Global Investments w/ Lyn Alden (TIP386)

Global Investments w/ Lyn Alden (TIP386)

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Stig Brodersen (00:28): Welcome to The Investor’s Podcast. I’m your host,   Stig Brodersen, and I can already feel that this  is going to be a great episode because today   we are joined by the one and only Lyn  Alden. Lyn, welcome back on the show. Lyn Alden (00:40): Hey. Happy to be back. Always glad to be here.

Stig Brodersen (00:43): So Lyn, I wanted to talk to you and the audience   about global investment opportunities but I wanted  to talk about inflation first because inflation is   just such a tax on everything that we do. So  I wanted to have that part as our foundation   before we venture into the different investment  opportunities that you see in the market. And   you recently wrote a great blog post about  treasury inflation protect securities or TIPS.  

So let’s kick this off and  perhaps you could explain   how TIPS work and whether it’s a good  inflation hatch in today’s environment. Lyn Alden (01:15): Yeah. So at the current time we’re seeing   a pretty good amount of inflation compared to the  historical average over the past couple decades.  

And it looks like in certain areas that’s rolling  over but it’s still quite elevated, especially   compared to bond yields. And so investors  find themselves … The risk is that if you hold   cash or bonds that are yielding 0%, 1%, 2% while  inflation is 4%, 5%, 6%, you’re getting devalued.   You’re losing purchasing power. And so one of the  ways that investors can deal with that is to buy   treasure inflation protection securities or TIPS.  And so some countries issue those as a small part   of their sovereign bond market. So my article  focused on US TIPS. And basically what they say is   we’ll adjust the bond coupon that  you’re getting based on inflation   levels. Official CPI in the United States.  And so that kind of takes away that risk  

of inflation. But my whole article focused  on the fact that TIPS can be very useful   as an inflation defense but they’re not perfect.  And so obviously if you have that extra inflation   protection built into your bond there’s no  free lunch and so that comes with some costs. Lyn Alden (02:24): So the main cost is that the TIPS yields are lower   than normal treasury bonds. And so in the United  States currently you’re getting like a negative 1%   yield on your TIPS. You’re  basically going to earn inflation   minus about 1%. Ironically you’re  guaranteed to underperform inflation  

by owning inflation protected securities which  sounds terrible but it’s one of those things where   right now the 10 year treasury yield is under  one and a half percent and the inflation   expectations by the market are maybe two and  a half percent while inflation’s currently   5%. Because they’re expecting that this is not  going to stay at this level for a very long time   and that the average inflation over the course  of, say the 10 year duration of this bond,   will be lower in the mid two range. Now if that’s  the case, if the inflation expectations are   true then normal bonds and TIPS will have about  the same return. They basically are optimized   around kind of that break even point. However,  if inflation ends up being higher than those   inflation expectations, like if inflation is 3%,  4%, 5% averaging over the decade, then those TIPS,   despite the fact that they will mildly  underperform inflation, will still do better   than normal treasury yields that are yielding one  and half percent while inflation’s 3%, 4%, 5%.

Lyn Alden (03:44): That’s kind of the trade off that you get by   owning TIPS is that you’re not guaranteed to keep  up with inflation but you have more protection   if inflation runs notably higher than people  expect. The other big risk of TIPS is that   you’re reliant on a government’s statistics  for inflation which include a specific basket   of good with hedonic adjustments and people  can debate endlessly about how accurate that   measurement is. I’ve done a work on this and  I think it at least mildly understates “true   inflation”. But everybody has their own  unique inflation basket. And so basically   with TIPS you risk having your official inflation  metric not keep up with real inflation and then   you also will mildly underperform even that  official metric because of the negative yield. Stig Brodersen (04:26): It’s always hard whenever you ask questions like,   so for us investors … Which I know I tend to do.  Because who are us investors? Like how old are we?  

What’s our consumption? What’s our income level?  What’s our debt like? There’s so many things that   go into a discussion about investors in general.  So are TIPS … With the flaws that you listed,   would you recommend that to any specific  type of investor and perhaps not to others? Lyn Alden (04:52): I think anyone who has bonds in their portfolio   at this time, which is not everyone. Because  younger investors might choose to exclude bonds   because of the poor yields and the inflation  and to focus on other assets and take the higher   volatility that comes with that. So obviously  TIPS might not be ideal for them. But I think   anyone who has bonds in a portfolio could benefit  from having a percentage of those bonds be TIPS.   And so I think this is an environment where TIPS  are I think useful to have if you own bonds.

Stig Brodersen (05:24): So giving that TIPS aren’t good   assets to protect against inflation, at least for  many different investors, what’s the best way if   you want to defend themselves against inflation?  And perhaps I can give you this unreasonable   constraint that you can’t say Bitcoin. And  the reason why I’m saying that is because   I’m sure there’s a lot of people out there who are  saying, “Lyn, we had here on the show a bunch of   times speaking with the Preston about Bitcoin.  Can we talk about that?” It’s not that there’s   anything wrong with that. We have like a bunch of  great episodes for that. But we also have a lot  

of listeners who do not believe in Bitcoin. They  don’t want to invest in it. More like traditional   stock investors who look into different  asset classes than crypto. What can they do? Lyn Alden (06:03): Generally commodities. And so it’s hard to get   sustained inflation while commodity prices stay  low. Generally a history of inflation is a history  

of commodity price inflation. Commodities  historically are a very poor performing asset   class. If you look over say a century of data,  commodities are one of the worst places to hold   money over a long term. Because if you’re holding  the commodity outright it doesn’t compound.  

