limit here. We have a lower bound to how much you can stimulate with money creation.

And the central banks, as smart as they are, figured out a way to blow right through that level and do quantitative easing. And that’s an experiment. And the references to the early 70s refer to experimentation. The parallels are incredible in this regard. But that caused inflation, a big increase in money supply, bigger than in any time in the past 20 years.

And then the oil embargo hit and you were off to the races. But then it compounds. And this is what I remember as a kid. I remember waiting in line on our assigned day to go to the gas station and get gas. And I remember the kid going out and changing the numbers on the gas price.

Merryn: Oh, you saw that?

Alec: Sure. And that just meant you wanted to get gas more.

Merryn: Yes.

Alec: Can I get a whole tank of gas instead of half of tank of gas that we were allowed. So that feeding frenzy is really what lights it up and makes it sustaining and very, very difficult to snuff out.

Merryn: And then, of course, that inflation drives everyone asking for more money. It drives the wage demands and it drives the union power as well because people want to collect together to give themselves more power when they see inflation rising. So inflation enhances union power, enhanced union power leads to higher wages, etc., and off we go.

Alec: Yes. And if you look at today, if you look at the elements today and say were those elements there in the early 70s, late 80s, a lot of those elements are there. Some elements are much, much worse.

Merryn: OK, what’s worse?

Alec: The valuation levels, particularly in the US and the S&P and the Nasdaq are just much, much, much, much higher than they were in the early 70s. The debt loads, just night and day. The debt loads now, the government debt loads now are on par with the spike in World War Two. And we have not been in a war. Crazy low rates.

So the ten-year Treasury was yielding 4% at the end of the 60s. It’s yielding now one… It just popped up to 2% today, yesterday. Now it’s a bit below. But we were as low as 0.5 on the US ten-year and we were negative on the Bund until last week. Quantitative easing is a complete experiment that makes going off the Gold Standard look like child’s play from a level of difficulty and trying to understand where this thing is going to go.

The wealth gap now is miles bigger than the wealth gap… There wasn’t much of a wealth gap at all, in fact, in the late 60s. Coming out of the war, everyone started the same and you didn’t have this big gradient between the richest and everyone else, and labour was very strong. A third of workers were in unions in the 70s. 6% in the US, and I think it’s around 8% in the UK of workers are in unions today. But the popularity, the public sentiment around unions is as high as it was in the early 70s.

Merryn: Oh, really?

Alec: You’ve had this…

Merryn: That’s interesting.

Alec: You’ve had this huge shift. Yes. You’ve had this huge shift. And I think it relates to the thing prior. The wealth gap is so high. And in particular, if you look at everything from the GFC through jaundiced eyes, it looks like everything the Fed has done, everything the government has done is to protect the wealthy. It’s caused massive financial inflation, financial asset inflation, which the 99 don’t really participate in though we’d like them to, and it’s just made the rich richer and richer and richer.

Merryn: And it also protects the old. That’s one of the interesting things about this whole dynamic is obviously the old tend to be wealthier than the young. They’ve had more time to build the wealth. And a lot of the things that we have done with quantitative easing, etc., forcing up asset prices, has been to benefit the old to the detriment of the young. And, of course, that’s something we’ve seen during the pandemic as well. You’ve asked the young to give up everything to protect the old.

And I keep looking at this. I was thinking about this this morning. It’s such a strange dynamic at a time when fertility rates have collapsed across the Western world and populations outside seven or eight core countries around Africa, etc. are going to start falling relatively soon. We have a falling number of young people, both relative to old people and also actually in many countries in absolute terms.

You would think that with that scarcity of the young, we would want to take care of them beautifully, we would want to look after them even better than we’d want to look after our old. But you only have to look at things, the weird dynamics of making children wear masks when adults don’t have to and focusing entirely on protecting the wealth of the old at the expense of the young to think, this is really bizarre.

Alec: Yes. We are living through an incredibly bizarre era. But I wouldn’t say… You have to differentiate the old. So the old that have financial assets, we’re protecting. The old that are on a fixed income…

Merryn: We are not.