It just sits there. And if you’re holding  commodity companies it generally tends to be lower   quality businesses. Now there are some commodity  companies that have done very well. Especially   in energy because they’ve been protected by a  cartel for decades. But generally it’s not good  

to have a company who doesn’t control the price of  their own product. So they generally are not the   highest quality wide moat businesses that might  be appreciated. The caveat there is that during an   inflationary decade commodities generally trounce  everything else. Like it’s not even close. And so   in the ’70s it’s pretty much all you would want to  own. In the 2000s commodities and emerging markets  

which have a lot of commodity exposure were the  way to go. They trounced everything else. And so   generally when you have these inflationary  decades you want to have some commodity exposure. Lyn Alden (07:11): And ideally you want to mix it up a little   bit so you’re not too focused on one commodity.  You don’t want to pick the one commodity that   maybe doesn’t do very well. Oil and gas are the  biggest commodities. I mean that market is bigger   than all other commodities combined so a lot of it  comes down to what that’s going to do over a given   three to five year period. But overall, I think  one of the best ways to have protection against   inflation is to have commodities and commodity  companies. And if someone wants to reduce the  

risk they can use commodity trend following,  which is basically saying … You’re kind of   acknowledging that it’s not a great asset class  to hold long term and that you generally want   to restrict your exposure to them when they’re  in an upturn. Because the upturns can be pretty   violently good. Just explosive gains. But then the  downside can be brutal in the opposite direction.   So I think some sort of either commodity  exposure or commodity related investments.   Could be commodity trend following, could be  commodities, could be commodity equities. They’re   generally the better way. There’s also real estate  if you can get it at appropriate prices which is   harder these days than it was maybe a couple years  ago. But obviously certain zip codes, certain  

regions of the world of your country wherever you  might live can be protection against inflation. Lyn Alden (08:17): And partly it’s because with real estate   you can leverage it more than most other asset  classes without it being silly. You can leverage   it with a mortgage because it’s a stable  asset. And so what you’re essentially doing   is you’re shorting currency. You’re shorting the  currency you borrowed that in. So if you have a   reasonably priced house and then  you have a 30 year fixed rate   mortgage on it at a rate that’s  at or below the inflation rate,   you’re shorting a depreciating asset and  you’re going long on an appreciating asset.   And so that’s historically been a better way. At  least better than stocks historically. And when  

it comes to stocks you generally want to focus  on ones that can control their costs very well.   And so people sometimes assume stocks will perform  better than bonds and inflation and that’s a mixed   track record. So obviously if you have something  like hyperinflation, you’d rather own stocks   than bonds because bonds will become worthless,  stocks will still be worth something when the dust   settles because you still own productive assets.  But if you have double digit inflation, like the   United States had in the ’70s, stocks can perform  about as poorly as bonds can in that environment.

Lyn Alden (09:20): It really depends on   some other factors like what’s happening to their  own costs, what’s happening to their evaluations,   what’s happening to treasury yields. But generally  if you do equities other than commodity equities,   you generally want to find companies that their  revenue is variable. That they have decent   pricing power, but then also that their costs are  rather fixed or controlled. Maybe they have large   depreciation write offs for example. Those sort  of assets which ironically tend to be some lower  

quality assets in good times can actually  do pretty well in those inflationary times. Stig Brodersen (09:53): Interesting. So Lyn, identifying the most   attractive asset class, that is just something  that constantly changes. Because circumstances   change. For example, gold was relatively cheap  in the late 1990s and the price was less than   $300 an ounce. I know it probably sounds crazy to  some people out there. The real rates were high   so opportunity costs for being in gold were just  correspondingly seen as high and on top of that   gold was coming off this 20 year bear  market. Like no one wanted to own it.  

But then the price of gold just exploded  in the years after that. And today we have   a new situation, not just with gold  but just in general. So if you have   to be ranking different asset classes on how  attractive they are, how would that look like? Lyn Alden (10:38): Overall I think a diverse mix of asset classes   is far better than any one asset class, especially  in this really uncertain environment where   partially whether or not we’re going to get  inflation or not is based on government decisions.   Because it’s going to come down to their  fiscal decisions. And so you have this   somewhat binary outcome where you’re dependent on  variables that are currently unknowable. You kind  

of know more as you go along. And so the first  thing I would do is diversify but then I would   tilt that towards asset classes that I find to be  more attractive. And so overall I generally think   that high quality commodity producers … I think  looking back at the end of this decade I think   this will probably be a commodities decade similar  to the 2000s or the 1970s or the 1940s. And so I   like mid stream energy transporters. I like some  of the higher quality energy producers. Ones that  

have low cost production, strong  balance sheets, long reserves.   I like copper. Certain metals for example,  especially related to electrification   I think is an attractive area. They got a little  bit overheated earlier this year. They became  

quite consensus. So whenever they’re maybe not  on fire is a good time to maybe go into those. Lyn Alden (11:45): I think many emerging markets   are reasonably attracting for a long term at the  current time. That doesn’t mean they’re going   to do well next year or the year after. But  I’d be somewhat surprised if emerging markets   have another lost decade like they have the past  decade. So they had this period of consolidation.  

A lot of that was valuations going down and  stronger dollar which tend to go in cycles.   A lot of capital’s kind of really very much  shoved in the United States at the current time.   And so overall all I find that valuations and  overall fundamentals in emerging markets are   actually pretty attractive, especially if you  go country by country. And so that’s generally   my approach here. Also I still like US equities.  I’m more selective with them because many of them   are at very above average valuations but I still  go through US equities and find that in general   growth year stocks are more likely to overvalued  even compared to their history than value stocks.  

So obviously growth stocks are going to be more  expensive than value stocks. We’re always happy   to pay up for a better company. But if you look  at say how much growth you get for your money   they’re a worse deal than they were  say three years ago, where the value   stocks are about the same deal that they were  three years ago. So that’s varied over time. Lyn Alden (12:53): But overall I generally like   value stocks and then if I go into growth stocks  which I still do I just have a higher hurdle rate.  

I’m more selective with those in saying, what  are my absolute highest conviction growth stocks   because I’m concerned about maybe the  broader valuations in that factor. Stig Brodersen (13:11): Let’s specifically talk about equities.   I know from reading your blog, this is  just amazing … Absolutely amazing blog.   I encourage everyone to go read it. We’ll make  sure to link to that in the show notes. But   what you put on the blog is that you pay  attention to CAPE and also the market capture GDP.  

That’s commonly referred to as the Buffett  indicator. That’s probably how many of our   listeners know it. Could you please talk  about the methodology of both factors,   why you look at it and perhaps also what the  empirical evidence suggests for those two factors? Lyn Alden (13:42): So in addition to looking at individual   company valuations I do like to pay attention to  broad valuation measures for different markets.   And so the most popular one is probably Shiller’s  CAPE ratio. So that’s the cyclically adjusted   price earning ration. And the theory there is  that instead of just looking at price earnings  

… Earnings can be quite ephemeral. So  they can go away in recessions and then   the stock looks expensive. And then earnings  can be very high during the peak of the cycle   and the stock looks cheap. And so Robert Shiller’s  approach there says okay, let’s look at a full   business cycle of average earnings either for  that company or for the stock market as a whole.   So the common version takes  the last 10 years of earnings,   averages them together, inflation adjusts  them, and you’re comparing current price   to that more structural earnings average which  normally includes a recession or two in the mix.   Not always but usually. And so you get this  smoothed out approach. And historically that  

has been a very good indicator for long term  returns. Not short term returns. CAPE ratio   tells you virtually nothing about what stocks  are going to do over a six to a 12 month period.   But generally if you look forward 10 years,   higher CAPE ratio periods provide much  lower returns than low CAPE ratio periods. Lyn Alden (14:55): And it’s challenging   because you have tax changes, you have changes  in how corporations operate in terms of say share   buybacks for example. And so generally for a  number of reasons the United States has had   higher valuations over the past 25 years  than most other periods in history. And yet  

they still provide decent returns. There was a  good study by Meb Faber a couple of years ago   and he’s updated it once or twice where he says  okay, so he noticed that the United States had   good returns even when you had a high CAPE ratios.  However, if you had an approach over this 25 years   where you invested in whatever markets had the  cheapest CAPE ratio, you did way better. And   not every year. Sometimes you would invest in  the cheapest markets and they just got cheaper   and then you’d invest in them again and they  got even cheaper. But over the course of his,   say, 25 year data set last I checked, if  you had a habit of buying, say, the 25%   cheapest markets around the world and then  updated that every year, you crushed the S&P 500   even though there could be a three year  stretch or a five year stretch where you don’t.

Lyn Alden (15:57): And so generally valuation matters   over the long run even though it does not matter  over the short run. But then you want to say okay,   what if a certain valuation metric has some sort  of data artifact in it that is throwing it off or   making it unrepresentative? How much faith should  I have in one metric? So we can actually say,   well that’s one useful metric but we can go look  at a bunch of others. We can look at the average   price to sales ratio of the market. We can look  at the average dividend yield of the market.   We can look at the sector adjusted valuations to  compare one market to another. A popular one is   the market cap, the GDP ratio as popularized  by Warren Buffett. If you add the market   capitalization off all companies in that market  together what percentage of the GDP is that?   And you actually can’t … Unlike the CAPE ratio  you can’t really compare that between countries   because some markets are just inherently  far more financialized than others.  

But you can compare it to its history  pretty well. And so generally speaking   that follows CAPE ratio pretty closely. And  generally during periods of unusually high   market cap to GDP you generally are unlikely  to get good penny or forward average returns   whereas when it’s unusually cheap you’re much more  likely to get very good forward 10 year returns.

Lyn Alden (17:11): And again, it’s not   guaranteed and it doesn’t tell you much about  the short term. But when you’re combining   multiple of these evaluation indicators together  it gives you an idea of forward return potential   long term. Which by extension if you do that to  multiple markets can give you an idea of where   you should invest or what areas you might want to  over weight or under weight without being certain   what’s going to happen but with having greater  probabilities of putting the odds in your favor. Stig Brodersen (17:37): One might come to the conclusion that investing   globally from a fundamental standpoint is just  buy the cheapest market. What I really like about   your research is that you go dig deeper than that.  Because aside from value which is a great starting  

point for your analysis but you’re also looking at  growth, debt, stability and the currency. So could   you please talk to us why are you using those  as your key metric to include a type of value? Lyn Alden (18:05): So the funny thing   is that according to data the value might be  enough. So using Meb Faber’s data for example,   you could ignore everything else and just buy  what’s cheap. The problem is you have to put   faith that that’s going to keep working. Which it  might or might not. We don’t know. And so you have   to give it a long time to know and so you won’t  be sure until 10, 15 years later when you had a   big opportunity cost if you were wrong. And so  what I like to do is, I like to say okay, value  

is a very, very important component but there’s  other things. And so one is we want to adjust   things for growth and sector exposure for example.  If you have one country, they have a whole bunch   of fast growing tech stocks and then you have  another company that’s got a bunch of kind of   lousy businesses and they’re cheaper and you say  well, I’m only going to buy that cheap company,   it’s like well, it might be worth paying up … How  much more expensive is that other country market   compared to this one? Because it is worth  paying up if you can get better companies. Lyn Alden (18:57): If you can pay 30% more but get companies that   are twice as good or growing twice as fast, that’s  worth it. It’s good to compare things on a sector   by sector basis and to look at various macro  factors with those countries. And so for example  