Alec: Have been getting hammered. Their cost of living increase has been nil, which is awful for them because the reality is their cost of living has been skyrocketing. The cost of living from a medicine standpoint, at least in the US, that’s not as highly regulated as it is in the UK, but old people are really struggling with this low/no rate environment. So they’ll at least get some benefit.

So the positive difference is supposed to be, if you listen to the central bank mouthpieces, that they have these great, new tools.. They all studied the 70s. I went back. In looking at literature, trying to find out and learn about the 70s, all the literature, all the academic literature is written by the people at the central bank. That’s what they did in grad school. So they know it really, really well. And I think it’s given them confidence, perhaps over-confidence, that they’re not going to make those same mistakes.

Merryn: OK. So what are they going to do?

Alec: I don’t know. I don’t know what they can do. They talk about new tools, but if new tools is represented by yelling at people and telling them not to ask for raises, we’re in big trouble. I think their new tools might just highlight to them sooner how screwed they are, pardon my language.

Merryn: Yes.

Alec: And how screwed we are. Because talk about sitting between a rock and a hard place. You want to fight inflation but you have a fragile economy. You fight inflation, you go into recession and people lose their jobs. And it’s very politically unattractive right now, just as it was in the early 70s, by the way.

Nixon was fairly famous for berating the Fed Chairman for not easing interest rates and increasing economic activity. It sounds very similar to the last President we had, and I wouldn’t be surprised if Joe Biden, in his kinder, softer way, makes the same points. He desperately does not want a recession into the midterms.

Merryn: Yes. Interesting. Is it possible that central banks don’t really have any tools at all to control inflation in that over the last 20 years or so, when they’ve thought that it has been them controlling inflation and we hear about their targets and their special tools for doing this, etc., inflation has just been low anyway because of globalisation, because of the opening up of labour markets in Eastern Europe, China entering the world economy, etc. All these things kept inflation low automatically, regardless of what central banks did.

So they’ve been bigging themselves up for something that was just happening. And now we’re moving into an environment where inflation is going to just happen because a lot of the dynamics, the big trends that have given us low inflation over the last 20-30 years are reversing. So it doesn’t matter what they do. It’s going to happen anyway.

Alec: Yes. It’s a little bit… And I don’t want to be too flip because they can jawbone. But to me, it’s a little bit like yelling at the TV and thinking you’re going to have an outcome on the football game.

Merryn: That’s very good. I like that. I’m going to use that one. I’m stealing that quote, definitely.

Alec: You’re welcome to have it. So I think they’re in big trouble. I think that when they did their academic papers, they didn’t think that this would be the set-up. But it’s just very hard. And if you’re ever going to listen to the very old people, the old people that still get asked to go on podcasts and TV, who want to talk about this, if you see what they’re talking about now, it’s this. They can’t see how we get out of this alive, I guess alive referring to economic health and stability. And I think it might be a good time to listen to old people.

Merryn: Yes. And if we were to listen to those old people, what would they tell us to invest in?

Alec: Yes. So you can imagine that this is where everyone in our firm wants to get to. OK. So what? What do we do? What do we do to protect our clients? And I don’t want to sound like a McKinsey consultant, but it does depend on the shape and nature of what’s driving this.

So obviously, you referred to the Fed being a bystander, I think the thing where they’re most clearly a bystander is the commodity prices. The Federal Reserve can’t pass an act that says go out and build more capacity, go out and drill for oil, go out and drill for natural gas, go build a copper mine. That’s not their remit.

The government can. The government could incent people to go drill for oil and gas. They have in the past. This government doesn’t seem to want to, at least in the US. And in fact, no government in the world wants to. But energy would be the first place to look, in that if that’s going to be the prime mover, the spark that causes this rolling inflation, then your safest place to be is in those that produce the inflating commodity that starts it and keeps it rolling.

Merryn: Yes, but you’re talking about old fashioned energy. So we’re talking about oil and we’re probably, in particular, talking about gas, which everyone is gradually coming around to recognising is a major part of the energy transition.

Alec: Yes. We’re almost exclusively invested in gas. So we have 15% of the portfolio in energy, and it’s very highly weighted towards gas because, as you say, gas was lumped in as part of the evil carbon emitter group. Lumping it in with coal is not fun for the gas guys. But it couldn’t be farther from the truth.

The only way you get rid of coal… It isn’t with windmills that aren’t selling now because the price of steel and copper are too high, and it isn’t going to be solar that only works for six hours a day. It has to be natural gas. So if you want to go get rid of coal, you’ve got to use a lot of natural gas. It’s the transition fuel.

And we were able to buy into these names at very low valuations because the zeitgeist drove the valuations down so low and stopped production to the point where you could easily see supply-demand getting out of whack and you could easily see governments following the logic and saying, in the end, we need these. And you’re seeing that in the EU. You’re seeing that in the UK. And you’re seeing that in the US. And we’re welcoming it.

Merryn: It’s amazing how quickly something stops being evil when you really need it, isn’t it?

Alec: Yes. Cold will do that and the cost of electricity. And one thing I’m seeing now that’s pretty alarming is an echo of what’s caused this. So why are we here? Why are natural gas prices and electricity prices so high? Because the zeitgeist, the ESG movement, which is fantastic, it’s all about participative and democratic capitalism, which I know you’re a big advocate for…

Merryn: I’m very keen on, yes.

Alec: As am I. You have to understand how this stuff works. Otherwise, it won’t work for long. Capitalism won’t be sustainable if everyone doesn’t participate. So it’s great to see this participation and all these ESG funds pop up. But because it’s rather new, it’s missed the target quite a bit, particularly on the global warming side.

And telling BP and Shell that they have to divest, they have to stop producing energy does two things. One, it’s not like it’s not going to get produced. When they leave… When BP left Iraq, Sinopec comes right in. The Chinese and the Russians come right in and they help pump oil with abandon. And I don’t know, if you’re a better, whether you want to bet that BP is going to do a better job for the environment or a Chinese or Russian state-owned enterprise. But I’ll be willing to bet anyone who listens to the podcast my standard bet, and I’ll take BP and Shell.

But the other thing it’s caused is a reduction in the amount of natural gas being produced. And lo and behold, the windmills and solar and the battery unicorns really can’t do it. You need baseload power that can come on and handle it. That’s natural gas, that’s coal and that’s nuclear. Nuclear has limited capacity. Coal is illegal, basically.

Merryn: Give or take, yes.

Alec: That leaves you with natural gas. And so at the same time the supply of natural gas went down because people forced it down, people power, including taking Shell to court in the Netherlands, so people cannot wipe their hands of this and say it wasn’t us, it was us, to now go after those companies and say that they’re making super profits and it’s their fault because they didn’t produce enough and we’re going to go after them and tax them more, well, what happens when you tax somebody more? You produce less, or you go elsewhere.

So if you’re taxing me in the UK, I’m not going to produce in the UK. There are plenty of places to go produce. I’m going to go to the West Coast of Africa. I’m going to go offshore Brazil. I’m going to go offshore Guyana. I’m going to go to the US and frAlec: in Texas. So we’re just going to keep the problem rolling.

Merryn: It’s interesting, isn’t it? And John and I, John, the Executive Editor of the magazine, we talk quite a lot about this bizarre hatred that people have in the UK and globally for these oil giants. They treat them like the enemy. Whereas, in fact, and I think you said that in a couple of years, we’ll probably look at these companies as our great national champions as opposed to our enemies.

Alec: We absolutely have to, and people need to suck it up if they think that these are evil companies. We’re seeing the same things in defence contractors in Europe. They’re talking about a social taxonomy, where they’re going to tax companies that they feel produce social ill. And right at the top of the list are European defence contractors.

I can’t think… I thought that the energy issue, the natural gas issue was the epitome of shooting yourself in the foot. But now, particularly in light of what we’re seeing in the Ukraine and in the South China Sea, telling your indigenous defence manufacturing base that we don’t like you anymore really isn’t a smart thing to do. And while you can buy oil from the Chinese and the Russians and the Middle East, I just don’t see England buying…

Merryn: Magnums.