in addition to valuation, I like to look at  growth. So for example you generally expect higher   valuations out of faster growing countries. So a  higher population growth or gross sector exposure.   And so you should for example expect higher  growth out of India than Russia. And if we’re  

looking to support sustainably for a long period  time higher equity valuations than Russia.   You can also look at debt levels because they  affect forward growth as well. They also affect   the possibility of currency devaluation or  other undesirable things that can throw off your   investment. That’s why you can rank countries  based on both public and private debt levels.   Then you can look at things like stability.  So there’s different ways to measure that.   There’s human rights indices. There’s  terrorism indices. There’s corruption   indices. There’s how many coup attempts have  happened in the past 10, 20 years for example.

Lyn Alden (20:04): And so generally if you’re investing in emerging   markets you’re accepting a higher level of these  various risks. These lower levels of stability   in exchange for higher growth and usually lower  valuations. And then the last one will be more   specific currency metrics. Like does the country  have a current account surplus or a current  

account deficit? Especially for emerging markets,  do they have very high foreign exchange reserves   relative to their GDP or are they low? Because  if they’re low and they’re running a current   account deficit they’re at risk of becoming an  Argentina or a Turkey where their currency loses   tons of value and they have little way to defend  it. And so I look at various currency metrics.   And so what I do is I try to rank countries around  the world or at least have a map of kind of what’s   going on so I can spot anomalies. Areas that might  be very risky or that might be very opportunistic.   So that I go in and then qualitatively look around  and see what I think. And so I like to maintain   that big quantitative metric to find where is  a good combination of both quality and price? Stig Brodersen (21:06): Whenever you specifically look at the US dollar,   I can’t help but think, how do you weigh the  euro? Because I’ve seen a lot of different   baskets that it’s compared to. The euro  always takes up a lot in that basket   for obvious reasons. But always makes me wonder,   so is the dollar strong? Is the euro weak? Is  that actually what we’re seeing right now or vice   versa? How do you weigh that relationship with  the euro whenever you’re evaluating the dollar? Lyn Alden (21:31): Well, the dollar index   is the go to one which yeah, the euro is  over 50% of that. But you do have the other  

40 some percent of it is a basket of other major  currencies. That’s still a pretty useful metric.   But then you want to double check that by going in  and comparing the dollar to specific currencies.   Especially major ones. How does the dollar compare  to the yen? How does the dollar compare to the   renminbi? How does it compare to say a basket of  emerging market currencies? And so that can tell   you is one currency weak or is the other currency  strong? And so historically the dollar because   we are the global reserve currency and we  have a more unusual currency situation than   other countries, we tend to go through these big  cycles of dollar strength and dollar weakness.  

Because we’re kind of the funding currency  for the rest of the world. And so that has   implications. And so over the past five, six  years we’ve been in what I would consider a   strong dollar period where the dollar is elevated  compared to the majority of other currencies. Lyn Alden (22:30): Not necessarily every single currency but the   vast majority of them the dollar’s been elevated  compared to say if you measured it 10 years ago.  

Now over the very long run the  dollar’s actually gone down   say over almost 50 years of being free floating.  The dollar has gone down against a basket of major   currency comparisons. But it’s been these  kind of big three waves. It had a big period   of weakness in the ’70s and a huge spike in the  ’80s and that rolled over with the Plaza Accord.   Then another spike in the late ’90s, early 2000s.  That rolled over. And then ever since around 2015  

we’ve been in another big spike. And so it hasn’t  gone as high as the previous ones but we’ve   remained somewhat elevated, where the dollar  is pretty strong. And that has implications. Lyn Alden (23:15): So that’s historically … Strong   dollar environments are very problematic for  emerging markets that often have a lot of   dollar denominated debt. So that kind of acts as  sort of like a quantitative tightening for them.   Generally you have … Every time the dollar goes  through one of those big strengthening cycles   usually some emerging markets get absolutely  crushed. In the ’80s it was Latin America.   In the late ’90s it was Asia. In this recent  cycle it’s been a little bit more varied. You   have Turkey, you have Argentina and just overall  you just kind of have a stagnation worldwide   with these high dollar based  debts that have gone up in value.  

And so a big thing to watch going forward is,  is this cycle of dollar strength ending because   if so you probably want to be in things like  emerging markets and commodities. Or are we kind   of going higher or staying at this plateau for a  number of years which can prolong this cycle and   make it so that maybe emerging markets continue  being lost money for at least a few more years. Stig Brodersen (24:14): Lyn, I would like to transition into   talking about this wonderful report here. And I’m  holding this up to the camera which clearly works   a lot better if you’re on YouTube than if you’re  listening to this as a podcast. But you give   all the markets a score which I found to be really  useful and interesting because you’re right. If   you follow the Meb Faber approach which is very  interesting whenever you study, it works for   all countries aside from Denmark and Sweden. Those  countries are very specific for different reasons.  