Alec: Flogger jets from Russia. It just isn’t going to happen and doesn’t make any sense. So you have to embrace your defence contractors as well because they’re the ones who give you the freedom to chain yourself to the headquarters of BP if you want.

Merryn: Well, quite.

Alec: I challenge anyone to chain themselves to the front doors of Sinopec, CNOOC or Gazprom. I don’t think that’ll work out well.

Merryn: I don’t think it’s going to work out well either. Although, if you were an honest protestor, probably you’d give it a go.

Alec: But I don’t want to… I listened to the last five or six of your podcasts to prepare for this, Merryn.

Merryn: Oh, thank you.

Alec: And I don’t want to contribute 100% of my time to what feels like a wet blanket and a bit of gloom and doom. So I do want to talk about some names because I…

Merryn: Oh, good. Yes. So we talked about investing in energy, absolutely. I know you’re quite keen on investing in gold during this period. And then you also have specific stocks that you think still really represent value, right?

Alec: Yes. And this is the beauty of being an active manager. Right now, our active share is 97%. So that means that 97% of the portfolio is different from the benchmarks that we are measured to. And that’s about as high as it’s ever been.

And that means we don’t own the biggest names. We don’t own the big growth names. We own a lot of idiosyncratic, small, weird names, or names that you’ll recognise but don’t like as a business for some reason or another. But it leaves us the most excited our team has been about the portfolio in the ten years that we’ve been running it.

Merryn: Oh, good.

Alec: And from a numbers standpoint, the free cash flow of the portfolio relative to the market is as high as it’s ever been. So the value orientation, if you will, is about as deep as it’s ever been. And I think it’s about as deep as it can ever get. Never say never, but it’s kind of the polar opposite of the equities that make up the benchmarks right now. But it…

Merryn: Oh, brilliant. So can we talk about a couple of the names that you have in there that might be interesting to readers?

Alec: So just, yes, I’ll stick to the stagflation or inflation theme. We’ll stay on our banana seat bicycles and talk about the 70s and our bell-bottoms and government cheese and UB40s for you in the UK. You remember those?

Merryn: I do.

Alec: It wasn’t originally a band. I had to tell my kids.

So just thinking about a stagflation playbook, number one would be energy names. So we’re loaded with BP, Shell, Schlumberger, California Resources, Woodside in Australia, Impax in Japan. There’s great energy opportunities all over the place. And these all, almost universally, sell at double-digit free cash flow yields. Gold you mentioned. So we’ve got 10% of the portfolio in gold, in gold miners. At heart…

Merryn: In the big ones?

Alec: Yes, Barrick and Newcrest would be the big miners. But we also own and we’re also in commodities through tech resources, First Quadrant. We own some bonds in First Quadrant. Then, in thinking about what else tends to do well, one is hard assets. Property and hard assets tend to do well because you can increase your pricing and keep yourself inflation-neutral.

Kinder Morgan, a fascinating company, completely left for dead. It is the largest natural gas pipeline company in the US. If you use natural gas in the US, chances are it comes through a Kinder Morgan pipeline. To try and build that pipeline today would be in the trillions of dollars.

And this is a $20 billion market cap company run by an energy visionary named Rich Kinder, who has been around since he left Enron, and took the pipelines with him, by the way, when he left Enron because they didn’t think they were worth anything. His base salary is $1 and he doesn’t allow any corporate jets, which is something from my deep value roots that I find quite attractive.

But they are a toll-taker. It’s 90%-plus contracted. These are long-term take-or-pay contracts with solid investment grade counterparties like utilities that use that gas to produce electricity. And as we discussed, I think we agree that natural gas actually has a bright future, not a dim future. So future better than the past, yields 6.5%, 10% free cash flow yield.

Vornado is an office property Reit. It’s the largest owner of Class A office space in New York. No one likes New York City right now because we’re coming out of Covid, just like they didn’t like New York City during the general financial crisis. They didn’t like it during the global financial crisis. They didn’t like it after 9/11. New York keeps coming back. It’s New York.