But there’s also a question about accessing. I  know that you’re spoiled in the states. I live   in Denmark and we don’t have the same access.  So just because we can see a study like oh, the   Filipino market is just great or whatever it is,  that’s great. We can’t access that ETF. And so   our selection is different generally in Europe.  It’s just regularly different than Europe. It’s   not just in Denmark. But all of the European  Union. So we have different types of access  

and if we can find ETF we can typically only find  one. And sometimes those terms can be outrageous.   But whenever you look across the globe,   which countries perform at the top and which  at the bottom in terms of attractiveness? Lyn Alden (25:28): Yeah. So the ratings change every   year and they’re based on those previous metrics I  discussed. So some of them have very high ratings   in certain areas and very low ratings in other  areas and they average out to in some cases like   a medium high rating. And so at the current time  … And again, this is not based on what’s going to   happen in six to 12 months because it incorporates  things like valuation that don’t tell you almost   anything about short term performance. It’s more  about what areas are likely to do well over the  

next say five to 10 years versus what areas are  at risk of kind of meltdowns or doing very poorly?   And so overall at the current time southeast  Asia scores pretty well among multiple metrics.   So that would include … So you can look at a  developed market like Singapore. You could also   look at emerging markets like Malaysia for  example. India, Indonesia. So overall that   market was very, very strong obviously decades  ago. It had another bout of strength in the   2000s decade. But many of those markets have  been in kind of a loss decade. But they have   generally very high currency fundamentals,  generally current account surpluses, generally   high reserves relative to their GDP, and just  overall decent demographics and growth trends.

Lyn Alden (26:39): On the other side of the coin I’m   also pretty bullish on Russia long term. They’ve  done very poorly over the past decade which was   a commodity bear market decade and obviously  Russia’s a very commodity oriented market.   So if you expect decent body performance in  the 2020s then in Russia generally you get   very high quality commodity companies  that generally have less debt than   their western counterparts and for  lower evaluations. And often longer   reserve life. Now, the cost for that is you put  up with some higher degree of political tail risk.   You don’t have the same rule of laws you have in  the United States or most of Europe. But many of  

those companies are very, very well managed. Many  of them are managed like their western peers.   I often like to point out that Lukoil for example,  the Russian energy company, has outperformed most   of its western super major peers over the past 20  years. And it’s in large part because they didn’t   do bad acquisitions or things like that. They’re  just really well managed. And so low debt levels  

and good production and not making any major  mistakes. And large insider ownership for example.   And so overall I kind of like  that barbell approach where … Lyn Alden (27:50): A lot of southeast Asia is energy importer and has   good growth demographics. And then Russia  you have bad growth demographics and cheap   but it benefits from a higher commodity price.  And so I kind of like that barbell approach.  

South America doesn’t currently score as well  as some of those regions but I do think that   if you were to get a weaker dollar period,  probably would also see a pretty powerful   I think resumption of growth  in those markets and they   would have a decent shot at moving out of this  kind of loss decade that they’ve experienced. Stig Brodersen (28:21): Whenever we look at the list   what I really like is that you  give them this score. You have this   moderate opportunity that’s more than 20.  A better investment opportunity like 23   and above. Like Singapore you have top ranked  as 26. And then you have the United States 15   points together with France. So everything  else equal the worst countries to be in. So   how do you think about position sizing according  to the overall country score? Should you for   instance still be invested in the states? How  much should you invest in Singapore? And if I   could just add a third one to that, because you  did mention that you did a few individual picks   in the states but does that just mean like if  you rank that you shouldn’t be indexing at all? Lyn Alden (29:07): This report’s kind of   meant so that very different types of investors  can use it. So some people might want to express  

that view through ETS. Some people might want  to say, “Oh, this market looks interesting. Let   me go see if I can find individual stocks  there that might be attractive.” And so   that’s the first caveat, that it’s going to  be used in different ways by different people.   I think another thing obviously to keep track of  is where you are. What are your expenses based in?   Let’s say an American finds that the US market  is over valued. They might not want to put 100%   of their assets in other countries because now  they’re taking on currency risk which could be   favorable currency risk. The foreign currencies  could appreciate compared to their home currency.  

But the point is they’re taking on potentially  more volatility because now their assets are   denominated in a currency that’s different  than what their expense are denominated in.   And so generally I think it makes sense for the  majority of investors to have a home country   bias to a certain extent. Obviously it depends on  the size of their market. If they live in a very   small country it’s hard to over weight that too  much without having too much concentration risk. Lyn Alden (30:09): But overall I think generally   you start with a home bias but then you can tilt  in certain directions based on where value is.   If you generally approach with say a value  oriented or a contrarian oriented mindset,   when a market has done very poorly for a decade  and when it’s cheaper than normal and you’re   seeing some … If you understand why that happened  and you’re seeing signs of reversal it’s worth   potentially over weighting that market. Probably  compared to most Americans I have more non   American equity exposure than I think the average  would. And generally what we’ve seen over the past  

decade is the United States outperform pretty much  every other market and so we see unusually high   capital concentration in the United States at  the current time. It’s a very crowded trade. Lyn Alden (30:51): If you look at the MSCI ACWI index which is one of   their broadest indicis, the United States market  is just under 60% of global market capitalization   which is pretty remarkable. Every other country  combined is 40% or 41%. Partially that’s warranted   because the United States benefited from these  huge FAANG companies for example. But it has   though … There’s not a lot of more places to  get capital to then keep shoving into the United   States. It’s very … Everyone’s on one side of the  boat. There might be still a couple of stragglers   on the other side of the boat but it’s not like we  still have tons of people getting on that side of   the boat. And so the big risk I think is that if  everyone’s piled into that trade, then it may go   through one of these big dollar bear cycles and  the United States market just performs poorly   then everyone’s kind of caught off on the wrong  side. I mean there was a brief moment of time in  

the late ’80s where Japan’s market capitalization  exceeded base market capitalization. And we all   know that that went very poorly for everyone  involved over the next few decades. And I’m not   saying that the United States is in that position.  Their CAPE ratios were even higher back then.   Japanese … They had like the highest CAPE  ratios on record from what I’ve seen. Lyn Alden (31:59): So it’s not to that extent but it is   a very crowded position and so I do think this is  a time worth, at least for very patient investors,   buying quality assets outside of the United States  and having some degree of geographic and currency   diversification. Because on a sector by sector  basis you can generally get higher quality  

companies for lower prices. Like you can get a …  Say an apples to apples comparison, you can get a   similar bank for a cheaper price. You can get a  similar healthcare company for a cheaper price.   You can get a similar tech stock for a cheaper  price. And so when you go down that list generally   I think that there is a lot of opportunity  outside of the United States. But in the US,   again, we see a larger valuation gap than normal  between growth and value. So I think commodity  

stocks in the United States just are attractive.  I think mid stream assets are attractive. I think   the healthcare sectors are easily attractive. I  still think a number of value oriented exposures   in the US are also attractive. It’s just that  we’re very tilted towards growth at the moment. Stig Brodersen (32:56): Lyn, we have a huge   set of investors here following the podcast who  like to look at individual stock picks. Foreign   stock picks. And typically not always in developed  markets. I was curious to hear how we should think  

about currency exposure. Say that our home  currency is the US dollar and the Euro for   instance. You mentioned Lukoil. I remember looking  into that many years ago and the fundamentals were   just so amazing. It was so cheap. So I bought a  bunch and the company performed well but the ruble   just plummeted at the same time. So it was a very  painful experience. And then as well as today,  

I do think it’s tricky to figure out what’s the  strength of the currency? Could you talk to us   about how do you evaluate that specific currency  and where that might go short, mid, or long term. Lyn Alden (33:45): Yeah. Currencies can move for all   sorts of reasons. A lot of it’s sentiment based.  So around sanctions or perceptions of the country.   Now, what’s interesting about Russia, they’ve had  some of the biggest disconnects between currency   fundamentals and currency performance. So if  you’re looking at countries like Argentina and   Turkey, they’ve had very, very poor currency  performance but this was predictable. And   in fact I weighted Argentina’s currency  very poorly in multiple reports in a row   leading up to the ongoing weakness that they’ve  experienced. And so when they exhibit things  

like low foreign exchange reserves relative  to either their GEP or their money supply   that’s a big warning sign for emerging markets  because they’re very reliant on that. You also   want to look for current account deficits or trade  deficits. That implies that either their economy’s   not producing well or that their currency’s  over valued and it’s basically making their   exports less competitive and making their  imports too strong. And so generally when   you have a structural situation like that it  eventually reverses and can be pretty violent when   it reverses. Usually a recession or some sort of  catalyst happens. Capital moves out of the country   and suddenly that reverts. It’s like you took the  escalator up and the elevator down in a way. And   so generally for currency fundamentals I want to  find countries with current account surpluses,   reasonable fiscal debt situations that  have high reserves relative to GDP.

Lyn Alden (35:12): Another factor for emerging markets   is you specifically want to look at dollar  denominated debt relative to size of their GDP   or relative to the size of their foreign exchange  reserves. Because these emerging markets that   have these truly spectacular currency failures,  it’s usually because they owe liabilities in a   currency that they can’t print. Usually dollars.  So they borrow from the foreign sector in dollars   and so they’re actually at risk of nominal default  and hyperinflation because they have no ability to   relieve themselves of those liabilities in  the way that a developed market can. And so   if you look at Turkey they had huge dollar  based debts in the corporate sector.   Their government sectors not been very leveraged  but it’s specifically in their corporate sector.  

With Argentina, it’s been the reverse where they  actually … They’ve gone through this so many times   there’s actually not a lot of leverage in their  private markets but their government takes on   dollar based debts and that’s been a source of  problems multiple times. And that happened with   southeast Asia back in the Asian financial crisis  in the late ’90s. It happened in South America   in the ’80s where these emerging markets they get  too much dollar based debts, run into problems. Lyn Alden (36:18): And so if you look at Russia   they have one of the highest foreign exchange  reserves relative to GDP among markets. Most years   they have a current account surplus. They actually  run a very tight fiscal situation. Often they have  

surpluses. Like most countries they had a deficit  in 2020 but less so than most others. They were   pretty conservative with how managed that. They  also have pretty low dollar denominated debt   relative to the size of their economy and  relative to their foreign exchange reserves.   So they’ve actually managed themselves very  well financially. I think that the had of their  

central bank is one of the smarter ones out  there and I think she’s done a very good job.   But they obviously have other issues. So one is,  Putin is not very popular on the world stage for   good reason. They have human rights issues. They  have corruption issues. They have sanction issues.   And then they’re also heavily exposed to commodity  prices. So when oil went [inaudible 00:37:11] last   year obviously the ruble lost a lot of its value.  At least temporarily. And going forward I’m pretty   optimistic on the ruble. If you look at most of  the fundamental aspects around it, especially  

if you get an ongoing commodity bull market, that  should be pretty good for the currency over time. Lyn Alden (37:27): Another thing you can look   at for example is the big mac index, which says  if you do a purchasing power parody comparison,   that’s another way of kind of measuring if  currencies are overvalued or undervalued.   And by most metrics the ruble’s undervalued.  Especially when you, again, look at all   those other metrics. And so if you were to  consider currencies to be like value stocks,  

right now the ruble would be an example of  a company with like a great balance sheet,   super low valuation, but just know one  wants to own it at the current time. Stig Brodersen (37:55): Lyn, one of the things   that you mentioned in your report is  that some of the problems of the US   don’t matter until they matter. I love that  phrase in itself. But like the structural   deficit that seems to gradually starting to  matter. Can you please elaborate more on that?