And then Simon Property Group is a mall Reit. It’s incredibly high quality, best malls in the US. And this notion during Covid that people weren’t going to go back to the malls, the malls have been flooded with people. They just want to get out and go somewhere where they don’t get rained on.

And the fourth area is the defence contractors I mentioned, so BAE, Saab, Rheinmetall. These are European defence contractors no one likes because they’re considered socially ill, if you will. The reality is they defend Europe from anything they need defending from and, more importantly, dissuade anyone from being interested in messing with Europe. They’re incredibly important.

They sell at very high free cash flow yields, nice dividends, and they will be defensive in a sell-off because we need them. And we need them increasingly. Think about it. People talked about the peace dividend. So with glasnost and with China being friendly, we had this massive peace dividend.

It allowed us to globalise our supply chains, and see how that’s working out now, which gave us more power over labour, which meant we didn’t have to deal with unions anymore. It gave you all these wonderful things, if you were corporates, that are now going away. So I think we’re going to get the flipside of a peace dividend.

Then the last area, and this is where the Orbises of the world tend to really shine, is in idiosyncratics. So in the 70s, there was a whole pocket of names that worked because they were either so darn cheap and hated, that there was nowhere to go but up, as long as they just muddled along, or names that have drivers that have nothing to do with economic activity or do better when economic activity is getting worse.

So in the names that everyone hates that are super-cheap category, I get eye rolls when I even mention the name, Bayer, the purveyor of Roundup and genetically modified seeds. They do all these evil things. But you don’t have to like a company to need a company. Without Bayer, world hunger would just go off the charts. You can’t feed the world without the ag chemicals and the genetically modified seeds that the Bayers of the world produce.

And because no one likes it and because they’ve had to pay out for a Roundup lawsuit, which they never should’ve lost, in my opinion, and it’s been appealed to the Supreme Court who is thinking about taking it on, you leave those things aside, Bayer is selling at six to eight times earnings and pays a very nice dividend. So while everything else is going down, Bayer can just hold up. It can be a huge winner.

Burford Capital is a fantastic, very interesting company. They invented the space that’s now called litigation finance. They look at people who are suing other people, or entities, who are running out of money and can’t afford to keep the lawsuit going, which is the number one tactic of a big company, just outlast the resources of someone who is trying to sue you, and they come in and they offer to pick up the tab. And offering to pick up the tab, they get half the winnings if they win.

Merryn: Ha, that’s a bit steep.

Alec: Yes. Well, half of something is better than nothing.

Merryn: Yes, better than half of nothing. You’re right. You’re right. I’m sure people are very grateful.

Alec: And they bring a lot to the table as well. They know the judges. They know the venues. They know what court it would be best to bring this to. And they know suits and they know probabilities. So just as I’m a manager of stocks and I need to figure out the risk-reward of a stock or a bond, they and a reinsurance company in Bermuda, where I am, needs to figure out the risk-reward of a risk, a risk of loss.

These guys figure out the risk and reward of cases. That’s where they bring their value add. And it’s not them going out and finding it. It’s not them going out and chasing widows and orphans and saying, let us handle your case. They’re not ambulance chasers. Those widows and orphans are finding them and saying, I can’t afford to keep doing this. And then they look at the merits of the case. They make a determination on the probability of success. And then they make a decision as to whether they’re going to pick that up or not.

And they pick up about 20% of the cases that come to them. And their return in invested capital is astronomical. They’re really, really good at this, and they’re one of the very few companies who are good at it. Some people try to come in and just can’t do it. But this sells at a single-digit multiple and we think it’s obviously completely idiosyncratic, would’ve been a fantastic name to own in the 70s.

Merryn: Yes. And I bet that they’ve got good times ahead. Nothing brings litigation like a good bear market, doesn’t it?

Alec: Exactly. And there’s a lot of litigation coming from Covid-19 as well. Now, the other category are these energy transition names that are currently considered to be bad and evil and do nasty things. But we can see, we have line of sight or logic says, no, they’re one of the good guys, where we can go and invest in that gradient, buy on the cheap when it’s considered to be evil, and ride that gradient up.