Lyn Alden (38:11): So because the US is   a world reserve currency we have an unusual  situation where ever since the ’70s specifically,   due to the specific deals we made with OPEC,  most energy worldwide is only priced in dollars.   So if France buys oil from Saudi Arabia they pay  in dollars. What that means is that any country in   the world that needs to import oil needs dollars.  And so that has made it so that essentially the US   props up the value of the dollar. So it makes  our exports less competitive and it gives us more  

importing power. And so for the United States  the downside for us is that we started running   these massive structural trade deficits  that they just never close. It just pretty   much keeps getting bigger over time. And that  supplies the rest of the world with dollars.   And those countries then take those dollars  and it filters up to the central banks and the   stock wealth funds. And then they reinvest  those dollars. And a lot of that goes back   into US markets. And so they buy our bonds, they  buy our stocks, they buy our real estate. Which  

sounds good. You want the rest of the world  investing in your country but the downside is   that it means that our net international  investment position keeps deteriorating. Lyn Alden (39:19): That basically the foreign sector   owns a larger and larger percent of our productive  assets. It’s like we’re becoming kind of a nation  

of renters as the foreign sector increasingly owns  our most valuable things. Our land, our companies.   They’re creditors to our government.  And so this cycle’s been in place for   … You can call it about 45 years now.  And there’s been counter rallies where  

other markets do better. Like so the ’80s you  had Japan do very well. In the 2000s you had   emerging markets do very well. But this has been  a very strong period of performance for US assets   somewhat at the cost of say the US industrial base  and the US blue collar workers. So we’ve kind of  

run into this big engine of trade deficits to get  recycled back into our capital markets which are   very good for those of us that own assets. But  we’re starting to see signs of that reversing. So   for the longest time oil was only priced in  dollars, now we see Russia pricing it in Euros   which is important because they’re one of the  biggest exporter of oil. They also have enough   military protection. There’s nothing we can do  about that from the United States perspective. Lyn Alden (40:19): China … They’re doing   trade with Russia and Europe doing trade with  Russia increasingly in euros rather than dollars.   And so that’s more currency diversification.  And we’re starting to see for example Saudi  

Arabia is still pricing their oil in dollars  but as we see many tensions between Saudi   Arabia and the United States, as we see that now  China is the biggest customer of Saudi Arabia,   that situation could potentially change over  time. And so overall this system has probably run   its course. The rest of the world is finding it  restrictive and Americans, especially those didn’t   benefit from the huge appreciation and capital  markets, are also finding it rather restrictive.   And so I think for a variety of kind of just  mathematical reasons and geopolitical reasons,   that is probably going to change over the  next decade or so. But it’s one of those   things that it’s got a very strong network  effect and takes a lot of time to change.  

And so we’re used to this big trend of say  bond yields going down. United States running   these big trade deficits. The rest of the world  shoving that capital back into its equity markets. Lyn Alden (41:20): But I think as we go forward that   could start to look pretty different. If that does  start to look different, if that starts to turn,   generally foreign markets could have a big catch  up period similar to how I would describe in the   2000s decade where going in the dotcom bubble,  US outperformed everything else. You had the   strong dollar. But then when that reversed  US equity markets did poorly for a while   and once the dust settled you had a huge  boom in emerging markets and commodities.

Stig Brodersen (41:47): What do you think that the Chinese   game plan here is in terms of currencies?  Whenever you see this increase in trade   that’s been settled in Euros, is that where it’s  going? Is it more like an intermediary step into   the whole China’s increasing power  one belt one road. Being the most   important training partner for more and  more countries now than the states and   have been for some time. Not necessarily  just in volume but number of countries.   That sounded like a leading question. But is that  the Chinese plan? Like if you had to put a horizon   on like 10 years, decades, centuries, is the whole  euro play right now just an intermediary step? Lyn Alden (42:26): I think so. China’s long term goal  

is that it wants to be self sufficient and  powerful. And in its current framework it’s still   reliant on the dollar in many ways. Because as  we discussed before at least until very recently   most energy pricing, most commodity  pricing globally was dollars.   And the United States likes that because we can  sanction any country that doesn’t play ball. We   can cut them off from the dollar based system.  And that makes it very hard for them to secure the   things that they need to get. And for China they  are a huge export nation in terms of manufactured  

goods. And they’re also good with technology in  recent years. Their big achilles heel is that   they’re a huge energy importer and commodities  importer broadly. And so in order to make sure   they get enough energy, get enough food, they have  to ensure that they can have commodity exposure.   And so partially the belt and road initiative is  to make sure they have access to infrastructure   and reserves in those different countries that  they can get those commodities that they need.  

Two, they want to be able to diversify the  ways that they acquire them. So they don’t   want to be exclusively reliant on the dollar  like they used to be in order to get those. Lyn Alden (43:37): The first step is it just includes   diversification. So dollars and euros, if in the  worst case scenario their dollar access gets shut  

off they still have the euro root that they can go  through. And so Russia will still sell them oil in   euros even if both of them were cut off from the  dollar based system. So there’s that. Longer term,   obviously China’s interested in lodging its  central bank digital currency. And so that   can potentially reduce the friction of using its  currency with some of those trading partners. And   so there’s no indication that China wants to have  the same sort of global reach as the United States   has had, both militarily and with its currency,  but it certainly wants regional sovereignty. Lyn Alden (44:14): Like it wants to have control over its own region   and it wants to not have any sort of foreign  power be able to cut itself off from the financial   system. And so we’ve actually been in a weird  case where for most of this 45 year history of  

the petrodollar system, the United States has been  the largest commodity importer and it was in our   currency. Now we have this weird situation where  China’s the largest commodity importer in many   cases. They’re using the second biggest commodity  importer’s currency to do it. They have a pretty   strong incentive to diversify the currencies and  then ideally in the long run for them to use their   own currency as much as possible. Not that other  countries will necessarily use their currency,  

but that China will be able to use it with  some of their trading partners at least. Stig Brodersen (44:56): A lot of Europeans and Americans,   whenever they think developing markets they’re  thinking India and China. There’s so many   interesting narratives. Not just the size of the  population. Especially India has an attractive   demographic outlook. A lot more than China  has. If you had to compare India and China,   which of the two countries are most  attractive for investors and why? Lyn Alden (45:18): I think it depends on the timeframe.  

Longer term, I think India has more opportunity.  With the bloodbath we’ve seen in Chinese equities   this year combined with rather strong Indian  equity growth, I think China’s a more interesting   contrarian play. I could have had a very  different answer if I was asked maybe a year ago,   whereas now I’d actually maybe lean a little bit  more towards China than I normally would have.  

But basically, the difference is  that India has stronger demographics.   So their population’s expected  to overtake China’s quite soon   because India didn’t do the one child  policy that China did so they have a   younger population on average and a faster growing  population. So they have that going for them. Lyn Alden (45:59): Two, a large part of China’s growth over the past   decade has been from leverage. So they’re about as  leveraged as the United States is now. And it’s in   slightly different areas. So for example, China  has less leverage on the sovereign level than  

most developed countries and they have kind  of moderate leverage on the household level,   but their corporate sector has had a very large  debt bubble, particularly in the real estate   area. And we’re seeing some of the negative  implications of that play out now with, say,   Evergrand risking of defaulting. So we’re going  to see how far that goes. They seem to be finally   addressing some of that and letting that play out.  And it remains to be seen how much contagion that  

will have. But essentially, if you were to  compare China to India over the past decade,   they both grew very quickly but China used  leverage partially to grow at that speed,   whereas India did that rather unleveraged. They  did not build up large amounts of leverage on   any of their public or private platforms to  have that growth. It was more organic growth. Lyn Alden (46:57):  The other difference is that China has a  higher per capita GDP at this point. Decades  

ago they were closer. So in some ways China’s  model’s been more successful in the sense that   that top down organizational structure’s been able  to, for better or worse, accelerate certain things   and the leverage has increased average standard  of living in China compared to India. But   the question of course that opens up is how  sustainable that is. So with India you have a  

democracy. Obviously there’s still human  rights issues there but it is a democracy. And   you have better demographics. So that’s generally  how I would sum up those two differences between   those two countries. Also China has been very  export driven, whereas India is much less export   driven. It’s more somewhat separate from the  rest of the world. Obviously it’s very strong  

in software so it exports software services.  And it imports and exports various things.   But overall it’s less tied in with  the global economy than China is. Stig Brodersen (47:56): Lyn, thank you for sharing   your framework for global opportunities. Could  you talk to us about how investors could build  

his or her own personalized global portfolio? What  should we consider? How do we do it in practice? Lyn Alden (48:10): I start out with a big diverse mix. I have   companies from my country, which is the United  States. I have foreign companies. Because over   the very long term equities are big compounder  wealth. Generally equities or real estate are the   ways we compound wealth over decades. And then you  can look around for certain counterbalances. So  

there might be environments where you want bonds  in your portfolio and then you can choose what   types of bonds are most attractive. Do  you want them as a big deflation hedge   or do you want to have them as dry powder to  rebalance into more equities? And then if you’re   in a decade where there’s a reasonable chance  of inflation and being a commodities decade,   one of the most powerful things is to have some  sort of commodity exposure. Could be commodities   themselves, could be commodities equities, could  be commodity trend following where you ensure that   you’re most exposed in the upside and limiting  your downside because it’s a more boom bust   lower quality area than other types of equities.  So overall I think it’s about starting from that   diverse starting point and then tilting into  areas where you think there’s more value. Lyn Alden (49:12): So it could be certain countries,   it could be certain factors, it could be, say,  commodities versus tech for example if you think   it’s going to be more inflationary,  more kind of emerging market based.  

And then wherever someone has expertise or that  they follow markets closely. So I incorporate,   say, bitcoin into a portfolio where obviously not  everybody would. And position size is what manages   the risk there. So when you add together equities,  some bonds, some real estate, commodities and  

some digital assets, generally I think that’s a  very attractive way to kind of preserve and grow   wealth over the long term, even though of course  you’re going to encounter periods of volatility. Stig Brodersen (49:51):  Fantastic. Well, Lyn, I want to be respectful  of your time. I know you’re super busy   and before we started recording you were also  saying that you were going overseas. A bunch  

of stuff are happening right now. So I will  let you go but before I do I would like to   give you the opportunity to give a handoff  to any other resources to our audience. Lyn Alden (50:09): I appreciate that. I’m at for people that want to follow my  work. I have free newsletters, free articles. I   also have a low cost research service. And  I’m active on Twitter, @lynaldencontact.

Stig Brodersen (50:20): Fantastic Lyn. And I can only endorse. I’ve   done that throughout this episode but I absolutely  love reading anything that Lyn’s putting out   there so make sure to go to It’s  always worth a read. Or go to a Twitter profile. Stig Brodersen (50:35): Lyn, thank you so much for   yet again making time for The Investor’s  Podcast. I hope we can do this again soon.

Lyn Alden (50:41): Happy to. Thanks so much for having me.

2021-10-13 22:04

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