And work with the companies to either help tweak what they do, so this is participative investing for us, these are the things you can improve to improve your profile, or sometimes it’s just a PR exercise. In fact, Drax, which is evil, produced 12% of the UK’s electricity via evil coal, announced seven/eight years ago, they were getting out of coal and they were replacing it with bioenergy.

Merryn: Yes. But we’re all a bit suspicious of that, because they use wood pellets that they import from Canada and burn in the UK. And we all look at it and go, really? So we don’t really like that.

Alec: There are some single-issue people out there who, the placards that they carry as they march in front of Drax’s headquarters are of beautiful willow trees in the Savannah portion of Georgia. These are not beautiful willow trees. These are paper mill trees and telephone pole trees and two by four trees that are in managed forests that have been managed for over 100 years.

And they’re taking… I know it's boilerplate and I know that the single-issue entities will find a picture of a log that looks rather straight and they’ll say, no, they’re cutting down perfectly good, round trees. They really aren’t. They are taking the scraps from the lumberyard, they’re taking the scraps from the telephone pole yards, they’re taking the scraps from the paper pulp mills, they’re taking the diseased trees, and they’re grinding them up, smashing them into pellets and they’re bringing them to the UK.

And they’re working really, really hard to try and find more local-sourced resources through switchgrass or fast-growing tree groves in the UK. And then they’re pelletising those and burning them. That is considered, by the rules, a zero-carbon source of energy because the…

And none of these forests are cutting down… All these forests that are managed are net growers. So yes, they’re cutting down trees that are 22 years old. It takes 22 years to grow a tree to maturity, and they’re cutting down 90% of those trees. So the forests are actually growing and capturing more. They are not stumping them. They’re not pulling the stumps out. So that carbon is going back into the soil.

They really are trying to do a good job. They’ve got bad PR right now. That PR Is going to go away. So I’ll place another bet. That bad PR is going to go away when they add the second phase, which is carbon capture. So when they burn the wood pellets and capture the carbon from the flue gas and transport it into the North Sea and sequester it three miles down into depleted wells, that will be the only energy source that is carbon negative.

Merryn: OK. That will be impressive. We’ll definitely have to stop bitching about Drax then. 2027, you think?

Alec: We will. But one of the funny things is I tried to get Drax to change the name because it has such a negative connotation. And Drax itself used to be a supervillain, but now he’s not so evil anymore. But it has connotations that…

Merryn: It does…

Alec: They just don’t need. Why they couldn’t just name it Haven, which was another one of their companies… Haven Energy would’ve been better, or Carbon Capture Inc. would’ve been nice too.

Merryn: Yes, we’d all buy that. We’d all buy that.

Alec: Exactly.

Merryn: They can double their share price overnight if it had a name like that.

Alec: But one of the good things for us is because it’s still controversial, it allows us to continue to hold it. So if it really appreciated to its full market value, we’d probably sell it and move on.

Merryn: Yes.

Alec: But the last name in this theme that I think is really interesting, it’s a great retail name and everybody can… This is the name I talk to my parents’ friends about, is Signify. I don’t know if you’ve ever heard of Signify, but I know you’ve heard of…

Merryn: No, I don’t know Signify. Yes.

Alec: Have you ever heard of Philips Lighting?

Merryn: Yes.

Alec: So they were smart and they did change their name to Signify. So it was the spin-out of Philips Lighting. And they make LED light bulbs. They are the dominant maker of LED light bulbs. It’s not just under the Philips name. They have several names. And if you think about the 70s, this is a great full circle back to the 70s.

When I was a kid in the 70s, the Presidents all talked about these energy initiatives and how we were going to conserve more, use less, all that. And that’s when solar took off. That’s when geothermal was a cool thing. None of it ever worked very well. People were making windmills and putting it out in their back yards. None of that made a hill of beans of difference.

What made the big difference was the compact fluorescent light. And the governments got behind that, they subsidised CFLs, and everyone replaced their incandescent lights with CFLs. Absolutely nasty light we all grew up with in our classrooms. It’s a terrible light.

Merryn: Yes, terrible light.

Alec: And so now, the LEDs are way more efficient than the nasty CFLs and way, way more efficient than the incandescents. And in fact, the studies that the EU has done, the highest return on investment from an energy saved standpoint is replacing a CFL with an LED lightbulb.

And just as in the 70s, when push came to shove and the governments really studied what the most effective way to conserve energy was, and they wound up subsidising light bulbs, that’s what Europe is about to do. And you’re going to see a big boom in demand for LED light bulbs and office efficiency and it’s going to be a wonderful period for Signify. And while we wait, it sells at a double-digit free cash flow yield. They just crank out cash.

Merryn: Wow.

Alec: They pay enough of that out for us to be OK. We’d like for them to pay out more, but it’s about 3.5% dividend yield. But they could pay out a lot more. And they are rolling up other LED companies. They’re also the leader in growth lights.

Merryn: What’s a growth light?

Alec: So a growth light, a lot of the farming now is going, quote/unquote, vertical, so using old warehouses to grow vegetables and fruit and marijuana using lighting.

Merryn: Also valuable.

Alec: Using growth lights, where you can grow much faster and you don’t have to use any pesticides. So it’s a lot of where fruits and vegetables are going. The electricity density of growing fruits and vegetables is going way up as the pesticides go down. So it’s a big, new, growing market that they dominate. So, really cool. I think these are really cool names…

Merryn: They are really interesting.

Alec: That we can get excited about.

Merryn: Yes. These are some of the most interesting ideas I’ve had on the podcast for ages, which is why I’ve let you talk for a good 20 minutes than I normally let anybody talk for.

Alec: Oh, thank you.

Merryn: It’s been great.

Alec: It’s hard to stop me.

Merryn: And, well, that’s great. I love that, yes, because it’s much easier for me when I don’t have to ask any questions because the other person just keeps talking. It’s like the dream podcast guest. Anyway, I am incredibly grateful to you because that was a great run-through of how the next decade might look, and I think probably will look, and how we can invest in it as a result.

But one other thing I must ask you before we close is are UK retail investors able to get access to your strategy without having to go through all the boring work of buying your suggestions themselves?

Alec: I think that’s pretty fun. But they can go to and they can find it very simply there. But I do encourage people to learn about what’s in the fund, to read the quarterly reports, to get Investing for Dummies to understand what they’re looking at, and decide whether they agree or disagree with what’s in the fund. And I think it’s so important now, when you have all these labelling issues. And I look at some of these funds that just slap sustainable on the names of their funds, and I think it’s criminal, what’s in them. And people really need to look under the hood.

Merryn: Absolutely. Exposure for some of those funds coming, I’m sure. Alec, thank you so much. I hugely appreciate it. And I also really hope that you will come back and talk to us again in a year or so and we can see how all this is panning out.

Alec: I’d love to. Thank you.

Merryn: Thank you. Right, everybody, thank you so much for listening. Again, we appreciate it. And I do have to tell you, I think John and I told you last week, that we have had more than a million listeners to the podcast since February 2020 when we changed platforms. We’ve no idea how many we had before that, so we’re just focusing on the new.

Over a million downloads. We hugely appreciate your support. If you would like to review a podcast, please do so on your podcast provider of choice. And if you do so, please make sure that you give us five stars, because that’s how we get in the great guests.

In the meantime, if you’d like to follow me on twitter, @MerrynSW. John is @John_Stepek. And if you would like to go to the website, You can sign up there, if you haven’t already, to our free daily email, Money Morning, normally written by John.

If you’d like to hear more on shareholder engagement and shareholder activism, which Alec and I were discussing at some point in the middle of the podcast, please do go and look for my new book, Share Power, How Ordinary People Can Change the Way that Capitalism Works, and Make Money Too. And Alec, I said I was going to send you over a PDF of it, and I am.

Alec: Thank you.

Merryn: Yes. Thank you for joining us. Talk to you again next week.

Don't forget – if you want to read more on shareholder democracy, buy Merryn’s new book, Share Power.